The 17.6-Year Stock Market Cycle

If we date back to 1900 and look at the stock market until now, we can notice a pattern. The market moves up for 17.6 years and moves sideways for another 17.6 years before repeating. This is not precise science but it’s just a pattern that has played out in the stock market. Art Cashin, Director of Floor Operations for UBS Financial Services and CNBC Market Commentator, noticed this first and he has dubbed it  “The 17.6-Year Stock Market Cycle”.

Stocks go up 7-10% per year on average in the long run but historically they have extended periods when nothing happens followed by long periods of returns well in excess of normal. From 1966-1982, the market went bounced around but essentially went sideways (DJIA went from ~880 in 1966 to ~870 1982). From 1982-2000, the market went up more than 10 times (DJIA went from ~870 in 1982 to ~10,900 in 2000). The current cycle started in 2000 and according to the pattern, we are going to move sideways till 2017! However, we have to keep in mind that it’s just a pattern and we can only know in hindsight if it has worked.

The market may move sideways in the next 6-7 years but there will always be opportunities present. The market always mis-prices companies so value investors can advantage of Mr Market’s mood swings.

Check out the following Youtube video by Art Cashin.

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Divestment of TMC

I just submitted my form to CDP  today to sell off my Thomson Medical Centre shares. Peter Lim is currently holding 85.42% of TMC and it’s no point that I hang on to mine as well. He is probably going to gain full control of TMC and de-list it thereafter.

It’s actually hard to let go a gem of a stock. TMC has always been a star in many investor’s portfolio due to its strong balance sheet, great cash flow and astute management. Looks like I have to hunt for other value companies now….

Analysis of an aerospace company

I recently looked into a local listed company involved in the aerospace industry. It is NOT a business that suits the value investing tenants. It is actually a company that has been having net losses for the past 3 financial years (FY2009 to FY2006). I analysed this company to learn from the mistakes of this company and to not have these negatives in the company that I invest in.

Looking at the FY2009 annual report, the CEO’s message didn’t touch on the losses and what the company did wrong. I was looking if there were reasons given by the CEO for the dismal results for the past few years but it was nowhere to be found in the CEO message. This is very atypical of a good CEO. A responsible and honest CEO would talk about the losses and share with the shareholders what went wrong frankly and not sweep them under the carpet.

In the 2007 annual report, the CEO mentioned,  “We believe we can overcome challenging times”. In 2008, the CEO cited, “We will overcome the challenging times ahead s we overcome the previous ones, emerging even stronger”. However, all these are not evident in the financial statements which can’t really lie unless one cooks the books.

Under the operations review section, the losses were solely blamed on the financial crisis even though the company has been having losses consistently and not only for that particular year.

Looking at the balance sheet, the company has huge trade receivables almost year-on-year and this is affecting the cash flow of the company.

Thus, when investing in a company, do look out for an honest CEO message and strong financials. You are putting money in a company so you would surely want the company to be run by truthful, dependable and competent people who can grow your funds.

The Panic Cycle

Panics emerge as markets crash down to earth after they have risen beyond levels that are sustainable. A useful model for tracing the stages which lead to a panic is supplied by Charles Kindleberger in his book “Manias, Panics and Crashes”. He built on the model that was established by monetary theorist Hyman Minsky.

Outlined below are the stages.

Stage I

Cycle starts with some kind of shock to the system that creates important opportunities for at least one sector of the economy. It could be an extraneous event such as a war or some even more closely connect to the economy eg. rise of the Internet.

Stage II

This event starts a boom, which is then fuelled by the expansion of bank credit and enlarging money supply.

Stage III

With more cash in hand, euphoria takes hold, leading to what is termed ‘overtrading’. This term can mean a number of things, such as heavy speculation in anticipation of price rises or it could mean excessive gearing, caused by buying speculative assets on margin.

Stage IV

News spreads of the spectacular profits being made by those involved in this trading. Kindleburger once said, “There is nothing so disturbing to one’s well being and judgement as to see a friend get rich”. So everyone else wants to get rich and a bubble forms. People who previously had never even thought about buying stocks suddenly start entering the market.

Stage V

The real danger signals appear when stock market news moves from the back to the front pages of non-financial newspapers. Illustrating this point was the alarming appearance of mutual funds as a Playboy magazine cover story at the height of the 1990s stock market boom. When stocks replace scantily clad young ladies with large mammaries in the most honoured position of a magazine such as this, logic has clearly taken a back-seat.

Stage VI

Not only does the stock market suddenly become inundated with inexperienced players but their very presence increases demand to sell all kinds of new equity issues that doesn’t make sense.

Stage VII

As the bubble grows, the markets become increasingly detached from the underlying assets they are supposed to represent.

Stage VIII

A number of scams and dubious investments come to the market.

Stage IX

By now, the more savvy investors sense the time has come to head for the exit. Newer players are unsure what to do so they tend to stay put, but the fact that some players are getting out tends to put a brake on the rapid upward movement of prices. Once this happens, there is an increasing movement away from assets into cash, further depressing prices.

Stage X

By now, the market is in full retreat with even hardened speculators realising that the peak has passed and there is competition to get out before everyone has abandoned the field. This may be followed by a specific event, such as a dramatic bank failure or the revelation of a particular scam.

Stage XI

This accelerates the rush to the exit and leads to revulsion against the very assets which were once regarded so highly.

Source: “Market Panic: Wild Gyrations, Risks and Opportunities in Stock Markets” book by Stephen Vines

A mispriced gamble

“To us, investing is the equivalent of going out and betting against the pari-muteul system. We look for the horse with one chance in two of winning which pays you three to one. You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing” – Charlie Munger, Warren Buffett’s partner and Vice-Chairman of Berkshire Hathaway.

Herd Behaviour

“Men, it has been well said, think in herds”, Charles Mackay once said.

Herd behaviour is common in the stock markets. In the stock market, herding behavior is irrational and is driven by emotion—greed in the bubbles, fear in the crashes. Individual investors join the crowd of others in a rush to get in or out of the market. When the market is rising, people who are not invested are driven by greed and want to enter the market to make money as well. When the market is falling, people flee out of the stock market, out of fear. This is a perfect example of herd behaviour.

A famous experiment by Muzafer Sherif conducted in 1937 shows the herd behaviour succinctly. A group of people was asked to sit in a darkened room and observe a point of light through a small hole. They were told that the light would move and asked to estimate the extent of the movement. In actual fact, the light did not move at all, but when the subjects were later placed in discussion grounds, all agreed that movement had occurred and discussed only by how much they moved. When subsequently questioned, none appeared to be aware of any group influence.

The proper way to invest is to be fearful when others are greedy and be greedy when others are fearful. Buy during a market crash and sell at the peak of the euphoria and you won’t go wrong. Yes, it’s difficult to sell at the peak but we can always sell around the peak when we sense the euphoria and when the P/E ratios are shooting through the roof.