Stocks and Commodities: The 18 Year Cycle

Includes: DIA, QQQ, SPY
by: Babak

If we step back from the day to day movements of the stock market and take a very wide perspective, we notice some overarching cycles at play. One of these is the 18 year stock market. Some, like Art Cashin in the video below, express it as a 17.6 year cycle but in reality this is not a precise determination. The 18 year cycle is more an average than an accurate, regularly repeating cycle:

18 year cycle dow jones industrial

Since stock prices are supposed to be random, it is odd to find such an orderly pattern. Why equity prices follow this rhythm may not be so befuddling if we consider commodity prices as their counter balance. For example, zooming in, we can see the period from 1980’s to the present for the Reuters/Jeffries CRB Index, the most popular proxy for the commodity markets:

While the equity markets went on a generational bull market from the 1980’s to their top in 2000, the commodities markets were in a painful and protracted bear market. This wasn’t just a coincidence. Over the long term, equities and commodities are on a teeter totter: when one is up, the other down; when one wins, the other loses. Of course this relationship isn’t evident until you step back from the short term fluctuations.

CRB futures index long term chart

The rationale for this is simple. The price of physical goods are expenses for corporations as they are the raw materials to produce things. When the costs increase, profits decrease. This trend continues until it reaches an inflection point where it can not continue. Profits decrease and a retrenchment takes place. Demand decreases for raw materials and their prices fall.

Then this trend continues until investments in the acquirement and production of raw materials is ignored. Mines take billions of dollars to develop and can take decades to ramp up production. Oil reserves likewise are expensive to find and exploit. As the current supplies are depleted, the prices of physical goods rises. It continues to rise until it reaches a tipping point when investment in the sector once again is lucrative. And the wheel turns again.

I was introduced to this cycle when I read Hot Commodities by Jim Rogers. This is a great introductory book to the commodities markets by the way. I highly recommend it.

According to economist David Rosenberg, we are halfway through the current bear market. This estimate is in keeping with the 18 year cycle if we assume that the top was in early 2000. And the counter estimate is that we have the same period of time left in the commodities bull market. But something is amiss.

The CRB index crumbled 57% from its top in 2008. We haven’t seen such a decline before in a commodity bull market. Those are serious deflationary forces at play right now in the world economy. Which is why central banks are throwing everything and the kitchen sink at it to prevent it from spiraling out of control. Here is a free 60 page book from EWI about the dangers of deflation and how to position yourself both defensively and offensively to benefit.

Rosenberg continue to believe in a healthy commodity bull market but I’m not so sure. What we saw last year was not a normal bull market but a speculative bubble caused by lax regulations which allowed large institutions to run roughshod over everyone else and walk prices higher. The aftermath of bubbles is always ugly and unpredictable to some degree so I have my suspicions that the regular cycle was tampered with, in a sense, by this.

Art Cashin on the 17.6 Year Cycle: