The next bear market low is on 22 May

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Three years ago Kerry Balenthiran predicted the end of the commodities bull market in 2015 and the “final crisis” of a 17.6 year bear market for shares. His predictions are getting more precise…

I’m in a restaurant in Windsor & Eton Central Station warning Kerry Balenthiran I’m going to give him a hard time. He wrote a book in 2013 that analysed stockmarket prices and predicted three more downward lunges in a 17.6 year bear market that was already thirteen years old, and a subsequent glorious 17.6 year bull market.

As an investor so indifferent to the level of the stockmarket I can’t even guess its level accurately, I’d be an unlikely cheerleader for Balenthiran’s analysis.

By subdividing a 17.6 year cycle others had also identified into 4.4 and 2.2 year subcycles corresponding to peaks and troughs going back to 1906, Balenthiran determined we’re in the dog days of a bear market, three consecutive 2.2 year periods of volatile and largely directionless prices, punctuated by three distinct lows, each higher than the last.

The first, scheduled for later in 2013, amounted to little more than a blip of questionable significance. The second, scheduled for 2015 was significant, although a low in 2016 may prove even more so. The third will be in 2018, and will set the stage for a 17.6 year bull market that could, he says end with the Dow Jones Industrial Average topping out at 100,000. An equivalent move from the FTSE might take it to 45,000, although that’s not so much a prediction as an estimation of what is possible.

Many mainstream investors regard technical analysis, extrapolating meaning from price movements, with the kind of scepticism usually reserved for fairies at the bottom of the garden. Within technical analysis, the study of cycles is a fringe activity. Cyclists, if that is what they are, are the looniest bit of the loony left, the astrologer other astrologers don’t take too seriously.

But I’m here after an almighty crash in commodity prices that happened right on time, and Balenthiran doesn’t conform to my loon stereotype. He’s a risk consultant, an accountant with a degree in mathematics. He’s affable. He can hold a conversation and eat at the same time somewhat more dexterously than I. We agree on the substantive issue…

There are cycles. Commodity prices go in long bull and bear markets. When demand exceeds supply, prices are high. When supply exceeds demand, prices are low. Commodity prices remain out of kilter for long periods because of the investment required to build up supply, and disinvestment required to use it up. Stock markets move in the opposite direction to commodities, what trader Jim Rogers coined a “negative correlation between stocks and stuff” because stuff is a cost to companies that produce things, and therefore eats into profit. Investors in shares like profits to be going up so bear markets in shares might correspond with bull markets in commodities and vice-versa.

Shorter cycles, business cycles, credit cycles, and presidential cycles, play out too, and longer cycles, relating to demographics for example. These cycles are amplified by feedback loops. Euphoria eggs traders on in booms. Fear perpetuates busts.

I’m just astonished that anything as regular as the clockwork precision of the Balenthiran Cycle could come out of this multitude of cycles. Wouldn’t they all cancel each other out?

Balenthiran agrees. It’s bonkers, he says, but also what he’s observed. The best analogy he can draw is a pan of boiling water. The heat is constant and the water is smooth, then suddenly and predictably it boils. His best explanation is psychological. The dot.com boom ended when investors realised their faith in technology stocks had outgrown reality. The market turmoil this year may be due to the dawning realisation that our faith in central bankers outgrew reality.

The whole idea of a commodity price driven cycle, though, harks back to the age of oil, steel and grain, which are of diminishing relative importance in modern economies. In the information age, much of what we value now is intangible, software and data, and so the impact of commodity prices on share prices ought to be weaker.

