Do cycles exist in the financial markets?
Take a look at the black line in the graph below. The U.S. stock market had a gigantic bubble back in 2000. When it burst, stocks came crashing down. Over the next several years, policy makers did all they could to get things going again, focusing mostly on monetary policy and increasing homeownership. This had the unintended consequence of creating too much inflation, which caused central bankers to tighten aggressively. Thus began what will almost certainly be declared a recession.
This mimics the US stock market bubble back in 1929 – the red line. When it burst, stocks came crashing down. The next several years, policy makers did all they could to get things going again, focusing mostly on fiscal policy and creating jobs. Over the next several years, this had the unintended consequence of creating too much inflation. In 1937, central bankers began to tighten via reserve requirements. Thus began what was called the Roosevelt Recession.
Japan had its own bubble in the late 1980s which deflated in the 1990s. That’s the blue line.
This is a chart that I first created many years ago. After the NASDAQ crash in 2000-2002, many people made the comparison between the NASDAQ and the 1929-1932 Dow. The interesting thing is, I don’t believe that many people have kept the comparison ongoing. They should, because the similarities — in both events and in price action – are striking. Click to enlarge:
I lined up the peaks along the x-axis, and I chart the graph weekly. The y-axis is the percent change. For instance, +1 equals a 100% gain. The peak in all the markets occurs at about week 400. They bottom around week 540. There’s a huge rally that goes into week 600. From there, things get a little muddled till another decline starts at around week 800. Right now, we’re at week 850, which is about 450 weeks after the NASDAQ peak in 2000. 450 weeks after the 1929 Crash puts us into the 1937-1938. As far as the Nikkei, 450 weeks from the 1990 peak puts us in the August-October 1998 period.
Here’s the good news. About 450 weeks after the Great Depression Crash, the market found its footing and rallied. Around 870 weeks after the Japanese market peak, the Nikkei bottomed out. After the Nikkei bottomed, that market rallied from 12,880 to 20,790 over the subsequent two years. After the Dow bottomed at 100, it rallied up to 150 just a few months later.
Now this analysis is fraught with potential pitfalls. But I have to tell you that I am struck by the similarities, particularly the 1937 analogy. That’s because the run-up prior to the 1929 Crash was in large part caused by enthusiasm over the introduction of a revolutionary new commercial technology: radio. You got a bubble, a devastating crash, followed by a recovery and inflation of another bubble. That’s exactly what happened after our tech crash.
Of course, this could also be the human tendency to find patterns in just about anything. We’ll see.
