"The Market - A Longer View"

Sydney M. Williams

Thought of the Day

“The Market – A Longer View”

May 14, 2010

While I am no student of long-wave theories, such as Robert Prechter’s Elliott Wave or the Kondratieff Wave Cycle, simple observation suggests there is some truth to the theory that there are cycles to markets. Since entering the brokerage business in 1967, I can identify three distinct periods. The DJIA first breached the 1000 mark on February 9, 1966, closing that day at 995.14. On August 12, 1982, the Dow Jones closed at 776.92 – a negative return of 21.9% after almost sixteen years. The second period began that same August day. Almost eighteen years later, on January 13, 2000, the same index closed at 11,582.43 – a 1390.8% positive return. The third phase, which we are now in, began in early 2000. (Both the S&P 500 and the NASDAQ peaked in March of that year.)

Long cycle bear markets do not go straight down. During the 1970s the market actually peaked in January 1973, at a time of the “nifty fifty” and during the 2000s the markets exceeded their 2000 highs by nominal amounts in October 2007, but the game, in both cases, had changed by the earlier date.

A characterization common to all three periods is that the psychology of investors is slow to adopt, and when it does the ground is already beginning to shift in the opposite direction. People remain too bearish as markets exhibit positive signs and they remain too bullish as markets turn negative. Much fund flows are the most visible example of this tendency. The simplest explanation is the fact we extrapolate our most recent experience. For example, despite the wiping out of about $6 trillion in equity value during the three year period ending March 2003, consumers continued to leverage their houses – the most significant asset for most people. Debt did not deter them, as the 1980s and 1990s had shown positive economic growth and declining interest rates. As George Soros so famously said in May 2000, “the music had stopped, but people were still dancing.”

It is unsurprising, but as bull periods persist, people, the media, and even professional investors become increasingly bullish. The train may be leaving the station, but they race down the track to jump on board. The same is true, in reverse, during bear markets.

Today, ten years into a bear period, the gloom is deepening; in part it is justified, as innovative investment bankers and traders created products, purportedly to serve society, but in reality to enhance their pocket books, and which eventually resulted in the mother of all credit collapses. Additionally, the situation in Greece and California are now visible manifestations of the dangers of unfunded entitlements. The obviousness of those problems, however, did not deter Congress from passing what will certainly prove to be the most expensive entitlement yet – the health care bill. It is characteristic of times such as these that negative news will dominate. It is the markets one must watch for clues as to where we stand.

During the 1970s the actual low point was reached in December 1974; so that one could divide those sixteen years (1966-1982). During the first half, bullishness persisted, capped with the above mentioned “nifty fifty” peaking in early January 1973. Regardless, the markets declined during those eight years. The second half – marked by final extrication from a seemingly endless war in Vietnam, gas lines, rising inflation, hostages in Iran and a general malaise – saw stock prices gradually rise. Five years into the “Great Bull Market” the market crashed in October 1987, and market Cassandras’ felt justified in their bearishness. Nevertheless, the economy persisted on its upward slope and within two years the market was at new highs. Twelve years later it was 400% higher. In the final few years of the ‘90s exuberance became truly irrational.

Markets are never predictable and the future is always opaque. But one must be careful to not get too caught up in hype of the moment. The media, which should largely be ignored by long term investors, is (naturally) principally interested in attracting viewers, so as to increase their revenues; thus their focus on the negative, the scary, the sensational.

A lesson, for me, is that during the second half of the 1970s, as news worsened, stocks became differentiated and gradually began to rise. For sixteen years the market traded within a range, but in the second half the lows were less low. It is too early to know what the future holds, but a guess would be that the March 2009 lows will prove to be the low and that the market will trade within a range over the next several years until a time comes that marks another sea change.

The market today is lower than it was eleven years ago – a time frame far more similar to that of the 1970s than that of the ‘80s or ‘90s. This period, too, shall, end. It is impossible to know when or the catalyst; it is more important to keep your wits, not lose faith in the long term future of the Country and to keep an eye on value.