The Observed Economy

The Observed Economy


I'm an amateur economist with fairly extensive formal training as a social scientist. I have a long-standing interest in modeling and simulation, and a nearly lifelong fascination with probability and statistics. Professionally I've done P&L forecasting for a Fortune 500 company and built models of customer behavior for a credit union.


2017 Investment Bulletin - 2 Jan 2017

by Chris Mitchell

KEY INDICATORS

* Labor Market Cycle: NEUTRAL
* Presidential Cycle: NEUTRAL
* Labor Market Trend: UP
* Rate Trend: NEUTRAL

Allocation Model: 90% equities, 10% bonds/cash

Rotation Selections: Large Cap Value, Energy

(see notes section for clarifications on allocation & rotation)

LOOKING BACK: A SMOOTH CLIMB

A bounce-back in emerging markets buoyed the Boom Wave portfolio for most of 2016, and the US rally at the end of the year more than compensated for a return to softness in the emerging markets. Large cap value fared particularly well, as the new political look in the US would appear to favor growth in old-line names that may have been overlooked during the recent tech run-up.

Personally I found significantly increased responsibility, along a modest rise in my wage during 2016. I feel reasonably well-positioned to glide into retirement or semi-retirement. There was a bit of excitement as we were flooded out of our rental and ended up moving, twice, shortly thereafter. But we were fortunate to have resources to cope with such an emergency.

LOOKING AHEAD: ROOM TO RUN

I will let a chart of current and historical Dow price levels say 1000 words about the outlook for the next few years. Boom waves vary significantly, but the theory forecasts strong stock market performance for the next few years. Any drawdown in 2017 would be seen as a 'head-fake', washing emotional investors out of the market ahead of a big run-up and forcing them to play catch-up later. We shall see, but patterns like that are why mechanical systems tend to outperform purely gut-level investing.

2017 boom wave outlook

I noted above that my job responsibility increased quite a bit, while my wage rose modestly. The small raise was welcome, and I received quite a bit of pleasant feedback. Still, it's worth noting in this context that it has been quite some time since the general trend was for income gains that correspond with increases in responsibility. To the contrary, the corporate ethos has been to cut jobs -- actively or through attrition -- and then to distribute the same work among fewer people. Perhaps a tighter labor market will finally change this math for awhile. I certainly wish you all well in your educational, vocational, or retirement activities.

DISCLAIMER

This bulletin is intended for informational purposes only and is not an offer or inducement to trade securities. Research suggests that a diversified buy-and-hold portfolio is the best strategy for most individual investors. The Bogleheads Wiki at bogleheads.org/wiki is a good place to get started with a buy-and-hold strategy.

NOTES

Rotation picks should be considered speculative. Rotation selection portfolio returns tend to be more volatile than allocation model returns in backtesting and out-of-sample real world returns. However, a blended portfolio of 85% allocation model and 15% rotation selections appears to be less volatile than either alone.

Fixed income is 100% US intermediate-term treasuries in the model portfolio. In practice I've substituted high grade corporate bonds and cash.

Equities in the allocation model portfolio are a fairly even mix of Large Cap Value, Mid Cap Blend and Emerging Markets. In practice I've invested, at times, in International Growth as a proxy for Emerging Markets.

For charting I usually just look at the Dow, although any cyclical index should be fine. Other cyclical indexes include the Hang Seng and the Morgan Stanley Cyclical Index.


2016 Investment Bulletin - 1 Jan 2016

by Chris Mitchell

KEY INDICATORS

* Labor Market Cycle: NEUTRAL
* Presidential Cycle: NEUTRAL
* Labor Market Trend: UP
* Rate Trend: DOWN

Allocation Model: 90% equities, 10% bonds/cash

Rotation Selections: Short Term Treasuries, Intermediate Term Bonds

(see notes section for clarifications on allocation & rotation)

LOOKING BACK: GLOBAL WOES

2015 was dominated by nearly continuous bad news from global markets, ranging from China to Greece. My emerging markets shares are down about 18% for the year as of this writing. The US was a relative strength, but only enough that the US-based selections in the portfolio broke even, roughly. Taken as a whole, an uninspiring investing year featuring a modest loss in the overall Boom Wave portfolio.

