Thursday, 29 December 2011

Ten Investment Commandments & Outlook for the Year 2012

The New Year 2012 is very soon approaching and we will be busy making different wows in order to improve our health, social and family life. Now, let us also make 10 commandments to improve our financial health through the year 2012 for our entire future lives. And at the end of it there is a brief view and outlook on different asset classes for the year 2012.

Commandment 1: Thou shall make a proper Asset Allocation Plan
Asset Allocation is the primary premise for investments. Long term statistical analysis has shown than 90% of our returns are due to proper asset allocation, 9% through stock selection ad 1% through market timing. While allocating assets, remember to allocate only that much funds to equities which you don’t require for atleast the next 5-years and which you can emotionally see it going down by upto 50% in the short term and not panic on it.

Commandment 2: Thou shall do proper budgeting
Thou shall not invest what is left after spending but spend what is left after investing. Investing without a purpose is bad, but investing when you have high-interest debt is much worst.

Commandment 3: Thou shall take proper family protection
Thou will not confuse insurance with investments. Thou shall take proper insurance cover of atleast 10 times your annual after tax expenses (revenue and average of past 3-year capital expenditure). Thou shall also take proper medical insurance.

Commandment 4: Thou shall take proper Asset protection
Before starting to build fresh wealth, it is our duty to protect our existing assets. Assets like house, flat, or car can be insured against accident and natural perils. The event of earthquake or terrorist attack to our flat/ house seems to be remote but the impact of such things could change our financial stability upside down. So protect your house and other major assets with proper insurance.

Commandment 5: Thou shall buy your own house for self occupation
Thou shall look into buying your own house in the year 2012 with some bargain and discount from the developer while trying to time it in the middle of the interest rate reduction cycle (because you may not be able to get your house at a discounted price at the lowest interest rate).    

Commandment 6: Thou shall not over invest in speculative items
This would include speculative or penny stocks, junk bonds, non cash flow generating commodities like gold or silver and non-revenue generating posh real estate like beach houses. Investments in these can be done only when you have a clear view on the above asset class and expecting to gain from the price movement in it. But, you have to remember that they are speculative in nature and will not go up in perpetuity and hence you should not marry with those investments but sell it when the right time comes.

Commandment 7: Thou shall learn difference between good and bad debt
Learn to distinguish between good and bad debt. According to me, bad debt would be that debt which is used to create Gruesome / Bad Capital Expenditure – those assets like car, beach house which take away money from your pocket or a house which do not put any money in your pocket. On the other hand, Good Debt would be that which helps you in creating an Asset which then puts money in your pocket (income) as well as scope for future capital appreciation e.g. rental property which earns rent, shares which earn (tax free) dividends and both having potential for future capital appreciation. Never borrow to incur a revenue expenditure like foreign trip or gruesome / bad capital asset like a car, beach house because they will not only take away money from your pocket in the form of interest payments but also put you into recurring waste revenue expenditure in the form of maintenance of that gruesome / bad capital asset like petrol, repairs, property taxes etc.

Commandment 8: Thou shall make a proper retirement plan
If you want to enjoy the same life style which you are currently even after your retirement or have the joy of bequeathing your wealth to your children then start planning for it today. And be realistic about it – make an estimate of thou needs which will keep evolving with your age and time and also consider inflation in your computations.

Commandment 9: Thou shall remember these principles while investing in equities:

