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This lulls the public into a sense that acute risk is no longer involved when they investCycles Study: A Useful Market Tool? I always avoid prophesying beforehand, because it is a much better policy to prophesy after the event has already taken place. Winston Churchill, 1943 From time to time, even very respectable analysts project our entire future based on some fairly precise cycle theory. For example, the theories of the Russian economist Nikolai Kondratieff have been dusted off by several analysts. For those of you not familiar with the Kondratieff Wave, it purports to see a regular set of long-term cycles beginning in the late 18th century, and projected forward into the future. Kondratieff s studies were a product of the 1920s and 1930s when many economists, including John Maynard Keynes, were imbued with the idea that objective knowledge about historical change could be projected into the future as an inductive science. Since Kondratieff formulated his theories, they have been used to predict that the 1930s Depression would go even lower than it did. To predict that, first, the early 1970s and, then, the early 1980s would dissolve into massive worse-than-1930s-style depressions. Even though these predictions didnt come to pass, Kondratieff was resurrected again in 2001. The desire for life formulas is strong. Faith that the future is mathematically measurable is so seductive that even after a cycles theory has been proven not to work, when things begin to look uncertain and the need for stability is great, the failures of past cycles prognostication are forgotten. But life is not a mathematically recurring phenomenon. Its a dynamic evolving process. Because of this, it is very difficult to equate any past era with our own with precision. Most cycles go back at least 100 years. But how can one compare the price of wheat in the days of the horse-driven plow with the price of wheat in the days of computerized farms? What resemblance is there between the price of a TV and a phonograph, or a computer and a quill pen? Exact comparisons are impossible. I am not saying that we should ignore all cycles study, rather that we should be wary of anybody claiming that a particular cycle is the key to the future. WAVES NOT CYCLES David Hackett Fisher wrote a fascinating book in 1996 on long-term price revolutions. But he does not call his work Cycles. Instead the title is: The Great Wave. And though he traces waves back to the 12th century, if you are looking for exact cycles you will come away from his book very disappointed. He agrees that life is a dynamic process and any recurrence in human events that can be detected is more akin to waves hitting a shore than a wheel describing an exact cyclical path over and over. But that does not mean all cycles practitioners are wrong. Indeed, there are some very good market analysts who use Elliott Wave Theory, Fibonacci number series, and even Astrology to predict where markets might go to next. But if their batting average is good, and if they are honest, they will admit that they also keep technical indicators, use chart patterns and many of the tools described in this book to complete their prognostications. And they use that most important tool of all, which can only be self-taught: they have a feel for markets, developed over years of experience. Cycles study has its place as yet another market tool. But only for use in conjunction with other market tools, certainly not as a magic bullet. OUR CURRENT AGE IS VERY DIFFERENT The main factor that has changed the whole equation and concept of economic cycles in our own times began with the desk-top computer. Though the computer was invented in 1946, it was not until the early 1980s that they could be made small enough and inexpensive enough for them to be widely used. Governments can now influence economies more acutely than ever before. We may never see a German Weimar-style inflation again, nor the deflation of the 1930s. They could more easily occur in the days when it took a long time to gather statistics together in a central location; then armies of accountants and economists had to digest, analyze, and interpret those figures using only manual tools. By the time the economists had compiled the data and had suggestions about what to do, many statistics were already out of date. And the problem, whatever it was, was already out of control. But the bad side of the ability to influence an economy with the help of computers is that governments really believe they can create prosperity and almost eliminate the natural rise and fall of prices that occurs in any free market society. This lulls the public into a sense that acute risk is no longer involved when they invest, and prods governments to tinker ever more fervently with the economy, when their prior efforts didnt work. Economies can be government influenced in a mild way, without huge damage. But if governments try to control them in a major way, and thus defy the tides of a free, dynamic society, the net result will be more dramatic fluctuation. Instead of a quick sharp bear market to squeeze out excesses, of the sort we saw in 1981 when government for once did the right thing, we will see a steady deterioration, where not only the economy suffers but the dynamism of society is eroded. THE THEORY OF CHAOS, WHICH ISNT CHAOTIC AT ALL, JUST DYNAMIC The more we learn about computers, the more we realize how much we dont know. In the early 1960s, meteorologist Edward Lorenz developed a remarkable set of equations that could only be used on a computer, which in turn led to what is now known as Chaos Theory. Stated simply, it says that the movement of the wings of a butterfly in Beijing can cause a tornado in Kansas. What that means is that our world is so delicately and intricately structured that any deviation from the norm, however minor, has a ripple effect through the entire systemany system, magnifying it as it goes. It doesnt mean that we live in a chaotic world. Rather, that it is impossible to predict anything exactly, because in order to predict exactly you need an infinite amount of information about the initial conditions. This leads us to two conclusions: 1.Chaos Theory demonstrates that cycles only work in very general ways.2.Governments should stop pretending they have all the facts necessary to create prosperity and get out of the way and allow the economy to go through its natural ups and downs, which will make for a lot less bumpy and corrosive ride. CYCLES CAN WORK WITHIN LIMITATIONS But there are parallels one can draw from the past that are valid for the future, though they must be modified to fit the context of the modern world and not be superimposed blindly. Human reaction to events tends to be similar in similar circumstances. Structures and equipment have limits to how far they can be pushed, and beyond that limit spells danger. For example, if you own a horse and buggy and you drive the horse until he drops without food, you have lost your transportation. If you drive your car until it runs out of gas, you are in the same predicament. But, if you then say that past cycles in the price of hay can equate to the price of oil, you are pushing the idea of cycles too far. Life isnt that simplistic. We do learn from the past. But Cycles Theory suggests that we keep making the same mistakes over and over. If this were true, life expectancy would still be around 40 years, and we would still condone child factory labor and lynch-mob justice. One reason we have not eliminated bear markets and recessions is not because we keep making the same mistakes over and over, but because, as we advance technologically, the problems we need to solve may be similar in a general sense, but they pop up with a different face and in a different context. If all bear markets looked exactly alike, we would cope better and faster. It is because each one, though bearing some resemblance to past bears, is unique, that we miss some of the road signs. Peoples reactions to boom and bust are fairly predictable based on precedent. But the details of how they will react, and how long it will take them to react depends on communications, whether newscasts are biased, and how informed and aware they are. Therefore the assumption that human affairs operate in mathematically predictable time patterns is just not true. There are fairly predictable sequences, but time is one aspect impossible to forecast. There is an old Wall Street adage which states that the market always does what it is supposed to do, but never when it is supposed to. DOORS TO CYCLES STUDY Do not, however, dismiss the findings of those who study cycles. Their research is useful to market analysis. If you study their statistics, you will often find that they have indeed found certain vague recurring patterns in human behavior. It is just that they push it too far and insist that there is a mathematical 9.3-year cycle in grasshopper plagues or computer sales, instead of looking behind the recurring event to discover what caused fluctuations in business or natural cycles at that time, and then try to find a modern equivalent reason. History does repeat itself up to a point, but, when the rerun occurs, it comes clothed in such different attire we almost never recognize it. TO SUM UP If you try to use cycles exactly, you will miss the wood for the trees. But, if you use the fact that human events tend to recur because we react to similar situa tions in similar ways, you have at your disposal a very valuable tool in the bear war. |
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