With that in mind, my notes from a year ago read "If we meet again in 12 months it will likely be for a bit of friendly chat and a reminder to 'stay the course'". The recent stretch of relatively mild labor statistic readings will usher in a few years of strong corporate performance, in theory. Caveats abound: stubborn long-term unemployment, low labor market participation rates, lack of lower- and middle-class wage growth, and a possible "new normal" of sluggish GDP growth. This time might be different, slightly. However, I don't think the post-war corporate or monetary regime has changed to the extent that business cycles are permanently altered. I'll remain invested in equities and hope for the best.

I've included a short personal note in recent years, and will continue the practice with a brief update this year. Late in the year I branched out from web development into social media operations, a new work area I'm finding quite interesting. As an old hand at web forums (I coded one from scratch in 2001), it's not entirely unfamiliar terrain. Overall I had more success with my personal capital than with my investment capital in 2015.

LOOKING AHEAD: WHERE'S THE NEXT BOOM?

The benign labor market (as measured by the US U-3 unemployment rate) didn't last long. U-3 hit 6.1 in mid-2014 and had dropped below 5.5 by mid-2015. In theory, that was still time for key players to match with productive jobs ahead of the next leg up in the business cycle. Tech booms like the recent runup in mobile and social properties usually spread to the larger economy as broad increases in productivity. The process is far from immediate, and it's also difficult to pick which sectors will benefit most. If a broader boom does happen, it will be good news for workers, since wage gains should go to the broader market rather than to the technically savvy, as often happens during tech booms. Smartphones and social sites like Facebook and Twitter are certainly reaching ubiquity. It will be interesting to see how the world's medium and small businesses take advantage of these new channels.

While the tactical allocation model says "stay invested", the rotation model has gone on the defensive due to the interest rate climate levelling off. Trading on that advice will put my overall mix at around 75% equities, 25% bonds.

DISCLAIMER

This bulletin is intended for informational purposes only and is not an offer or inducement to trade securities. Research suggests that a diversified buy-and-hold portfolio is the best strategy for most individual investors. The Bogleheads Wiki at bogleheads.org/wiki is a good place to get started with a buy-and-hold strategy.

NOTES

Rotation picks should be considered speculative. Rotation selection portfolio returns tend to be more volatile than allocation model returns in backtesting and out-of-sample real world returns. However, a blended portfolio of 85% allocation model and 15% rotation selections appears to be less volatile than either alone.

Fixed income is 100% US intermediate-term treasuries in the model portfolio. In practice I've substituted high grade corporate bonds and cash.

Equities in the allocation model portfolio are a fairly even mix of Large Cap Value, Mid Cap Blend and Emerging Markets. In practice I've invested, at times, in International Growth as a proxy for Emerging Markets.

For charting I usually just look at the Dow, although any cyclical index should be fine. Other cyclical indexes include the Hang Seng and the Morgan Stanley Cyclical Index.


2015 Investment Bulletin - 1 Jan 2015

2015 Boom Wave Theory investment bulletin

by Chris Mitchell
lensman00@yahoo.com

KEY INDICATORS

- Labor Market Cycle: NEUTRAL
- Presidential Cycle: UP
- Labor Market Trend: UP
- Rate Trend: NEUTRAL

Allocation Model: 90% equities, 10% bonds/cash

Rotation Selections: Large Cap Value, Emerging Markets

(see notes section for clarification on allocation & rotation)

LOOKING BACK: A CHOPPY YEAR

2014 was a classic stock-picker's year with some sectors outperforming others and seasonal variations in volatility keeping market timers guessing about their exit and entry points. It was nice to be able to rely on a mechanical system to make the decisions for me. My hunch is that any reasonable system that takes emotion out of the investing equation will outperform a majority of individual investors, who are well known for falling prey to panic and elation in their trades.