Ø      Bull and bear markets run for several years. Hence determine the primary trend of the market and don’t generally go against the primary trend
Ø      Market is supreme and above everybody - no Government, Central Bank, Industrialist or Operator can alter the primary trend of the market – they can only complicate the wave structure
Ø      Once a low is made – it gets and has to be tested once or twice – if it gets tested again and again it means that it was not the low and market is eventually going to break it
Ø      Right asset allocation and getting the macro view right are far more important and profitable rather than individual investment ideas
Ø      Never invest or trade more than you can reasonably afford to loose
Ø      Put stop loss at a logical, not convenient, place and always adhere to it
Ø      Cut losses and let profits run. Don’t let a profit get converted to loss
Ø      If you wait too long to buy, until every uncertainty is removed and every doubt is lifted at the bottom of a market cycle, you may keep waiting and waiting
Ø      Act on your own judgment or entirely on the judgment of another
Ø      Tips are for waiters and not investors
Ø      When in doubt, stay out and don’t get in when in doubt
Ø      Don’t overtrade
Ø      Don’t invest or trade based on hope
Ø      Learn to accept your mistakes in the market (otherwise market will make you accept it in a cruel way) and then analyze and learn from your mistakes
Ø      Wherever possible, trade liquid markets
Ø      Don’t believe everything which a corporate official says about his / her company’s stock
Ø      When opinions in the market are too unanimous – beware because markets are famous for doing the unexpected
Ø      Never be sentimental about an asset class or individual stock
Ø      Market is more of an art rather than science
Ø      Simple logical things work far better in the market place rather than complex algorithms, theorems, valuations principles, DCF etc
Ø      Buy the stocks of companies that have shown consistent growth in earnings and producing those goods / services which people cannot do without
Ø      Last but not the least - Never try to catch the top and the bottom because only fools can do it

Commandment 10: Thou shall not forget the above 9 commandments and keep reviewing, changing and refining it with time and your financial condition.

View on different Asset Classes:

Equities: The year 2011 was bad for equities with it loosing around 25% and valuations correcting from 18x P/E (15% premium to long term averages) to 13x (10% discount to long term averages). This correction synchronized with stubbornly high inflation, rising interest rates, policy holiday by the Government, various scams, depreciating rupee resulting to forex losses and uncertain global environment. What is the solution of all these problems and where the end lies, probably nobody knows. I just know one thing that we have to buy equities not at the best time but when we are moving from worst to bad times – probably the year 2012 will be that when we will move from worst to bad and with discount valuations invest in equities for the long term. And when shopping for stocks, during period of crisis, buy companies which are leaders in their businesses, have good management, currently facing P&L problems but with clean Balance Sheets. The Sensex is likely to bottom out in the range of 12800 to 14000; but the important point is that the roots of a new multi year bull market is likely to sowed in the year 2012 which is expected to take the Sensex to 35000 to 40000 by the year 2016 to 2017.

Fixed Income: Kindly note, that currently the inflation is high at close to 9.5% but the average for the past entire decade (2000-2010) was just 5% while the current interest rates are high at close to 10%. Therefore, if you have free surplus cash and don’t require for some years than take long term Bank FD and / or NCD of a reputed company and lock in at around 10% to 11% for the long term. On the other hand if you don’t have free surplus cash immediately but earn regular monthly income then lock into a long term (say 10 years) bank recurring deposit at around 9.5% and enjoy the high interest rates while inflation eventually does fall and at the same time build capital for your future.

Gold: As explained in one of my previous columns, Gold is a speculative financial asset with no real industrial use and whose value depends on the value of US Dollar, real interest rates in the US which in turn depend on nominal interest rates and inflation over there and then the value of Indian rupee against the US Dollar. Till the global world is in turmoil Gold is likely to rise over the next few years. However, nothing can just go up one way – over the past few weeks international gold prices has corrected by almost 16% while Indian Gold is steady because the Indian rupee has depreciated by almost 20% during the same period. It would not be out of the way to expect Gold to correct in the year 2012. Hence, look into buying Gold between Rs.2100 to 2200 per gm in the year 2012 and a price of Rs.5000 per gm cannot be ruled out over the next 3 to 4 years.

Real Estate: High interest rates have taken its toll on this sector with retail and commercial real estate prices and rentals crashing by 30% to 50%. Residential sector has been resilient because of the developers withholding price power due to easy credit available from banks who in turn are supporting them since they don’t want that to be classified as NPAs after the problems already faced by the airlines, metals, mining etc sectors. So, it’s a chicken and egg situation but residential sales have dipped by 20% to 40% in different pockets of say a city like Mumbai. So, look to buying your house in the year 2012 with some bargain and discount from the developer while trying to time it in the middle of the interest rate reduction cycle (because you may not be able to get your house at a discounted price at the lowest interest rate).   

