On Long Waves and Long Term Valuations
April 24, 2010
The uncanny regularity of periodic 15 to 17 year stock market cycles depicting alternating secular bull and bear markets over the last 150 years or so is a pattern I have referred to on numerous occasions in previous missives. The underlying framework governing long term cycles can be described as “long wave theory”, which originated during the early part of the last century through the works of well known economists like Schumpeter, Kondratieff and Kuznets. I think it’s important to pay serious attention to economic and stock market cycles, in addition to fundamentals and market technical indicators, to form views on entry and exit points for asset allocation. with that aim in mind, i have summarised below an interview with a leading authority on long wave theory - david barker, who got famous in 1987 with the publication of his first book “jubilee on wall street: an optimistic look at the coming financial crash” a few months before the crash of 1987. He then produced a second edition of his book in 1995 which predicted the current secular bear market and last year (after taking several years of from financial markets to start a venture in life sciences focussed on applications of nano-biotechnology) came out with a third edition “jubilee on wall street: an optimistic look at the global financial crash” which predicts an extension of the current bear market until 2012.
Here are some salient points to consider:
long waves last 50-70 years and can be divided in four segments: the first is the “spring” period characterised by early inflation, followed by the “summer” period which experiences runaway inflation and a rise in commodity and raw material prices, which then moves into a “autumn” period which is a time of disinflation and is good for stock and bond prices and financial speculation. The final period is “winter” which implies deflation and a bear market for stocks.
“The long wave at its heart is an ebb and flow of corporate efficiency and that is manifested in debt structures and price structures”; debt structures eventually get too big leading to overcapacity and a long wave winter which eventually brings about a purging of the debt and companies go out of business to remove the overcapacity.
While he had originally thought (in 1995!) that the current long wave winter period would end in 2009, he now expects a debt bust which will lead into a final low (for the economy, stock markets and commodities) in 2012 , after which an emerging market and innovation boom will rapidly lift the global economy and markets.
The coming emerging market boom is best represented by a chart which plots the share of global consumption in emerging markets versus the u.s.- the two lines crossed over in 2007 with consumption in emerging markets currently at 35% and the u.s. share at 25%.
The big risk factors over the next two years which can worsen the downturn going into 2012 are likely trade wars (as countries try to export their overcapacity and deflation to each other) and tax increases.
expects china to have a severe debt and real estate crisis by 2012, but also thinks that its subsequent recovery will be far quicker than what most people would expect and thinks china will be a leader of the long wave spring period in many respects.
Japan could present good investment opportunities earlier than other markets during the spring period, particularly their large cap companies with good dividend yields which have access to global markets. However, their 200% debt-to-gdp structure poses immense risk to this view.
Expects nanotechnology, alternative energy and space exploration to be the drivers of innovation growth in the next cycle.
A fascinating big picture view which provides a useful framework to plan asset allocation decisions over the next several years. its interesting to note that two other prominent wave/cycle theorists i follow – bob bronson ( i have presented some of his wonderfully informative charts previously) and bob precther (of the elliot wave fame) think that the final bottom of the current downturn will occur in 2014 (bronson-see chart below) or 2016 (precther). my personal opinion is that the private debt deleveraging process in the developed world is likely to take another 5 years or so to play out and emerging markets (mainly china) have a huge amount of excess capacity to write-off as well during this period. however, given china’s primary concern of maintaining social stability, a dramatic and quick write-off of this excess capacity (causing a collapse in gdp) is unlikely and that they would have a strong preference to achieve this objective over several years.
On long term valuations:
and finally, an update of my favourite (and time tested) long term valuation chart for the s&p 500 by the yale economist rober shiller. shiller expects another housing market dip and views stocks as being very expensive (by about 35%) :
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