The recommended rotation trades from last year were REITs and US small caps. My REIT fund, acquired near the start of the year, was the big winner for 2014, gaining nearly 20% before I sold in early October. Small caps also did reasonably well, as I delayed that trade for some months and bought into a dip. As of this writing, my small cap fund is up about 7%. Even bonds, which I recommended hanging on to along with some cash despite widespread fear of a 'bond bubble', did quite well as yields took an unexpected dip in the first part of the year. Finally, that cash is also looking stronger on the global market, whether you want to buy imported goods or just fill up the gas tank.

My only trading error may have been getting back into the market too early in anticipation of 2015. I went from 0% to 90% equity allocation just before the October dip and am only now drawing roughly even with most of those trades. Emerging markets are part of my current equity allocation. Those were beat up even worse than US stocks and still show a loss as of this writing.

Personally, I wound down my data processing business of seven years and returned to full-time work in web development under contract to a large company. However, the industry is the same I've worked in and around for the past 12 years here in Oregon's Silicon Forest: semiconductors. Whatever the popular device of the day, there is bound to be some electronic magic in there somewhere.

LOOKING AHEAD: BUILDING BLOCKS FOR A LONG BULL MARKET

I seem to do best with my trades when I simply read the model without trying too hard to interpret in light of the news and superfluous trends. At its core, the model cares about two things: the well-known U-3 US unemployment rate and the four-year US political cycle. The U-3 rate stands at a moderate level (5.8% as of this writing) that historically signals 5 year bull market stretches, while 2015 finds the four-year political cycle at its historical apex, in the year after mid-term elections are held. The specific timing of trades may be a little fuzzy: the mild employment market might drive a boom beginning in 2016 rather than in 2015, but the other benign indicators suggest that an investor may as well get in now and hold for at least a couple of years. If we meet again in 12 months it will likely be for a bit of friendly chat and a reminder to "stay the course" as far as investments are concerned.

The rotation model's picks are a subset of the allocation model's standard equity mix, so this year's guidance is simple: get in the market and stay in the market.

My personal goals are to gain mastery of my new job position and continue to network within the company. My co-workers are very interesting and entertaining, and I have been enjoying the social side of office life after working out of a home office for several years. It's not a startup environment or Google, but there is fun to be had at even a larger technology company. I'm also working toward formal certification as a software tester.

For now, boom wave theory underpins a personal investment system. I'll continue publishing this annual newsletter, and tracking real-life results. As of this writing, my allocation trades since the system's inception are about .50 correlated with movement in the Dow (Pearson's R).

DISCLAIMER

This bulletin is intended for informational purposes only and is not an offer or inducement to trade securities. Research suggests that a diversified buy-and-hold portfolio is the best strategy for most individual investors. The Bogleheads Wiki at bogleheads.org/wiki is a good place to get started with a buy-and-hold strategy.

NOTES

Rotation picks should be considered speculative. Rotation selection portfolio returns tend to be more volatile than allocation model returns in backtesting and out-of-sample real world returns. However, a blended portfolio of 85% allocation model and 15% rotation selections appears to be less volatile than either alone.

Fixed income is 100% US intermediate-term treasuries in the model portfolio. In practice I've substituted high grade corporate bonds and cash.

Equities in the allocation model portfolio are a fairly even mix of Large Cap Value, Mid Cap Blend and Emerging Markets. In practice I've invested, at times, in International Growth as a proxy for Emerging Markets.

For charting I usually to just look at the Dow, although any cyclical index should be fine. Other cyclical indexes include the Hang Seng and the Morgan Stanley Cyclical Index.