Happy New Year 2012 with good health and sensible wealth creation!

Friday, 23 December 2011

The American Stock Market Super Cycle – 300 Years & Beyond

The current turbulent and volatility witnessed in all the asset classes including equities, bonds, oil gold, industrial metals, real estate etc and the synchronized global bear market which we are currently observing is leaving many investors totally agashed. There has been lots of panic and every investor, analyst, fund manager are debating whether this is a bull market correction or a bear market and if the answer is the latter, than whether a structural or a cyclical one. The developed markets are currently under lot of turmoil due to the debt default problems in the Europe and danger of the euro breakout while the US has its own problems of high debt, slowing growth and elevated unemployment levels. The problems of the developed world are well documented and there may not be any need to discuss them in detail over here. And as far as solutions for the same is concerned, then as of now their Governments and other regulatory authorities have not found it. Some market experts like Mr. Robert Prechter of Elliot Wave International is predicting the US Dow Jones Industrial Average (DJIA) would go to around 400 levels i.e. a crash of almost 97% from the current 12000 levels. While on the other hand Mr. Glen Neely who follows the Neo Wave believes that the US DJIA will touch 100000 (yes, there are 5 zeros after 1) not earlier by the year 2020 but latest by 2060. Such, is the difference in opinion between two renowned individuals following Elliott wave.

I am neither nor claim to be an expert like them. However, I do my own wave and market cycle analysis. I am making an attempt to predict the next 60-year large movement in US equities based on my study of human behavior, mass psychology, behavior finance, socioeconomics and the “madness of crowds” spanning back by around last 700 years including the minor financial revolution of the 1550s, troubles of Henry VIII, Francois I, the Fuggers, the Genose and eighteenth century “madness of crowds” like the South Sea Bubble, Tulip Bulb craze and the Mississippi bubbles and then combining all those with Elliot Wave, Neo Wave, market cycle studies, math cycle analysis, astronomical and planetary cycle analysis, Dow Theory, Fibonacci retracements, Earnings Yield Vs Bond Yields, cyclically adjusted P/E multiples, long term dividend yield and growth rates, inflation rates, interest rates etc have formed my own view on the long term market cycle in which US might currently be. I present in this article my personal views on the same.

Before proceeding further, kindly note that this study is a cycle analysis spanning over centuries of American civilization. This is not any short term prediction or projections. The cycles will run into several decades. We will call this the “Market Super Cycle”. Since, over the long term human civilization grows and man’s progress is dynamic and logarithmetic, the start to finish of the market super cycle would be trending upwards. However, during human civilization there has been periods of depression, severe recession, deflation, wars and other natural and human catastrophic events, the cycles are certainly not straight forward uptrending, even when compared at the super cycle level or sub-cycle level. What I mean by this is that we all know that stock markets don’t go up or down in a linear manner – but in an erratic manner giving bulk of the returns over a short period of time while not giving any return or infact giving negative return over most of the other time. The same is true with the long term “market super cycle”. During the “trending advance” of many decades there will be couple or more decades within that which will be the “corrective phase”. This correction will be both price and time wise. There are chances that a whole generation of investors will not actually know that stock market goes up also or there are bull markets also! And for them it would not had been wise to invest in the stock markets. There have been periods wherein there is depression all over or other periods of very high inflation or worst stagflation and these periods will be repeated. All these have happened and have possibility of happening in the future. So, where we are currently and what are the past cycles telling us.
I have data for the US markets since 1789 which is shown by Exhibit 1.

Exhibit I: US Stock Market Index 1789 to 1900

Source: Foundation for the study of Cycles
Now, Exhibit II graphically depicts the US DJIA since its inception at 41 in 1896.

