I love to post about economy and investing in my blog, I do that to communicate with other people interested in the topic, get feedback for my thoughts from those who know the topic, in short to test my ideas and meet the people across the wire.

My investment motto is:

I never trade on charts and TA (Technical Analysis), I invest strictly on fundamentals. But I believe that there is no better way to check fundamentals then charts and TA

Economic cycles

The economy is a highly cyclical matter, similar to weather seasons or a pendulum. The slow and steady growth is impossible, as everyone is trying to jump ahead of competition, good and bad surprises do shake the economy, the manias and panics defy fundamentals and foreign economies are beyond any control. But as a pendulum swings, for every boom there is a boost. If we had 5% GDP growth at some point, it has to end up with a recession, that’s the price for the boom.

The blood of economy are money. Whatever happens in production and consumption has money as source and outcome. The main property of money is what is driving the economic cycle – it is inflation or deflation. Inflation is when money supply and velocity (speed of money circulation) is growing too fast. Deflation is when money supply decreases and velocity is slowing down. What is usually taken for inflation – increase of prices – is just a shadow of inflation over price stickers.

The Great Depression

So the economy cycle is, essentially, the swing from inflation to deflation and back. There is a long, or Kondratieff, cycle, when inflation secular trend is to go up for 20-30 years, and then go down for another 20-30 years. Every secular trend ends with absurd valuations. The inflationary trend ends up with Treasury bond yields in the 15%-20% range. The deflationary trend ends with Treasury yields in sub-1% range.

The extreme deflationary shock is called The Great Depression. So far the Great Depression in US happened three times – in 1835, 1875 and 1929. The Fourth Great Depression will happen soon, maybe starting within 1-5 years. The Fifth Great Depression will happen 60-70 years from now, and so one.

There is nothing special and wrong about Great Depression, it’s a very important and useful part of economic cycle. It’s goal is to shake out the bad debt, mostly through defaults and bankruptcies, and start the new fresh cycle with no debt and clean balance sheet. As for investor, there are tons of investment opportunities on every part of the cycle, even during the depression. Usually the Treasury Bonds are making a home run during the early phase of depression, then the collapse of commodities creates the amazing opportunities few years later.

I have a separate article in Kondratieff wave here.

The short Kitchin Cycle

The Kitchin cycle lasts about 4 years. The inflationary phase takes 2-3 years, then the deflationary phase takes 1-2 years. Sometimes the deflationary phase ends with recession. Sometimes it ends with just a slowdown, or growth recession, then the two cycles join together into one 7-year cycle.

If the Kondratieff secular wave is inflationary, the inflation part of Kitchin cycle is especially inflationary, while the deflation phase is not that much deflationary. In opposite, when the wave goes down, the inflation is just a blip, while deflation is painful.

Investing using cycles – rotation

The main tools of the investor are: stock indices, stock sectors, Treasury bonds, AAA-bonds, high-yield bonds and commodities. Almost at every point of the cycle at least something goes up and at least something goes down. So the cyclical investor always has at least something long and at least something short or in avoid list.

The sequence of peaks and troughs of every market tool or financial/economic indicator is more or less known and every confirmed peak is a signal to rotate money from something to something else. There is nothing so good to buy and hold, unless you are happy with minimal return or don’t want to have some fun.

Using charts and TA

I think that using a chart and TA to predict the moves of the same chart is more or less like pulling yourself up to the air by pulling the hairs up. Why doing that?

What I prefer is to use one chart to predict another chart. This way you don’t need to guess the top or the bottom. You wait for a confirmed top or bottom and then expect the top (bottom) of another chart. The relationships and sequences are huge in number, some are well known, some are tricky. For example:

  • The home improvement retailers will peak after the peak in new+existing home sales
  • The utilities, REITs and financials/banking will peak before S&P500
  • Junk bond prices will peak after treasury bonds
  • Junk bond spreads will bottom after banking sector peaks
  • PCE (personal consumption expenditures) will peak after real hourly earnings
  • S&P500 will peak after PCE peaks
  • Involuntary inventory accumulation peaks after PCE and is observable by sharp decline in bond prices
  • Industrial production will peak after S&P500
  • Cyclical sectors stocks peak after Industrial production
  • Capital spending peaks after Industrial production
  • Job market peaks after Industrial production, too (i.e. it trails market peaks, sometimes by a while)
  • Commodities peak after Industrial production
  • Junk bonds are crashing after capital spending peaks

About major indices

The broad stock indices, like S&P500 are often misleading. The sector rotation at the top and bottom of the market means that large sectors may move against the index trend. That means two things. First, tracking industry sectors is far more important that tracking $SPX. Second, going long or short $SPX is usually counterproductive, as you always get long something that should be avoided or short something that is booming. It is far better to go long or short the particular sectors of the economy

Fighting emotions

It is very counterproductive to invest on emotions. Usually it happens when you can be qualified as a “bull” or a “bear” and start investing against the prevailing trend. The best way to avoid being bull or bear is to chop the investment universe into sectors and then become bull and bear in various sectors at the same time. Being long and short at the same time helps you to look at the market moves with a calm gaze

The Resession obsession

Leave the recession to politicians, it’s their problem, not yours, as long as you have job, of course. What investor has is a bull markets and bear markets in various instruments. For example, real estate, some financials, utilities and consumer durables related stocks will start crashing down long before the recession starts and actually can reach near the bottom at the point the recession starts. The first day of the recession could be a good day to buy some utility stocks, so it’s too late to be a bear at that point

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