Most investors are
familiar with the Year Five Phenomenon, which assumes buoyant stock prices in
the fifth year of the decade. Yet few
realize that there are also corollaries to this phenomenon, viz. a sluggish
economy and negative investor sentiment.
All three aspects of the Year Five Phenomenon are a direct consequence
of the 10-year cycle, which we’ll discuss in this issue of the report.
The 10-year cycle is the
dominant directional cycle for equity prices.
Its influence can be seen clearly in most decades. In the first half of the decade the cycle
tends to create unusually volatile and choppy market conditions. The second half of the decade, by contrast,
is usually marked by steadily rising stock prices and often witnesses a runaway
stock market. Indeed, most stock market
manias occur in the second half of the decade.
The reason for this is because the 10-year cycle bottoms at the end of
the fourth year of the decade; the subsequent lifting of cyclical downside
pressure in years five through nine accounts for the relentless bullish
tendency of stock prices in most decades.
It can easily be seen
then why stocks tend to rise in year five of the decade. It’s also easy to see why investor sentiment
tends to be bearish during the fifth year despite rising stock prices. Negative psychology is a consequence of the
volatility and slowing monetary velocity during the previous year in which the
10-year cycle bottoms. It takes about
1-2 years for the typical investor to recognize a shift in the market tide. Therefore the lack of juncture recognition on
the part of most investors is apparent in the fifth year of the decade.
The fact that the
10-year cycle was down last year explains why the economy is sending mixed
signals in 2015. Consumer spending has
noticeably slowed this year, as the latest retail sales figures have
shown. Another sign that willingness to
spend right now is at a low ebb can be seen in the recent appeal for donations
in the wake the major earthquake in Nepal.
According to reports, donors in the U.S. and other Western countries
have been slow to respond to a United Nations appeal for $415 million. Two weeks after the earthquake only 2 percent
of that sum had been pledged. By
contrast, in other major disasters such as the 2010 earthquake and the 2013
Philippines typhoon, at least 60 percent of the goal was raised in the first
two weeks after the event despite the fact that in both cases the requested
sums were much larger.
A similar occurrence
took place following the previous 10-year cycle bottom of 2004. In 2005 the stock market spent several months
of that year in a trading range before finally closing the year with a
gain. Moreover, the U.S. economy was
slow that year while consumer sentiment was tepid and retail spending was
sluggish. The following year 2006
witnessed the proverbial coming out party for the consumer spending and stock
market gains. I expect the economy will
show a similar pattern in the coming year with retail spending slowly picking
up traction and showing improvement by the fourth quarter. Next year should be the “coming out” year for
the consumer and retail investor alike.
Consumers
have been adding to their savings stash this year, as previously
mentioned. Economists assumed at the
start of 2015 that plunging oil and gasoline prices from late 2014/early 2015
would stimulate a consumer buying binge due to the savings in energy
costs. But instead of spending the fuel
cost savings, consumers funneled that extra money into their piggy banks. This creates a rather substantial reservoir
of fuel for a future spending binge.
Consumers
tend to oscillate wildly between overspending and over-saving. When they go too far to one extreme, the
pendulum goes in the opposite direction.
When consumers are convinced that fears of a global economic slowdown
are overblown, they’ll eventually emerge from their shells and start spending
and investing again.
I
note with interest that the New Economy Index (NEI) is still on a positive
trajectory as of mid-May despite a slowdown in the more mainstream retail
economic indicators. NEI broke out of a
multi-month sideways trend a few weeks ago and is near an all-time high as of
this writing. Although the indicator has
been a bit sluggish since the breakout to new highs a few weeks ago, the chart
still points to a positive intermediate-term retail spending outlook for U.S.
consumers in the aggregate.
Clearly, investor sentiment among investors is considerably less
bullish than it was in the previous two years.
Aside from the residual effect of the 10-year cycle bottom, central bank
monetary policy can also be blamed for this.
So far, 2015 has been marked by extreme apprehension on the part of
traders and investors as the U.S. Federal Reserve’s monetary policy is
uncertain. While central bankers in
Europe and China are embracing a dovish stance, the Fed seems uncertain as to
which policy to pursue in light of conflicting reports on the state of the U.S.
economy. This uncertainty on the part of
the Fed is holding the market hostage and is generating unnecessary anxiety
among market participants.
The solution to this problem is simple, but the Fed’s current
leadership appears clueless to what is required. A straight-forward statement by the Fed as to
whether the central bank will raise interest rates this year or keep them
unchanged – yea or nay – is all that’s needed to lift the veil of
uncertainty. I’m convinced that if the
Fed made an unequivocal public statement on interest rates for the balance of
2015, it would push a lot of sidelined money back into the market. For now, though, the market remains hostage
to the Fed’s equivocation and lack of decisiveness.
The confused interest rate outlook on the Fed’s part is nothing new,
though. The same thing was witnessed in
the previous Year Five of the decade in 2005.
The Federal Reserve under Chairman Greenspan’s leadership had embarked
on a campaign of rising interest rates starting in 2004, and by 2005 the rising
rates were generating uncertainty on the part of investors. Yet the effect or rising rates – and the
initial uncertainty it generated – gave way to a desire to purchase equities as
a hedge against a perceived inflationary trend.
Rising interest rates always create apprehension at first, but
this uncertainty gives way to the widespread belief among investors that the
economy is on the mend since interest rates are trending higher. For this
reason it will be important to monitor the progression of the 10-Year Treasury Yield
Index (TNX) in the coming months.
If market interest rates have indeed bottomed (as the long-term
inflation/deflation cycle suggests) then we should eventually see higher bond
yields in the coming year. This in turn
would send the message that the economy is definitely improving and would also
remove all reason for equivocation on the part of the Fed.