Exhibit II: US Dow Jones Industrial Average 1896 to 2011

  Source: Dow Jones & Co.
Both these exhibits I and II, pictorially depict the US stock markets over the past 222 years i.e. from 1789 to 2011. One thing is clearly visible in the past 222 years of US stock market history and that is that over the past more than two centuries, the stock markets have trended higher. Now, within them there have been periods running into decades where they have lost upto even 90% of its value in nominal terms. There have been periods wherein the markets have lost significant value in real terms. Having said this, one thing is clearly brought out that history is dynamic and loarithmetic, not static or linear. Looking back at the 222 year chart of the US stock market we notice that sometimes advances occur in spurts followed by consolidation phases that last for long periods of time. Then again, the reverse happens. This reveals the market’s behavior. The relatively consistent advance on a log scale for the last 220-plus years demonstrates the logarithmic nature of economic progress. The market super cycle which we will use will help us forecast on a logarithmetic basis. We will have to deal with the complex reasoning of crowd psychology and chaos theory. The patterns observed over the past 222 years might be repetitive but with some variations. These repetitive patterns can then be combined to create larger patterns of appearance or design similar to the smaller structures.  

Now, let us classify the “market super cycles” which have occurred during the past 222 years. Kindly note, that these are “market super cycles” of the highest degree and hence have been captured on the highest scale. Within the “market super cycle” there would be smaller degree market cycles and sub-cycles running along side with it. Each smaller degree cycle might be running in the same direction (trend) or opposite direction (corrective) of the next higher degree cycle. The purpose of this study is not to capture the small degree cycles or sub-cycles but only the larger “market super cycle”.

Now, how do we define “market super cycle”. I have derived the “market super cycle” by studying the price behavior of the US stock market for the past 222 years spanning across more than 2 centuries. Now, if we study the past 700 years of human history and evolution of money, banking and finance then we realize that the problems which the world is facing then we see the evolution of banking which began around the time 1390 after the “loan shark” era was over, the “French invasion” in 1494 when the rogue bankers were caught, the “price revolution” in Europe from the 1540 to 1640, setting up of the Amsterdam Exchange Bank in 1609 and Bank of England in 1694.
Again, if we study the past 700 years of human history and evolution of money, banking and finance then we realize that the problems which the world is facing today regarding the European debt crisis is not just about today but has been there in history over the past several centuries and the earliest count of that was in the sixteenth and seventieth centuries when various European Governments defaulted on their debt in the years 1557, 1560, 1575, 1596, 1607, 1627, 1647, 1652 and 1662. Further, if we study the past 500 years history of the evolution of debt and bonds, then there used to be cycles in bond prices also. For example, in 1814 during the time of Napoleon and Nathan Rothschild, the latter purchased perpetual European Bonds at 55 Pounds in the year 1815 and sold it at 85 pounds in 1817. If we see the history of the stock markets beyond the past 400 years, the United Dutch Chartered East India Company was formed in the year 1602. Despite lot of difficulties which the company faced, the stock price rose from 100 in the year 1602 to 786 by the year 1733, this inspite of the fact that from 1652 until the glorious revolution of 1688 the company was being challenged by bellicose British competition. Such, sustained capital appreciation combined with regular dividends and stable prices marked the performance of this stock. As early as 1650, total dividend payments were already 8 times the original investment, return CAGR of 27%! The ascent of the stock was gradual, spread over more than a century and though its descent was more rapid, it still took more than 60 years to fall back down to 120 in the year 1794. The rise and fall of the stock closely tracked the rise and fall of the Dutch empire. The lesson we learn from all this is that the rise and fall of the entire stock market of a country which has happened steadily over certain centuries cant just collapse in 1 or 2 or even 10 years – it may take some decades for it to finally fall and go into oblivion, if ever it has to happen.

There have also been lots of bubbles over the past several centuries including the Tulip bulb in Netherlands, South Sea Bubble, Mississippi scheme, Florida land bubble etc but those were bubbles or some kid of fraudulent schemes and hence cannot in any way be compared to the US stock market.

