Financial topics

[JonLaw]

[url]

Lastly, John pointed a finger at boomers and X-ers. The market in 1966 was as richly valued as it was in 1929. The oldest boomer was 20 in 1966. Why did they do it again?

Mannfm,

The market in 1966 was not as richly valued as is was in 1929.

The final bull peak during the K-Cycle Summer/Awakening secular bull market in the 1960s was rather sedate.

The reason was that the GI generation was still in control.

You need to look at long term returns rather than your formula. The long term returns from the 1960s need to take the bubble in the 1990s into account.

- Jon

[Higgenbotham]

And the best of all possible sources for prices over the centuries is David Hackett Fischer's "The Long Wave." He uses basic commodity prices and runs his data back into the medieval era.

One thing notable is that price data is not the smooth sine-wave curve one may imagine, but as he says, a wave, that starts slowly, builds up, and breaks ... and levels off at the higher level of prices. The mechanism he gives for this is very similar to the generational turnover John cites, when the last people with direct experience of things have died off and the younger generations start trusting that a rosy state of affairs is the natural order of things.

The 20th Century Price Wave began about the time of the Missionary Awakening and is due to crest any moment now, if it hasn't already, and then we're in for a period of what he calls Equilibrium: very slow growth and low interest rates.

The last such wave-and-equilibrium started in the 18th Century, which I have already pegged as a mega-Crisis era, crested during the post-Revolutionary High (in the States), and touched off the Victorian Equilibrium. And note that the 19th century was in equilibrium with respect to commodity prices *despite* the massive industrial development that occurred then.

I have "The Long Wave" shelved right next to "Generational Dynamics" and "Fourth Turning."

Thanks, I was able to find this book tonight. For those who are not familiar, David Hackett Fischer's book is online at google books. He dates the Victorian Equilibrium from circa 1815 until 1901.

In my last post on page 274, I had noted the period from 1797 to 1821 in England as being a period of price instability/transition where the gold standard was suspended, similar to our post 1971 period. Fischer shows a graph in his book of the inflation wave that began in 1730 and terminated in this 1797 to 1821 time period. As shown on the Bank of England website, there was a final inflation rate blowout that terminated in England in the early 1800's, followed by deflation, then an equlibrium. The graph on page 4 of Fischer's book corroborates this by showing the peak of the price wave a few years later, a dip in prices, then the period of price equlibrium below the early 1800's price peak.

http://www.bankofengland.co.uk/educatio ... /chart.htm

http://books.google.com/books?id=-efB6G ... es&f=false

The link above should go to page 4 of the book. As near as I can tell, prices peaked around 1810, fell 10-20%, then leveled out.

My guess has been comparing to this period (though I think our period will be much more catastrophic as there are only certain elements that compare) we see the final inflation rate blowouts in 1800 (or so) and 1980. The rate blowouts are followed by the final price blowouts in 1810 (or so) and 2007 (possibly).

[vincecate]

Exponential
growth curve fitting requires a long period of time, encompassing as
many cycles as possible. The DJIA only began in 1896 [...]

The FTSE goes back further. From 1800 to 1900 it went from like 19 to 37. So about double in 100 years. Then in 1971 it is about 200 and in 2007 it was over 3000. So about a factor of 15 in 36 years. Inflation of stock prices under paper money is different than under gold money. Just looking at earnings, and ignoring inflation of the paper money, I don't believe you will correctly value stocks when paper money is changing in value so fast. And extrapolating trends from before fiat money to after pure fiat money seems very wrong.

http://www.finfacts.com/Private/curency ... rmance.htm

If there was a totally stable 5% inflation and companies were growing in real terms at 3% then roughly I would expect the stock market to grow around 8% per year. Just valuing stocks based on earnings would not be correct. Now when the inflation rate is changing things get more complicated. The higher the inflation rate the lower the P/E that makes sense, as bonds will have higher yields. With 5% bonds a P/E of 20 might be OK for some stock but at 10% bonds then the same stock would need a P/E around 10 to be as attractive. So rising inflation and interest rates is really bad for stock prices. But stable inflation rates will tend to increase stock prices beyond what earnings alone would indicate.

Imagine that some previous scientists made accurate measurements of a redwood tree for 100 years from 1800 to 1900, during which time the tree about doubled in height. Then a new scientist has been doing new measurements since 1971 but this new scientist uses some funny yard stick that gets 5% shorter every year, so his data shows the tree is now 15 times taller than it was in 1971. If you know the yard stick used for the new measurements is getting shorter, it would be foolish to just lump the old data and the new data together. To get a theory that accurately predicts the future growth a different young tree you had better not treat the two data sets as one, unless you first correct for the inflated heights in the second set before pooling the data.

Some people try to correct for the inflated stock prices by looking at the DJIA in terms of ounces of gold. This makes sense to me. And in terms of ounces of gold, I expect the DJIA to go down.

http://www.321gold.com/editorials/russell/dow_gold.html

[John]

This morning I received a lengthy message from an online
correspondent:

> >> Subject: Autowave shows end of the UP (as I interpret it)

> Hi, John,

> As an options trader/investor who utilizes technical analysis I
> see something that says, STOP buying calls and prepare for puts,
> possibly on a very long timeline.

