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BEING STREET SMART 

by Sy Harding

THINK CYCLES NOT ENDLESS TRENDS. December, 1999.

 The favorite forecasting tool of scientists, economists, and yes, investors, is to simply extend the current trend into infinity.

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 change.

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 it.).

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 century.

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.

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