Market Super Cycle

Now, let us re-look at Exhibits I and II. There have clearly been 3 market super cycles over the past 222 years – the third one is currently going on which might end somewhere in between the years 2060 to 2075. The first market super cycle began at 2.7 in the year 1789 (actually it might have begun much lower around 20 to 40 years back but because of lack of data we would assume it to begun from the year 1789). This up trending wave of the market super cycle lasted till 1835 where it ended at 23. Then, the corrective wave of the market super cycle commenced which took it to 8 by the year 1860. Kindly refer to Exhibit III which shows the Trending and the Corrective phase of the market super cycle I and the returns during each of the periods. Kindly note, how in the Market Super Cycle I, the returns if held over the entire cycle (trending and corrective) was just 1.54% CAGR over 71 years while if the stocks were just sold before the start of the corrective phase it would have been 4.77% over 46 years. Similar results are obtained for market Super Cycle II with slightly higher returns. Currently, we are in market Super Cycle III which I believe, based on all the studies which I have done and mentioned before in this report, that it will end around 28000 which is be beyond the year 2070 – the trending cycle might end somewhere between 2038 to 2050 at close to 75000 levels on the US DJIA while the corrective phase in all probability is likely to end around 28000 levels on the US DJIA beyond the year 2070. This conclusion has also taken into account the “Math Cycle Analysis” and the “Astronomical & Planetary Analysis” into account which I present after the conclusion. Those two would be a different kind of research work to read for the investors.   

Exhibit III: US Market Super Cycles - 1789 to 2070

Market Super Cycle
Start Date
End Date
Star date Index Level
End Date Index Level
Number of Years
Return CAGR (%)
Market Super Cycle I
Trending Phase
Corrective Phase

Market Super Cycle II
Trending Phase
Corrective Phase

Market Super Cycle III
2070 & Beyond
Trending Phase
2038 to 2050
89 to 101
7.23% to 6.35%
Corrective Phase
2038 to 2050
2070 & Beyond
20 to 32
-4.81% to -3.03%

Math Cycle Analysis

There are different math cycles like the 9.1 year cycle, 40.5 year cycle, Kondratieff wave of 56 years. The first step for any mathematician researching in any time series data is to try the spectrum analysis. It looks this way (we use the period scale in years as an X axis, the Y shows the strength of some particular cycle). To calculate this periodogram, the Fourier transform of the auto covariance function of the oscillator has been done. To be sure, we have tried to calculate the spectrum with the oscillators based on different smoothing periods. The strongest cycle here is 9.1 years cycle. The peak on 9.1 year definitely points on the importance of this cycle to American economy. Another strong cycle is 40.5 years cycle. The forecast up to 2023 year has been obtained by the Math Cycle Analysis.

Exhibit IV: Math Cycles

Summarizing these composites all together, we can get a long term forecast based on “Math Cycle Analysis” as shown by Exhibit V. The chart shows that the US markets will make some kind of high in the year 2012 and remain volatile for many years beyond it and finally make a low around the year 2020. The US markets are then likely to rally and make significant highs around the year 2023. This forecast chart also implies that the US market might make new highs only around the 2023!
 Exhibit V: Long Term projection Based on Math Cycles

The above long term forecasts of the US DJIA based on different planetary movements including the Jupiter 11.9 year cycle, Saturn 29.4 year cycle and the Saturn–Neptune 35.9 year cycle shows that the US markets will make some kind of top in the year 2010. The markets will correct up to the year 2015, then rally until the year 2018 and subsequently make a bottom around the year 2021. The US markets are then likely to rally and make significant highs around the year 2023. This forecast chart also implies that the US market might make new highs only around the year 2023!

Astronomical and Planetary Cycles

There are also different astronomical cycles based on the position of the planets in the solar system. For example, certain astronomical cycles which are useful are the Jupiter 11.9 year cycle, Saturn 29.4 year cycle and the Saturn–Neptune 35.9 year cycle.