> All the folks on CNBC are saying buy. I could be very wrong, but
> I am not buying calls today and I am watching news reports
> closely.

> There's a study called Auto Wave. It concerns me that the
> autowave for all the major stocks I track has completed for the
> weekly, daily, and on down, and for many the autowaves have
> completed for the monthly and quarterly charts. By completed, I
> mean it is signalling the up move is over for now. This is not to
> say that there will be a big drop, but it does look long term. I
> have never seen this before, although I've only been using this
> method for 8 years. History on Qcharts only goes back to the 80s
> and for many stocks the 90s. I learned my approach from Gary
> Williams Achiever's Choice Quest beginning in 2003 and have been
> an active trader ever since. I wouldn't say I've gotten rich,
> more because of my mindset (fear) than my charting ability.

> I am watching your site closely since you are the best informed
> and best source on what's going on in the world. I wonder if
> there is something on the horizon about to break. Thank you for
> the marvelous work you do.

I'm not familiar with the Auto Wave study, or why it's significant
that autowaves have been completed. Does anyone have any experience
with this?

---

Pat - since you're as stingy as I am, you'll be pleased to hear that
I've been able to order a used copy of Fischer's book for $3.45, plus
$3.99 for shipping, which makes the shipping more expensive than the
book.

JonLaw - I'm not sure what you're saying. Of course I agree that the
sovereign debt crisis is a pending catastrophe, but so is the
overpriced stock market. I also agree that the stock market was more
overpriced in 2000 -- at 314% of trend value on 1/14/2001, while it's
at 176% of trend value today.

** Great Depression and Dow Jones Industrial Average
** http://www.generationaldynamics.com/cgi ... 010.i.djia

However, that doesn't mean that the stock market is less dangerous
today. To the contrary, the Law of Mean Reversion says that bubbles
have cumulative effects, so things are MUCH worse today.

John

[Higgenbotham]

Sharelynx has done some phenomenal long term work on the Dow Gold ratio.

http://www.sharelynx.com/chartstemp/DowGoldRatio.php

Prechter, in his At the Crest of the Tidal Wave, shows some long term US stock market charts dating back to before 1800. Those charts appear to be normalized to the DJIA. I think Prechter worked with The Foundation for the Study of Cycles to come up with these charts.

Prechter's charts show a US stock market index price of about 4 in 1800, 40 in 1900, and 4000 in 1995, the year the book was published, which of course has grown to about 10,000 today. Comparing this to David Hackett Fisher's inflation waves shows that US stock prices increased approximately 10 fold during the Victorian Equilibrium period of stable prices, but increased 250 fold during the following inflation wave.

This gets into the first e-mail discussion I had with John years ago. A 10 fold growth rate over 100 years is 2.3% (compounded annually) real growth (in the absence of inflation). The Sharelynx data shows something similar. Their 200 year growth rate would be something like 2.0% (exactly 20 fold over the past 150 years as a reference point, with the line being straight), where the annual rate of price increase in the DJIA has exceeded the annual rate of increase in the gold price by 2.0%. I had originally thought to take the annual increase in above ground gold supply into account, but am not sure whether that should be done or not, or how to do it. In theory, the gold price stays even with inflation, so this should not be necessary.

As I pointed out to John years ago, a 2-3% long term growth rate is unsustainable. It has never occurred. Therefore, the slopes of all these straight lines on the log charts are too steep if a time horizon beyond 200 years is taken into consideration. I would estimate the real sustainable long term growth rate over the past 2 millenia to be closer to 0.5%.

Whether any of that is relevant to the discussion depends on whether things are undergoing a phase change to slower or negative growth. Based on Elliott Wave Theory, Prechter would say he has evidence a phase change is near (fifth of a fifth of a fifth, overthrow above the 200 year channel, and all that). I agree for different reasons. I won't get into all those reasons here. An example:

http://netenergy.theoildrum.com/node/6356#more

If recent 2.5% real growth rates revert to a mean value of 0.5%, this implies approximately 1.5% real contraction in the economy for a very long time, which implies stock prices will go to or near ZERO, which is where I think they are going.

For those who believe for whatever reason that 2-3% real growth rates are sustainable for a few more decades, then 200 years of data are adequate.

[thrive]

This morning I received a lengthy message from an online
correspondent:

I'm not familiar with the Auto Wave study, or why it's significant
that autowaves have been completed. Does anyone have any experience
with this?

John

Hi, John,

AutoWave is a study provided by Qcharts Plus stock market technical analysis software. This is what the Qcharts website says. “AutoWave ™ is a family of tools from Quote.com that finds Fibonacci price patterns, and suggests patterns that may emerge in the future. AutoWave is open and does nothing in secret. It applies, automatically, a virtual Fibonacci Projection tool in as many places as possible on the chart, and reports patterns that match your definition of success.” A Google search on Qcharts AutoWave Study turns up a PDF with lots more info.