2014 Investment Bulletin - 29 Dec 2013

2014 Boom Wave Theory investment bulletin

by Chris Mitchell
lensman00@yahoo.com

KEY INDICATORS

- Labor Market Cycle: DOWN
- Presidential Cycle: DOWN
- Labor Market Trend: UP
- Rate Trend: NEUTRAL

Allocation Model: 0% equities, 100% bonds/cash

Rotation Selections: Small Cap Value, Real Estate Investment Trusts

(see notes section for clarification on allocation & rotation)

INTRODUCTION

I've been studying business cycle theory since 1987, when Black Monday piqued the interest of a young man soon to enter the labor market. How could otherwise robust economies yield such wild swings in markets? In 2008 I began to devise a real business cycle theory based on what I saw as an oversight: the labor market had been considered a lagging indicator but my research showed it was also a leading indicator. My research quickly became Boom Wave Theory, and to validate the theory I moved on to build model portfolios which I have also been investing on and tracking since 2009.

Boom Wave Theory appears to straddle the economy and the markets right at the point where business cycles drive booms and busts. In the Boom Wave Cycle model, each year is rated for its cyclicality, so ultimately the model seeks to account for the stochastic movements that have kept real business cycle theorists -- and real businesspeople -- on their toes for so many years.

OK, let's descend back to Earth from the 30,000 foot theoretical view. I've also been recording annual Boom Wave Theory bullet points since 2011 in anticipation of writing a newsletter. This year I've decided to get to work and start writing. Further background on the theory plus some charts have been available on my site since 2011.

LOOKING BACK: A BOOM WAVE BULL RUN

In September 2012 I wrote that "if Boom Wave theory holds up the Dow and other cyclical indexes should make a moderate to strong move up over the 15 months beginning Q4 2012". That certainly did come to pass as the price level of the Dow is up around 22% in that time. Cyclicals had a great year, as did the broader US market.

By contrast, Emerging Markets, one of the rotation selections for 2013 as well as a component of the equity allocation model portfolio, had a rough year. My personal portfolio was holding International Growth as a proxy, which did somewhat better.

The tendency for an up market in the late stage of a Boom Wave is historically very strong. This recent 15 month run ranks only 6th out of 9 historically among Boom Waves tracked by the model (assuming no major price swings in the last two trading days of the year). From Q4 1954 through Q4 1955, the Dow rose over 50%!

Personally I took profits on about half of my equity holdings in early August and the other half in recent days. The August trade was a good sleep-at-night trade which I don't regret as it came near a temporary market top. Still, I was a little surprised by the market's recent push to new highs. As of this writing, the Schiller P/E 10 ratio sits at a rather pricy 26. My August and December trades closed positions originally taken in October of 2011 when the P/E 10 was around 21.

One somber note, for both the economy and for me personally, is the unemployment rate. While there are signs that the recovery is finally beginning to feed on itself and accelerate (as forecast by the labor market trend indicator), the process has been nerve-wrackingly slow.

My regular work as a marketing database guy, usually a veritable flood, came as something more like rivulets in 2013. Part of that is due to task automation, which I had a hand in. I had also been urging a client to push harder into Chinese markets, which he began doing.

It may take a few years for those investments to pay off and in the meantime budgets are tighter. So my personal experience is very much in line with my macro understanding of the current issues and trends: it may take some time before current investments make it back into the broader US economy, but when they do we will probably be surprised at the economic surge that results. I remain optimistic about long-term prospects for the US and global economies and only slightly less optimistic for the average worker, who will continue to face challenges from automation and regional economic dislocations. In the next section I'll look at the short-term forecast.

LOOKING AHEAD: BLOW-OFF MARKET TOP POSSIBLE

Coming off a long bull market as forecast by Boom Wave Theory, 2014 enters looking like a typical late blow-off phase where the market tops dramatically and then either corrects or trades choppily sideways for much of the year. I can't be as confident of that forecast as I was of the recent bull market, but the 6 comparable periods in market history range from tepid to scary. January appears likely to see a big move to either the upside or downside, which I interpret as either a blow-off top or a correction (or perhaps both).

