In the wake of a stunning increase in stock market values, this would be a good time to revisit our understanding of business cycles. The Foundation for the Study of Cycles was established in 1941 in an attempt to understand and predict future events in the economy as well as in the stock market.
Today, the foundation keeps track of more than 1,200 cyclical events covering everything from biology to the weather. They are the "go-to" organization for cycle information, with some studies that go back as far as the 1400s.
What a study of business cycles shows us is that we have been living in a relatively calm environment since the 1950s. Before that period, cycles were catastrophic. To illustrate how bad it was, we had the Great Depression of the 1930s during which the unemployment rate was more than 30 percent. Stock market averages dropped by 90 percent. By comparison, the past 70 years have been relatively stable.
Business cycles are measured by the time elapsing between each trough, and they come in several forms. The most famous is the Kondratieff Wave named after the Russian economist who identified the 55-year business cycle demonstrated in capitalist countries. He was sent to Siberia because, while capitalism was supposed to be dead, his wave analysis chronicled the boom periods.
Next up is the 13-year cycle, which is then divided into three or four-year cycles. These smallest incremental cycles are the ones that impact business and investment decision-making the most.
Meanwhile, different components of the economy have their ups and downs at varying times. They don't all march in lock step. Economists who have been reasonably successful at predicting the future have cobbled together a matrix of leading indicators that, combined, have been found to be an effective tool.
When predicting future movement in the stock market, one obvious component of the matrix is corporate profits, while others include retail sales and the cost of borrowing money. The Purchasing Managers Index is yet another barometer used to determine what companies are buying from each other.
If we're trying to predict a stock market downdraft, it's not enough to notice that these indices, as a group, have finally turned negative. It is more critical to notice when their rise from month to month has started to slow down. Things may still be going up, but if the rise itself is slowing down, it's a forward indicator of a coming recession. On this basis, the jungle tom-toms of market cycle watchers are sending the message of a mild recession in 2014.
The research produced by the Trends Research Institute indicates that the stock market will have to struggle to gain much more in the face of corporate profits that are now rising slower than they were at this time last year. This doesn't mean that everyone should bail out of the market, because the longer-term cycle indicates a string of great years through the year 2020. Those who bail out of the market usually wait too long to leave and lose money as a result. Then, totally traumatized, they wait too long to get back in. A wiser course is to remain invested in equities while reallocating to a more conservative mix of funds (or stocks.)
The good news is that an overriding 13-year cycle, mentioned previously, indicates that the years from 2015 to 2019 will constitute a worldwide economic boom period. Subtract 13 years from 2015 and what do you get? We could be looking at a repeat of the years from 2002 through 2006.
Apart from just the power of a business cycle, there are some fundamental forces in play that include the continuation of low, albeit rising, interest rates and the fact that we will be coming off a soft economy in 2014. Staying the course through what could be a tough summer and disappointing year next year should pay off for those who will be fully invested for the "snapback" and the sustained rise for the subsequent four or five years. You don't want to know what's in store for us beginning in 2020, but we'll cross that bridge when we come to it.