A Melt-Up, Then A Melt-Down In 2014

Market events such as crashes and panics are thought by economists to be random, unpredictable events.  To the contrary, such events are nothing if not predictable and often arrive with recognizable regularity.  A cursory examination of the last few decades will prove this to be conclusive.

Writing in Barron’s, Randall Forsyth pointed out that each cycle of 40-years plus “has been marked by blowups.”  He cited the following debacles: Penn Central (1970), Herstatt Bank (1974), the Hunt Brothers (1980), the October 1987 crash, the S&L crash (1990), the mortgage securities and Mexican crises of 1994, the emerging-market debt crises of 1997-98, the dot-com crash of 2000, and the housing crash of 2007-08. 

“Two things stand out” from these crises, writes Forsyth: “The calamities escalated in scale.  And each came during or at the end of a tightening cycle by the Federal Reserve.” 

Forsyth’s observation that financial crises have increased in magnitude since circa 1974 is a testament to the increasing strength of the “winter” phase of the Kress 120-year cycle.  The periodic market crashes of each decade since the 1970s have progressively worsened due to this acceleration of deflationary pressure exerted by the long cycle. 

The 120-year cycle is a composite cycle, which means it has multiple components.  Arguably the most dominant of these components is the 40-year cycle.  There are three such 40-year cycle bottoms within a complete 120-year cycle.  Each previous 40-year cycle was accompanied by a significant market event or economic crisis.  It would be highly irregular if 2014 didn’t witness a discernible setback of some sort with the 40-year cycle bottoming later next year.

Incredible as it may sound, we’re one of the lucky few generations that get to witness the momentous changes wrought by the 120-year cycle bottom.  The discoverer and exponent of this cycle, Samuel J. Kress, called it the Revolutionary Cycle.  This long-term cycle of inflation/deflation is always characterized by revolutionary changes, either social or economic in nature, and the last such generation to witness a revolutionary cycle bottom was in the 1890s.  It was that generation that saw the revolutionary change in the U.S. away from an agrarian economy and towards an industrial one. 

Financial and economic crises typically set the stage for social and political changes of a revolutionary character.  It isn’t for naught that the 120-year cycle is known as the Revolutionary Cycle. 

The late Mr. Kress fervently believed that the upcoming 120-year cycle bottom in late 2014 would witness the demise of free market capitalism and the beginnings of a full-fledged socialist political revolution in the U.S., and he wrote extensively concerning this.  With the upcoming implantation of State-mandated universal health coverage – right on schedule in 2014 – it would seem that Mr. Kress’ prediction was on target. 

The set-up for a market melt-down in 2014 as the 120-year cycle bottom draws closer is the developing “melt-up” in the weeks and months ahead.  Pushed higher by a floodtide of share buybacks and concentrated institutional buying interest in a select few shares, the major indices have defied the bearish pronouncements of analysts and letter writers for most of 2013.  With their backs to the wall, these erstwhile bears are slowly admitting defeat and have begrudgingly joined the ranks of the bulls.  This trend will likely accelerate into 2014 before the market encounters turbulent waters later in the year.

When there is near unanimity of opinion about the stock market’s direction, the bulls will be faced with a serious challenge.  A one-sided, bull-dominated stock market is a top-heavy one and is quite vulnerable to unexpectedly bad news.  The bad news for 2014 could be an anticipated hike in the Fed funds rate, an economic slowdown in China or trouble in euro land.  This is when the downside pressure of the long-term cycle bottoming will inflict maximum damage. 

On the institutional front, Goldman Sachs analyst David Kostin is one of the very few dissenters from the super-bullish consensus among analysts making 2014 forecasts.  He rightly points out that the market hasn’t suffered a serious decline in two years and is ripe for one in 2014.  “We had a 40% rally in the past 18 months with no correction,” he recently told Barron’s.  “It’s hard to identify why, but an increased probability of a correction next year is worth emphasizing.”  Unlike most Wall Street institutions, Goldman tends to be on the leading edge of critical market junctures.

Also worth noting is the research by Ned Davis which shows that mid-term election years (i.e. the second year of a presidential term) show an average decline of 21% going back to 1934.  “But,” adds Davis,” “after the low was hit in those years, the market, on average, gained 60% over two years.  So a correction [in 2014] should be followed by a great buying opportunity.”  This assessment jibes with the 120-year Kress cycle view which suggests a major bounce-back following the cycle’s bottom in late 2014. 

For now the bulls still carry the day on Wall Street.  Look for this state of affairs to reverse at some point in 2014 after the last of the bears have capitulated and joined the bulls.  Indeed, the anticipated revolutionary changes produced by the upcoming 120-year cycle bottom may well begin with a revolutionary change in Wall Street’s sentiment profile.

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