Wednesday, September 3, 2014

A new 10-year cycle begins soon

Among the components of the 60-year economic super cycle due to bottom this fall is the 10-year cycle.  It is this cycle which is the core component of the super cycle and is responsible for this year’s financial market behavior.  The upcoming bottom of this cycle, followed by the commencement of a new 10-year cycle, will also herald a major opportunity for investors in the coming 1-2 years.

The 10-year cycle is unique among the Kress cycles in that it’s one of the few cycles whose peak is not a separate cycle.  When other cycles in the Kress series peak, the half-cycle component forms a distinctive cycle by itself.  For example, when the 4-year cycle peaks the 2-year cycle bottoms simultaneously; and when the 12-year cycle peaks the 6-year cycle bottoms.  Since there is no 5-year cycle in Kress cycle theory, the 10-year cycle peak is a true peak.

Another unique aspect of the 10-year cycle is that it’s the only one of the twelve yearly cycles that bottoms at the same time each decade, namely in the fourth quarter of year four.  This is the reason for the “Year Five Phenomenon” which sees the stock market rally in every fifth year of each decade.  The lifting of the 10-year cycle downside pressure at the end of year four creates a major lift for equity prices during the year that follows.

In the 10-year cycles of the past two decades the cycle has been relatively benign.  This normally happens when bull market conditions are prevalent.  Only when a bear market is underway, as in 1974, does the 10-year cycle bottom emphatically.  The last two 10-year cycle bottom years, in 1994 and 2004, saw lateral trading ranges develop in the Dow and S&P for much of the year prior to the cycle bottom.  After the cycle bottomed in October ’94 and October ’04, the indices broke out of their ranges and went on to higher levels as a new 10-year up cycle kicked off.

The “hard down” phase of the 10-year cycle in 2014 has produced a lateral trading range in the Russell 2000 Small Cap Index (RUT).  In the Dow, however, the influence of the 10-year down cycle has been much more benign and the end result has been an upward-sloping trading range for the Dow (see chart below).  The implication behind this pattern is that a secular bull market is well underway.  Accordingly, the upcoming cycle bottom will likely produce higher stock prices in 2015 as a new 10-year cycle will act as a favorable tail-wind for stocks (instead of an unfavorable head-wind). 

As previously mentioned, the 10-year cycle bottom will serve as a catalyst for the famous “Year Five Phenomenon” in 2015.  This is one of the facets of the 10-year cycles that is worth delving into, namely the tendency for the year following the 10-year cycle bottom to be a stellar one for stock market investors.  Since the 10-year cycle always bottoms around the start of the fourth quarter of the fourth year of the decade, the fifth year of the decade is the year that typically gets a major boost from the newly formed 10-year up-cycle.  The 10-year cycle then peaks around the start of the fourth quarter of the ninth year of the decade.  Thus the years X-5 and X-9 of the decade nearly always see impressive gains made in equity prices. 

In his book, The Right Stock at the Right Time (John Wiley & Sons, 2003), author and trader Larry Williams made the following observation about the fifth year of the decade:

“What we see is that in 11 out of 11 times the fifth year in the decade produced a rally or a market-up move, making it the strongest year in the 10-year pattern….Without a doubt the fifth years of the decades have been where the bulk of wealth has been made.  [Yale Hirsch’s] work showed a total gain of 254 percent in the five years…”  Clearly, there is money to be made in 2015 with the “Year Five Phenomenon” at work.

Once the 10-year cycle bottom is in the rearview mirror, we should see some important changes taking shape.  A major reason for the sluggish economic recovery until now has been the head-winds created by the long-term cycle.  With a brand new cycle underway starting in October, 2015 should be a breakout year for the U.S. economy.  Consumer spending will increase as the momentum behind the recovery gets a huge push from the newly formed cycle, as will business investment spending. 

Equities should also post yet another positive year as the “Year Five Phenomenon” kicks in thanks to the 10-year cycle bottom.  Watch for small investors to start coming off the sidelines next year.  They’ll put more of their money into stocks as they slowly recognize the reality of the secular bull market.  Commodities should also benefit from the cycle bottom as investors begin to minimize their heavy holdings of cash and Treasury.

With the 10-year cycle bottom only a few weeks away, the exciting opportunities of 2015 and beyond should make the uncertainty of recent years more than worth the wait.