Commodities are still a basic building block of life, he says. The commodities boom that started around the turn of the millennium was caused by China building the infrastructure of the future, and the Middle East too. It diverted money out of Western economies resulting in the stagnation here. China, particularly, has built more than it needs, and while the demand for commodities is falling, production continues because the alternative, shutting mines and plants is more painful than running them at a loss, for now…

Already manufacturers of some goods reliant on petrochemicals, plastics, for example are benefitting from lower costs. Ultimately, competition will ensure prices fall and consumers benefit. The double whammy of increased profitability and higher consumer confidence will stoke the stock market. Meanwhile mining companies will shut down mines and some will go bust. Bondholders will take control and sell them cheaply allowing a new generation of investors to profit.

Balenthiran chose the Dow Jones Industrial Average for his study because the data goes back furthest, and when you’re studying a 17.6 year stockmarket cycle you need a lot of data. Even the last 110 years only gives him three complete bull markets and nearly three bears. Forty bulls and bears would be more conclusive evidence that the cycle repeats, he admits, but the data doesn’t exist.

The Dow includes just thirty albeit massive US stocks, but Balenthiran says they’re representative of the market and applicable to the UK. Perhaps anticipating my scepticism he’s bought along a chart comparing the Dow and the UK’s FTSE 100 back to 2000. The major dips and troughs correspond, as close as one can tell considering the scale. The two indices are not traces of each other though. Over the period, the Dow has outperformed the FTSE.

Balenthiran says his cycle predicts when peaks and troughs will occur to within 5-10% of their maximum extent, but it doesn’t tell traders much about their magnitude except that the lowest lows tend to be early in bear markets. The cycle might tell you good times to be in, or out of the market, but it doesn’t say how much you will save or lose by acting on that information and if, as in 2013, a predicted event falls within the 5-10% margin of error, it may not be worth acting on.

Trading the cycle is particularly difficult in, as we are experiencing now, its dog days. Near the end of the bear, the market is at its most volatile and unpredictable.

That hasn’t stopped Balenthiran (see part 2: Trading our way to FTSE: 45,000).

Using shorter cycles he’s discovering, he’s making more precise predictions. He expects the current market downturn to reach its low around May 22, before a rally and one final death-throw from the bear as predicted in the book, in 2018.


The 17.6 year Stockmarket Cycle by Kerry Balenthiran is published by Harriman House

Comments

Hi Richard,

Thanks for the opportunity to revisit my forecasts 3 years on and also thanks for lunch. As you say, the criticism is that with only three cycles to go on, there isn’t much data to back up my cycle. But within the broader 17.6 secular year cycle, the twists and turns of the 4.4 year cyclical bull markets and 2.2 year cyclical bear markets demonstrate the validity of the cycle. It’s ability to forecast future peaks and troughs is the true test and 2015 has been a good one.

The FTSE has moved sideways for 16 years (with massive swings up and down) and if my cycle holds true we have two more years of sideways movement before the next great bull market gets underway and we say good bye to FTSE 6000 forever.

Regards,

Kerry

You'd have to differentiate between the S&P 500 and the FTSE 100 as they are different indices with different patterns I would imagine. And from a valuation point of view they are at very different points in their respective valuation "cycles". For example the S&P 500 has just come off of near-bubble valuations while the FTSE 100 is below historically normal valuation ratios.

I'd be interested to know if Kerry has different forecasts for the two indices. I haven't read his book so apologies for my obvious ignorance.

Kerry had better speak for himself, but my impression is that the pattern is similar, peaks and troughs occur at the same time, although their magnitude is different. He believes his cycle can tell you when it's a good time to be in the market and out of it. He doesn't claim it will tell you how good or bad it will be!

The peaks and troughs apply equally well to the S&P 500 (.INX) and FTSE 100 (UKX) as they do to the Dow Jones Industrial Average (.DJI), a quick look at the Google Finance 10 years chart (using compare) illustrates this (ticker codes in brackets) .

As Richard says, my cycle is about sentiment (bull and bear) and not the magnitude of price movement. Cyclical bear markets can be sideways moves overall (containing a large drop) over a period of time (2011 – 2013), or a large drop over the whole time period instead (2000 to 2002).

Regards,

Kerry

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