Especially when it supports the desired investment conclusion, investment strategists roll out cycle analysis. There are a great many cycles that analysts have discovered over time. They range from the grand to the minute. Kondratieff cycles unfold over many decades. Various other patterns unfold within a single trading day. Within cycles of any length there are ebbs and flows. While they can be helpful if properly recognized, they are at best a composite of historical data. In any individual instance, markets may do well in normally weak periods or poorly in normally strong periods. Properly used, cycles help investors to identify the probability framework in which innumerable other factors interact to influence price movements.
In our own analysis, we opined at the end of the 1990s that U.S. markets were about to enter a long weak cycle that would likely last for a decade or two and would fully correct the valuation excesses that developed in the long strong cycle that encompassed the final two decades of the twentieth century. We believe that we are still in that long weak cycle.
Within that cycle, markets are experiencing the second major rally of the twenty-first century. Two 100% plus rallies have followed two 50% plus declines, leaving us today at 1999 price levels. While we believe it probable that at least one more major decline will unfold before the long weak cycle ends, there is no way to know how far the current rally will extend before reaching its peak. Shorter term cycles remain positive.
The most popularly discussed cycle is the four year presidential cycle. The current year, the third in the cycle, is historically the strongest of the four. This young year-to-date is certainly living up to the cyclical forecast. It is important to recognize, however, that each year in the cycle rises on average. Obviously, markets don’t rise every year, so the cycle can’t be relied upon as a sure guide. It is merely an average of past experiences, which can give us an indication of tendency.
The current year has benefitted greatly from the massive support of government fiscal stimulus and the Fed’s QE2 monetary stimulus. Will that support continue to push prices higher, because investors believe that Obama and Bernanke will simply not allow the market to decline? Or will the myriad fundamental problems that I discussed at considerable length in our year-end commentary (January 28th entry) ultimately overcome government largesse? These are unknowable answers, dependent upon the outcome of many largely unforecastable events. At best we can weigh probable rewards if the answers are positive against the probable losses if the answers are negative. The ability to accept risk depends heavily on the ability to replace assets if the results turn out to be negative.
Momentum is a powerful force, and major stock indexes have advanced in eleven of the past twelve weeks. Supplemented by the current favorable position in the presidential cycle, confidence is high and is pushing prices higher. A caution, however, is that positive sentiment is similar to where it was in 2007, the last third year of a presidential cycle. That year saw the peak in stock prices that preceded the destructive plunge in prices from 2007 to 2009.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.