Despite still-low rates, fixed income vehicles (funds, ETFs) could benefit in the short term from flight-to-quality market action in Q1 and Q2. There remains risk of a swift interest rate hike pulling down values of fixed-income vehicles. While the model deems a dramatic rate hike in that time frame somewhat unlikely, and the Fed has indicated that will happen only when the unemployment rate drops to 6.5%, the prudent might prefer to stay partly in cash. It would be idle money waiting for the next ride to bull territory. A few years ago, my brother described the way the system trades as a "cash ratchet" and I can't improve on that wording.

The model, which can give preliminary readings years in advance, will call to re-enter the market in late 2014 and hold through most or all of 2015. Regarding the "art of the trade" I'll be looking for the first day after September 1st, 2014 where the 50 day moving average of the Dow shows an upward slope, and move to an equity allocation of 80%. As the unemployment rate crosses below 6.5% , expect the Fed to begin taking upward interest rate actions. On the other hand, a period of moderate unemployment will help clear excess supply in the labor market, and those clearing periods are central to Boom Wave Theory. Such inflection points have tended to signal multi-year bull markets in cyclical stocks.

As for the long term, I've observed that bull markets tend to come in the form of alternating research booms and export booms. During research booms, investments are made in technical niches and a disproportionate share of the benefits go to the technically skilled. During export booms, the broader economy benefits as technical innovations spreads throughout all sectors and industries, often in surprising fashion.

For instance, the 1990s were a research boom when the internet blossomed and the 2000s were an export boom when web-based tools were applied to disparate markets (most notably the real estate market). The recent boom followed this trend and was a narrow research-based boom concentrated in energy innovation, social media and mobile devices. The next leg up will likely be larger and broader-based as those innovations find novel application in US and global markets.

I might look to move a small slice of my personal investments into the relatively volatile rotation selections of REIT and Small Cap Value. Preliminary thoughts on timing would be to grab an REIT slice immediately to see if it might be a safe haven in a rough market, but save Small Cap Value investing for later in the year when the next big run-up appears imminent (perhaps after a correction, capitulation and base-making series of chart events).

Personally I'll try to stay adaptable to changing conditions and redeploy my personal capital. In 2014 I plan to dust off my accounting skills and learn QuickBooks as I have an A/R job in my queue.

BEHIND THE SCENES

While the core Boom Wave models are very stable, I'm continually looking for ways to improve my personal portfolio performance. I may add some momentum strategies to my own trades, as swapping underperforming funds for outperformers early in a bull market appears to have significant potential. I'll have to keep in mind that additional trading means additional fees. I'd also like to have a more comprehensive understanding of the bond market. While I have some understanding of yield curves, I haven't internalized that knowledge as thoroughly as I have on the equity side.

I'll also be looking at ways to gradually publicize and monetize Boom Wave Theory and the associated portfolios, other than by trading in my own modest portfolio. I can see various possibilities: finding a partner for academic work, founding a hedge fund, taking this newsletter into broader distribution and a subscription model, hosting a web forum and selling ads, etc. Or perhaps some enterprising young research analyst would like to spend part of their bonus to buy the whole thing outright (consulting services included). In any case I hope to continue providing some form of free economic information.

DISCLAIMER

This bulletin is intended for informational purposes only and is not an offer or inducement to trade securities. Research suggests that a diversified buy-and-hold portfolio is the best strategy for most individual investors. The Bogleheads Wiki at bogleheads.org/wiki is a good place to get started with a buy-and-hold strategy.

NOTES

Rotation picks should be considered speculative. Rotation selection portfolio returns tend to be more volatile than allocation model returns in backtesting and out-of-sample real world returns. However, a blended portfolio of 85% allocation model and 15% rotation selections appears to be less volatile than either alone. In practice I've stuck solely to the allocation model percentages but might dip my toes into the rotation picks in 2014.

