It has been said that any sort of statistical historical analysis of the financial markets is fraught with danger, given its reluctance to play by the rules. But there is one rule that even the market has adhered to time and again, regular as clockwork, as though it was rendered powerless by its command. This rule has been dubbed as the four-year cycle, and it’s quite relevant to India too.
The origins of the cycle remain rather dubious. In the book ‘Cycles: The Mysterious Forces that Trigger Events’ by Edward R Dewey, there is an interesting story about a group of investors on Wall Street in 1912: having heard that Rothschild had analysed Consol prices and discovered a mysterious set of curves in their oscillations, which he used for forecasting price movements, the group engaged the skills of a mathematician to replicate this formula.
Success ensued when the group adapted their investment strategy to a 41-month cycle. In 1923, the cycle came to academic attention when Joseph Kitchin published an article entitled ‘Review of Economic Statistics’, outlining the discovery of a 40-month cycle resulting from a study of US and UK statistics from 1890 to 1922.
At the same time, WL Crurn, another fellow Harvard professor, found a cycle of 39, 40 or 41 months in commercial paper rates in New York. The Kitchin cycle is now taken as being about four years in duration.
Looking back at history, when Great Britain was the dominant economic power of the world, this cycle would fluctuate anywhere between three and five years, averaging four.
More recently, however, the US has taken over this role and, because politicians cannot resist intervening with monetary and fiscal policy to help get re-elected, the cycle has become phase-locked with the US presidential election cycle, mandated at four years.
A logarithmic chart of the Dow Jones Industrial Index reveals the four-year cycles quite clearly. By using statistical procedures, one can extract the cycles from the raw data and place the lows every four years, as regular as clockwork. Since 1938, the cycle has only failed once — in 1987.
To conclude, given that it’s virtually impossible to tell when the market is going to top out, you can use the averages as a guide to tell when the cycle is long in the tooth and when it isn’t.
Extract from a report by Robbin Griffiths Head of Asset Allocation, Rathbones
Heed the signs
Investment timing is very much like crossing a road with traffic lights. When the light is red, crossing the road is a risk not worth taking. The best option is to wait for it to turn green, even though you lose time.
Stock markets follow a four-year cycle. Use that as your traffic light. Buying into equities at the very top, when they are about to enter a bear phase, is like crossing the road at a red light.
Given that it is virtually impossible to predict the top, let the past averages of the cycle guide you. On an average, the bull leg of the four-year cycle lasts 34 months; the bear leg may be about 11 months.
All things considered, by using the statistics of the total and average cycle length, the beginning date of the cycle, the influence of seasonality and the current market conditions, we can say that the low of the (US/UK) market could occur some time in October this year.
Placing the lows on the cycle is easier and more precise than placing the tops, for the simple reason that fear overcomes greed.