In comparison to fixed cycles, the astronomical/ astrological cycles have irregular structure. Because the planets move not evenly and sometimes might be even retrograde (if being observed from the Earth), these astro cycles give additional dimension to our research which is impossible to get using the spectrum analysis only. The basic technique used to catch the planetary cycles is the Composite Expert module. The result obtained by this module looks like the one shown in Exhibit VI.

 Exhibit VI: Jupiter Geo Longitude Composite – 1792 to 1972  

In brief, the composite is a special kind of a diagram where we can see the change of some analyzed parameter (like DJIA, or price, or relative price oscillator) in respect to some astro event (like position of some planet in Zodiac or angle between any two planets). On Exhibit VI, the upper diagram shows how the analyzed index changes when Jupiter comes through the Zodiac. Looking at this diagram, we can tell that when Jupiter ingresses in Taurus, the DJIA is high and is starting a downtrend movement; when it reaches 15 degrees of Leo, this index is low and starts up trend.
The stock market usually leads the economy by one year. Bill Meridian's study of US economic production over the same time period shows that the economy bottoms when Jupiter is in Virgo. Thus, the finding that the stock market bottoms in Leo makes sense. We understand very well that the composite gives us the picture "in average", because there are a lot of other factors (and non astronomical as well) that hit the stock market. My modest purpose is only to demonstrate how astronomical factors also move the economy.
It is very difficult to specify what astronomical cycles are important and what are not. This problem is not the math problem only, it arises of the fact that analyzing long term periods we have no enough data to produce the mathematically (statistically) correct research. So, in any case, conclusions will be hypothetical, but providing enough evidence to accept it as a working theory. To select the playing planetary pairs, we have compared the two composites created on two different independent intervals- 1789-1900 and 1900-2004. After that, we have created composites for each of these two intervals and compared them. If these two composite give approximately the similar composite diagrams, we would have to accept this composite model as a working one. Kindly look at Exhibit VII.

 Exhibit VII: Composite Jupiter Position Geo 1789 to 1900 & 1900 to 2011

The reader will observe two composite diagrams, the upper is created on 1789-1900 data, the lower composite is calculated using the data 1900-2011 year. Though they are not identical, there are similarities there- tops and bottoms are almost the same (for example, Jupiter in Taurus - downward trend; Jupiter around 15 degrees of Leo - upward trend starts for DJIA). I have marked some turning points by red arrows. To understand better what is going on we can consider the composite diagram as a memory of stock market regarding to the position of the planets above. When any planet comes through some point on Zodiac, the stock market somehow "remembers" it. While time is going on, new "memory" of the event is added to the previous one, making this cycle stronger. Then something totally new occurs (like slow moving planets ingress another Zodiac sign), and the memory of the past starts to fade; the cycle is weak and ceases to exist.

Summarizing these composites all together, we can get a long term forecast based on planetary cycles as depicted by Exhibit VIII. The long term forecasts of the US DJIA based on different planetary movements including the Jupiter 11.9 year cycle, Saturn 29.4 year cycle and the Saturn – Neptune 35.9 year cycle shows that the US markets will make some kind of top in the year 2010. The markets will correct until the year 2015, then rally to the year 2018 and subsequently make a bottom around the year 2021. The US markets are then likely to rally and make significant highs approximately in the year 2024. This forecast chart also implies that the US market might make new highs only around the 2024!

 Exhibit VIII: Astronomical & Planetary Cycles - Long Term Forecasts of US DJIA till 2025


After extensively studying all the aspects mentioned in this report, I conclude that the US stock markets are currently in the market Super Cycle III of the Grand Market Super Cycle which started latest in the year 1789 (from where we have data) and which is likely to make a top at around 75000 levels on the US DJIA between the years 2038 to 2050 after which the “corrective phase” within the “Market Super Cycle III” is likely to commence having a downside target of close to 28000 which is probable to be achieved not before the year 2070.