Fixed income is 100% US intermediate-term treasuries in the model portfolio. In practice I've substituted high grade corporate bonds and cash.

Equities in the allocation model portfolio are a fairly even mix of Large Cap Value, Mid Cap Blend and Emerging Markets. In practice I've invested in International Growth as a proxy for Emerging Markets.

For charting I usually to just look at the Dow, although any cyclical index should be fine. Other cyclical indexes include the Hang Seng and the Morgan Stanley Cyclical Index.


Mid 2013 Dow update - 18 May 2013

Back in September I posted some prior charts for the Dow. I made the statement that "the Dow and other cyclical indexes should make a moderate to strong move up over the 15 months beginning Q4 2012" if boom wave cyclical influences held sway during that period. Since we're halfway there, I've prepared an update.

May 2013 Dow vs historical

The solid line on this updated chart shows the current Dow relative to October 1st against the backdrop of what I posted before. So far the Dow is on track to turn in a nice performance. One thing that I find striking is that this recent move to the upside isn't particularly unusual by historical standards. Comparing this bull run to its peers, it ranks #6 out of 9. Imagine the frenzy if the Dow were up 35% in the last 7 1/2 months and not a mere 15%!

Of course, it's an impressive run nonetheless. It remains to be seen whether the market advances further but the chart indicates that it's possible, perhaps even likely. Past boom waves have usually pushed the Dow even higher by the end of their final boom year. On the other hand, the chart shows that most of the upside for the fifteen month period has been attained by June 1st. And I'll reiterate that however promising Boom Wave theory may be for understanding multi-year business cycles, its value as a shorter term forecasting tool is still unknown. The best evidence we have indicates that most individual investors would do well to maintain a diversified portfolio of low-cost index funds. The Bogleheads Wiki is a good starting point for that strategy.

Looking ahead, as long as the unemployment rate remains above the lower 6% range, visibility beyond the end of 2013 is quite limited. Once the labor market returns to its natural rate, the model should forecast another long boom wave.


Boom wave update - 2 September 2012

Does it seem like the economy is booming? Other than producing a few new products and some isolated market bubbles (Hong Kong real estate, corn prices, etc.) it's a bit of a stretch to say we're experiencing a boom. Jobs certainly haven't come all the way back yet, although most of the stock market just about has.

According to Boom Wave theory as outlined previously, we're entering the latter "up" phases of a six year boom cycle. At the start of 2009 the Dow stood at about 8800. It's now trading above 13,000. And the theory calls for yet another leg up. If that happens, perhaps it will be accompanied by the kind of economic growth expected in a strong recovery.

The 15 months -- five quarters -- from October 1 to the end of next year is analogous to the portion of previously observed booms that is most reliable in the data used to develop the theory. Here are the eight comparable periods in the Dow from the start of October in the fourth year of each boom wave:

Boom Wave update

Assuming a normal distribution, the average return over this 15 month period should be in the range of 20 to 41% (at 95% confidence level). Perhaps we should note that thinkers like Taleb and Mandelbrot believe that stock returns do not conform to normal distributions.

To sum up, if Boom Wave theory holds up the Dow and other cyclical indexes should make a moderate to strong move up over the 15 months beginning Q4 2012. If that doesn't happen then we can extrapolate that either 1) the theory doesn't work; 2) the period is a statistical outlier or perhaps; 3) the market is essentially unpredictable.


Boom Wave theory - 11 September 2011

A key component to the industrial cycle model I published here last August is what I call boom waves. These appear as regular patterns of growth kicked off (or at least signaled) by certain inflection points in the labor market.

Boom wave: A six year pattern of industrial activity that has tended to follow periods of moderate unemployment (5.5% to 6.1% range) in the postwar era.

The model was constructed by looking at average DJIA returns over eight prior postwar booms. Please note that most of what is said here could also apply to varying rates of GDP growth. It's often said that the stock market is not the economy. While this is true, the research at hand seeks to measure cyclical business activity. Those cycles are picked up with great sensitivity by certain stock market averages.

