A review of business cycles can offer a glimpse into the future. The practice can be especially gratifying when times are tough, because the history of cycles reflects the tremendous resilience of the world's business and financial communities.
In 2001, I wrote about the Kondratieff wave ("Hanging Ten on the Kondratieff Wave"), which was the Russian economist's theory that business cycles show a long-term steady pattern over successive 50-or-so year cycles. Generally speaking, long-term economic growth tended to end with an orgy of excessive borrowing -- businesses and individuals spending loan proceeds that they couldn't pay back.
It would be nice to further refine the notion of cycles so as not to have to guess where we are. The answer resides in the fact that the actual long cycle is 52 years and it is broken into smaller chunks of 13 years each. Within the 13-year cycle are even smaller periods of from three to four years each.
Then, to complicate matters, there's the seasonal stock market cycle commonly described as "sell in May and go away." This is the reference to the fact that two-thirds of market gains take place between October and April. Only a third of an average annual gain happens during the summer months.
Since cycles exist, how can we understand them well enough to maintain perspective and remain confident when it feels like we're otherwise peering into an abyss?
One clue is something called the leading economic index -- a statistic that is an aggregate of many economic factors. It can be accessed at www.conference-board.org, and it blends components such as housing starts, interest rates, the stock market and new orders for consumer goods. Changes in this indicator predict an economic high-water mark by an average lead time of 13 months and a low point by about 10 months.
The leading indicator is not to be confused with the Consumer Confidence Index, which the Conference Board also calculates. Despite all the attention it gets in the press, consumer confidence is largely useless as a forward indicator. One economist claims its only value is in predicting the demand for used boats.
The stock market is only slightly better as a forward indicator of future economic events. In far too many cases, the market has continued to rise while the economy has already entered a recessionary period. Under these circumstances, investors are saying, "Don't confuse me with the facts when I'm enjoying a nice buzz of irrational exuberance."
As an example, the highly respected analyst Mark Hulbert has calculated that a fair price for Facebook is about $15 per share based on conventional stock analytics applied to growth companies.
It helps to know which business cycles are important. Some of the most popular, but the least important, are those having to do with presidential elections and seasons of the year. These are not useful because they are short term and just confuse the issue.
At the end of May, for example, the stock market dropped by about 6 percent. Some seasonal traders would say that this is right on schedule with the rule of thumb about summer doldrums.
For anyone tempted to bail out of stocks, however, a Goldman Sachs exhaustive survey going back to 1900 indicates that the market has rarely lost money during the summer months. On average, after all, it has gained 3 percent per year during the summer. While September was the worst month, it showed a loss in just 51 percent of all past years. So, resist the urge to think short term.
Bottom line: Keep basic business cycles in mind and remember that, like the tides, they can be predicted with reasonable levels of certainty -- or at least enough certainty to serve the needs of long-term investors.
courtesy of: http://www.mercurynews.com
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