BEING STREET SMART
by Sy Harding
CYCLES NOT ENDLESS
The favorite forecasting tool of scientists,
economists, and yes, investors, is to simply extend the current trend into
The problem with such thinking is best illustrated by
the fact that the world hardly ever comes to an end. Yet for centuries 'trend
extending' has regularly predicted just such a result - based on everything
from holy wars or black plague centuries ago, to nuclear weapons, the depleting
ozone layer, AIDS, and communism taking over the world, of more recent times.
In the 1940s, it was scientific fact that there would
not be enough land to feed the growing U.S. population by the year 2000.
However, trends only continue until conditions
Farmers learn new soil management, new cattle feeding
and breeding techniques. Science develops healthier seeds. Farm machinery
manufacturers provide more efficient equipment. Oblivion is not only avoided and
the trend reversed, but the problem cycles to the opposite extreme: food
surpluses, overflowing government food warehouses, gifts of surplus grains to
foreign countries, even subsidies to farmers to leave their fields unplanted.
Cures are discovered for the most devastating of
diseases, with the result that the straight-line trend to extinction on that
front is not only halted, but reversed to ever-longer life expectancies. Not
surprisingly, that new trend is then extended in a straight line in the opposite
direction, to fear that ever-longer life expectancies will bankrupt the Social
Security system, and ever-older but healthier elders will drastically change the
world in previously unimaginable ways.
Communism spreads around more than half the planet,
raising a real concern that it will take over the rest of the world, but in the
process stretches its untenable economics past the limit, and the trend reverses
to the present expectation that communism is headed for oblivion (don't bet on
Nowhere however, is the tendency to extend trends in
a straight line, without expectations of reversals, more prevalent than in the
world of economics and investing.
A few years ago the U.S. budget deficit had been
worsening for a couple of decades, to such an alarming degree that economists
competed with each other with dire forecasts of how soon the country would be
bankrupt. However, government cut-backs, combined with a big surge in tax
revenues (thanks to the booming economy and explosive stock market of recent
years), not only produced a balanced budget, but a budget surplus. Now that
trend is being extended endlessly into the future, primarily by Congress, as it
makes plans to spend the surpluses it expects will continue well into the next
For the seventeen years prior to the beginning of the
current bull market in 1982, the market made no progress for buy and hold
investors. The Dow hit 1000 for the first time in 1965, made repeated runs at
1000 through the 1970s, but failed to break through until 1982. Investors
extended that going nowhere trend into the future and stock-brokers couldn't
pay the public to look at the market.
Instead, investors fell in love with gold, which had
soared from $35 to more than $800 an ounce. Extending that trend into infinity analysts predicted gold would soon reach
$2000 and then $3000 an ounce. Investors suddenly couldn't get enough of it,
even melting down family heirlooms to extract the gold.
We know what happened. Gold reached $875 an ounce in
1980 and then the trend reversed to the downside. With only temporary rallies
since, gold has been in a 19 year long bear market, plunging 70% to its current
level around $260 an ounce. Needless to say, the downtrend in gold is now being extended into infinity.
Meanwhile, the Dow was at 800 in 1980. As mentioned,
no one was interested in it. Gold at $800 an ounce, and in an up-trend, looked
like a better bet. But, almost unnoticed, the stock market began to reverse its
trend, to the upside.
By 1994, the Dow was at 4000, 500% higher than its
level in 1980. Only then did investors take notice, and begin to chase that
trend. How do we know? Because 85% of all the money currently in mutual funds
flowed in only since 1994.
So now, with the Dow above 11,000, that trend
is being extended to infinity with talk of a new era, 20,000, even 30,000 on the
Dow likely in just a few years.
Investors might do themselves a big favor if they could train themselves to think cycles, not endless trends.