I did not realize the AutoWave study was exclusively a Qcharts study and not a common study that everyone uses. It is part of the analysis method I have learned and use without knowing the intricacies of how it works, similar to how I drive a car but don't know how the electronics work (sorry about that!).

On Thurs, July 1 the AutoWave lines “completed” (that is my terminology, the line actually draws, vs the line not being there at all) on the Weekly and Daily charts which signaled to me the down was over. While investment sites I follow were saying, “short, short” I stayed on the sidelines and watched the move sideways then up on Tues, July 6.

AutoWave lines can form on an individual timeframe, let's say the daily chart, but the stock can keep going up and the AutoWave line keeps going up with it. But, when the AutoWave line is complete on all my timeframes, that is when I take special care. And since the Monthly chart's AutoWave line completed (some in May, many others yesterday) I am seeing this could potentially be a longer term down. ALSO, there are many other indicators I track, and I do not rely solely on AutoWave. It is just telling me to be very careful.

What I have written about the AutoWave is what I see from my vantage point, and I do not declare that I am “right” it is what I see based on what I know.

Thanks to you, John, and to all of the other very knowledgeable forum members. I value your insights.

[John]

That's very helpful. Thanks for the information.

John

[browner55]

Hello John,

I am almost in 100% agreement on your prediction on the stock market. However, as a self-check, I always like to play a little "devils advocate." The chart you have been using showing the PE that recent spiked to 123+ and is now sitting at close to 19 got me to thinking.....Couldn't you have the stock market remain a fairly range bound level around here, but have earnings continue to grow and achieve the same revision to the mean? I know it sounds counter-intuitive for the stock market to not go up a lot under this scenario, but it just went from 123+ to 19, which is fairly dramatic.

[Higgenbotham]

Hello John,

I am almost in 100% agreement on your prediction on the stock market. However, as a self-check, I always like to play a little "devils advocate." The chart you have been using showing the PE that recent spiked to 123+ and is now sitting at close to 19 got me to thinking.....Couldn't you have the stock market remain a fairly range bound level around here, but have earnings continue to grow and achieve the same revision to the mean? I know it sounds counter-intuitive for the stock market to not go up a lot under this scenario, but it just went from 123+ to 19, which is fairly dramatic.

I'm not John, but remember this recent article addressing that question.

If you fit the last century's earnings into an exponential growth curve, and extrapolate that curve to 2009, then you get a trend value for about $41 for 2009. So in the absence of a bubble, you should not expect earnings per share to be above $41 for some time to come.

But it's a lot worse than that, since earnings have to fall much farther, to compensate for the bubble highs. This is the Law of Mean Reversion, which says that if a value is well above trend for many years, then it has to fall well below the trend value for roughly the same number of years. This is simple math, since it says that the average growth rate in the future will equal the average growth rate in the past.

Much more in the article:

http://www.generationaldynamics.com/cgi ... gd.e100102

As reported S&P 500 earnings came in around $17.48 for the first quarter of 2010. The estimate based on reporting so far for the second quarter of 2010:

http://www.bloomberg.com/news/2010-08-0 ... aug-4.html

[aeden]

Since the Federal Reserve was created in 1913, the U.S. dollar has lost 96 percent of its purchasing power. The truth is that just a two percent inflation rate will wipe out half of your purchasing power within a single generation. In the chart below, you can clearly see that the beginning of the rapid rise of inflation in the United States coincided with the creation of the Federal Reserve....

Inflation.png (12.42 KiB) Viewed 6305 times

The point those in charge are so removed from the current condition's it does not matter what anyone can or should do.
The reality is that no matter how smart, how strong, how educated or how hard working American workers are, they just cannot compete with people who are desperate to put in 10 to 12 hour days at less than a dollar an hour on the other side of the world. After all, what corporation in their right mind is going to pay an American worker ten times more (plus benefits) to do the same job? The world is fundamentally changing. Wealth and power are rapidly becoming concentrated at the top and the big global corporations are making massive amounts of money. Meanwhile, the American middle class is being systematically wiped out of existence as U.S. workers are slowly being merged into the new "global" labor pool.

Read more: http://www.businessinsider.com/22-stati ... z0vm2sFBiU

As we watch it unfold it is not a matter how, but when as the forums and John's work suggest. We have been warned even before we were all born what would happen.
http://generationaldynamics.com/forum/v ... 2720#p6138

The road to ruin in a Empire never started in a day or a year but consequences of its action. I do not see the wisdom to change the course.
Given the disconnects what event can usher in the gradualism to assert the tipping point inclusive to the changes needed.
In the interim we will provide services to the Customer for products we all need. I have read elsewhere consumers are tired of being pushed around like vegetables on a plate. I guess if American's like being veggy's the process will continue to there self absorbed future with a terrible cost indeed.

http://www.opensecrets.org/news/2010/08 ... r-lob.html