A fairly consistent six year pattern emerges:

First year: up (increased cyclical activity; rising DJIA)

Second & third years: variable but often flat to modest increases

Fourth & fifth years: up

Sixth year: down (decreased cyclical activity; falling DJIA)

Intercorrelations among annual returns for the eight boom wave periods average about .50 (Pearson's r). Notably, though, five of the eight correlate with the others at very high levels (>.60) while the other three are not significantly intercorrelated (although no negative correlations are observed).

The two year period spanning the fourth and fifth years of the boom wave corresponds, in theory, to 2012-2013. The latest boom wave kicked off as the unemployment rate rose past 5.5% in 2008. This two year period is the most consistent observed in the model, featuring DJIA gains ranging from 18% (mid 1990s) to 56% (mid 1970s). Two year gains have averaged 37.5% across eight boom waves. However, please read the caveats below if this finding makes you want to contact your broker!

A hypothesis:

Is there a period of accurate labor matching that takes place in times of moderate unemployment? When the labor market is neither too tight nor too loose, perhaps people (or at least a certain group of people) make job changes for the right reasons, get into projects that best suit their talents and at first through their personal gains and investments and later through the products of their labors drive the economy to higher levels.

A real-life example:

An acquaintance of mine then employed as a web developer changed jobs during 2008, with the unemployment rate at about 5.5%. He left an old-line tech company, moving to a social media startup. Fast forward three years: his company recently announced plans for an IPO and my acquaintance has been promoted to management. His company appears poised to vault to new heights. At the same time, social media (Facebook et al.) along with mobile devices and the software that runs them have emerged as economic drivers to an extent that seems surprising, but perhaps in retrospect should not.

This chart illustrates the current boom wave in blue (Dow Jones Industrial Average) against a background of historical averages in red. 2009 was the initial year, 2010 and 2011 are midpoint consolidation years and 2012 and 2013 should, in theory, be a long boom period as projects come to fruition and are monetized, followed by a correction in 2014.

Boom Wave current vs historic

Elements of the theory certainly have some appeal. The idea of a "natural rate" of unemployment is widely held, yet has thus far found little real-world application. This theory places an optimal range of unemployment firmly at the center of a dynamic model of labor activity. The booms observed - five years of expansion followed by a downturn - align well with our historical knowledge of expansionary periods. Folk wisdom in the business community also regards the length of a business cycle as roughly five or six years. For the investor the potential to explain the dominant cyclical activity of the market is compelling (the model correlates best with highly cyclical indexes like the NASDAQ and Hang Seng).

All the usual caveats apply, of course. I completed the basics of this theory in 2009 and it is still firmly in the validation phase. While I think the next two years should be telling, reality often diverges from even sound theory and frankly I can't be certain at this point whether the theory is sound.

The safe way to double your money is to fold it over once and put it in your pocket - Kin Hubbard


Market Note - 10 June 2011

The Morgan Stanley Cyclical Index closed below its 200 day moving average.

Market Note - 17 February 2011

The Morgan Stanley Cyclical Index closed at an all-time high today. The previous high close was in July of 2007.

A Forecast of US Industrial Cycles - 26 August 2010

The first product I'd like to share is some output from a forecasting model of the US industrial cycle. It's a very simple model. The well-known four-year political cycle (sometimes called the "presidential cycle") is represented by a fixed progression, and modified by inflection points in the labor market. The labor market is generally thought of as a lagging indicator, but if you subscribe to the idea of recurring cycles there is no reason it can't also be a leading indicator.

US Industrial Cycle

The model forecasts slow industrial activity this year and perhaps into early 2011, followed by three rather strong years for the major industrials.

The Dow data points are year-to-year change based on the index's initial opening prices each October. The implication is that there is a "real" industrial year that runs from Q4 through Q3. The backtested model is strongly correlated with the Dow (.621 Pearson's r).