The bust wasn't Mr Brown's fault, of course, but a worldwide phenomenon. His failing was to be so naïf as to think that economic cycles could be tamed by supposedly clever financial management. The rhythm of boom and bust has been with us as long as economic activity itself. As investors, we need to take to take a step back in order to understand this process a little better.
The study of cycles fell out of fashion during the 1990s and early 2000s, partly as a result of a belief that clever central bankers and politicians had finally learnt from the mistakes of the past. In truth, no 'paradigm shift' had really occurred. While it is possible to mask cyclical tendencies in the economy for a time, this merely delays and exaggerates the eventual outcome.
While politicians may not be able to harness the economic cycle as they might wish, we as investors can improve our lot by understanding the forces at work. Cycles in financial markets are much more regular and predictable than many people realise. If we identify the intervals involved, we can time our investment decisions accordingly.
The 17.6-year cycle
My own research into these patterns has identified a cycle in the stock market of 17.6 years' duration. While others have spoken of such a cycle before, I believe I am the first to have detailed its make-up. The 17.6-year cycle is itself made up of smaller cycles of 2.2 and 4.4 years' duration. These rhythms link the major turning-points in equities of 1929, 1987, 2000 and 2007. Without wanting to sound immodest, I have called this cycle the 'Balenthiran Cycle'. Knowing that a major stock market top such as that of 2000 or 2007 is due has obvious benefits to investors. It allows us to position our portfolio away from equities and into a more promising alternative. Thereafter, we can shift our funds back into stocks as the next major bottom is scheduled. One thing to note is that the turning points are not precise dates but rather a period in which to expect a trend change, within the longer stock market cycle.
Figure 1: Dow Jones Industrial Index 1929 to 1947
Chart 1 shows the long-term bear market in stocks that occurred between 1929 and 1947 in America's Dow Jones Industrial Average. (I chose the Dow for my research because reliable data goes back much further than for our own stock market. However, I would stress that my findings are equally applicable to the UK.) This chart shows that the market spent 17.6 years predominantly in a range between 100 and 200.
Figure 2: Dow Jones Industrial Index 2000 to 2013
The Dow and the FTSE have been in the same sort of phase ever since the year 2000. Since the turn of the millennium, the Dow has been largely stuck between 9750 and 14000 - see chart 2. There are remarkable similarities between the bear markets of 1929-47 and 2000-present that may not be immediately obvious to the naked eye.
The first low of the 1929 bear market came in 1932, just after the 2.2-year turning point (1931) following the 1929 high. The second low happened in 1938, approximately 8.8 years after the 1929 high, also in line with the Balenthiran Cycle. The same is true for the 2000 bear market where the first low happened in 2003 and the second low occurrred in 2009. A similar pattern is in evidence for the bear market between 1965 and 1982.
Balenthiran Cycle
The precise make-up of a Balenthiran bear market cycle is displayed in figure 3. The end of Phase 3 corresponds to the major lows seen in early 2009. The structure now calls for a further low in 2013 - being the end of Phase 5 - which is equivalent to the 1942 trough in the bear market of 1929 to 1947.
Figure 3: Balenthiran Cycle - Bear Market
Source: The 17.6 Year Stock Market Cycle
Tops in the stock market should be thought of as processes that occur over time rather than finite events. This process involves a battle between bulls and bears, and leads to increased volatility with a broad sideways range over a number of months before a big move down. Market bottoms, on the other hand, are finite 'events', typically a V-shaped rapid plunge and bounceback that catches the majority of investors unawares.
Looking at recent market action in Figure 4, we can see evidence of market tops and bottoms and it appears that the Dow Jones is currently going through a topping process.
Figure 4: Dow Jones Industrial Index 2009 to 2013
Source: FreeStockCharts.com
The Balenthiran Cycle model therefore provides investors with a market roadmap so that they can anticipate the twists and turns of the market and plan accordingly. By understanding historic market behaviour, investors can gain an edge that will allow them to ensure that they have the right strategy for the prevailing stock market conditions.
If future market behaviour is consistent with the cycle, the coming 2013 low should not be a new lower bear market low but rather a correction of 20 to 30 per cent, bottoming around 9750. I anticipate that we will see the topping process complete over the next month or so and the low to occur in the autumn.
According to the Balenthiran Cycle, the 2013 low should also not be exceeded ever again. That said, we should see another low in 2015 and continued volatility until 2018. The coming 2013 trough represents the last great buying opportunity of this long-term bear market, just like that of 1942. It should therefore be treated as an ideal opportunity to buy and hold from a low price and ride the next great bull market to 2035.
Watch a video of Kerry discussing the Balenthiran cycle.
