Wednesday, July 1, 2009

S&P500 adjusted for inflation - "Secular Cylces" - July 1, 2009

My My, what a very interesting chart I came across reading on rizholtz "The Big Picture; this chart is originally from TheChartStore.

From my university studies I understand that, if my memory on index construction serves me correctly, this chart takes the S&P500 Index and deflates it with a price index (the CPI index), to get real values (since all neo-classical economist are interested in "real" stuff).

Aside from all this basic technical blabber, the implications of this chart are quite profound if we are indeed in a current "Secular Cycle." As the chart explains "Secular Cycles" are "a series of cyclical ups and downs." For example, "the crash of 2008" is merely within a secular cycle that started from the crash of 3/31/00 (look on chart). So if this is really the case, arguments of V shaped, W shaped, O shaped, Z, A, B, C or whatever shaped recovery analyst are speculating about, can be quite irrelevant (if this secular scenario is true).

From a technical analyst standpoint, its very possible that this current market is finding a bottom and starting recovery. However, considering the time frame of the secular cycles this could be a very prolonged recovery that happens slowly. Which means, this leaves room for short term (year to year) downward movements. However, as long as a bullish higher high and lower high can be established, recovery maybe surely in track. The problem is seeing such long periods trends is very difficult as we are all affected by the short term data and the happenings of the now.


*Historical note:

1st. Secular Cycle

From a historical perspective, these secular cycles occur during some of my favorite periods in economic history. I'm not sure what happened in 1906, but this is right in the middle of the start of late industrializors such as India, Japan, and Russia. Of course one of the peaks of the secular cycle start with 1914 World War I. Post WWI all the previous nations mentioned suffered from post war depression. With huge decreases of demand, rapid prices falling in agriculture and manufacturing.

Though fortunately the during "interwar" period there was recovery, in the United States I'm not sure of exactly how they recovered, but Japan exported there way outta the depression (to no surprise, look at their current situation today with reliance on exports; score one for the school of dependency!). Russia with the whole scissor crises arguably "squeezed agriculture and forced" industrialization (huge debate in the literature I won't bother to get into the details). Towards the 1930's India managed to gain some tariff autonomy and enjoyed temporary gains from ISI (though again this is also arguable). As we see most of these nations experienced a recovery to similar to pre-war levels give or take a few (in agriculture and industry, though in Russia Industry growing much faster). All this is enjoyed up until 1929; this we can call the first "Secular Cycle" that ChartStore choosed to point out.

As we see the first secular cycle can be said to included two major events in world history.

* World War I
* The Interwar Period

The Second Cycle:

We all know as 1929 hit we see the infamous Great Depression. The literature on this event is huge! The effects of the great depression had profound world wide effects with the birth and death of new institutional order (anyone want to argue this? can the great depression be constituted as an Olsenian shock?). The second great event seen in this "second secular cycle" would be World War II. Post 1945 we see a slight depression, but then leads into that Famous uptrend post 1945 that we always see in our highlighted Macroeconomic 101 text books (approximately 1949 to the mid 60's as seen on the chart).

As we see two great events in world history for this "second secular cycle." :

*the Great Depression
*World War II

The "Third Secular Cycle"

I'm quite unfamiliar with this part of history though I know enough to perhaps to throw a few ideas around. In terms of world implications I'm not sure, but certainly the Oil Crises and the Vietnam war were big factors within the "third secular cycle," in the United States. One of the words that gets tossed around in this period is stagflation, also this is the time when central banks were like little babies exploring the new world order (look at the monsters they turned into today, from concerns with stable growth, price stability, and healthy labor market, to getting their hands dirty in politics, regulation, and world policy and much more...)

I haven't studied the economic effects of the Vietnam war, but I can only imagine the huge drag on the economy it must have been. Though, the cultural imprint they left on Vietnam, may have left traces that could have contributed to Vietnam's Current economic position today (I'm sure there's a literature on this but I haven't explored it).

I will point out a few things for this "third secular cycle" :

* Oil Crises
* Poor Monetary Policy may have exacerbated the economic situation
* Maybe the Vietnam war had negative effects ( maybe examine the cost of the war of as a % of GDP?)


If we are indeed in a 4th secular cycle I can certainly list a few events contributing to this cycle.

* Obviously the first would be the tech bubble crash
* The housing crises would be the second big one

Subprime, the Credit Crisis, systemic damage... I would probably categorize all of them as sub categories under the housing crises.


Final Thoughts:

At this point, if the secular cycle ideas/theories/hypothesis are indeed true, it is only a matter of fundamentals working itself out over the short/long term (over the next few years), before we get a nice sustained long rally in the S&P500 (rallies similar to 1875 - 1906, 1949 - 1968, and 1982 - 2000).


  1. Nice Post Alex and truly interesting chart! As you mentioned, if we are currently in a secular cycle, the impact of the chart is quite profound, and I'm afraid we are and my personal opinion is we have not hit the bottom yet.
    A rough computation gives an average recovery time of 300 months, that's a "mere" 25 years... The thing is not to miss that train.

  2. WoW! how did you calculate that!? you know Quant analysis always bewilders me. Next time we chat on bloomberg maybe you can explain a little bit about it. Anyway if we have 300+ months we definitely will get a sustained rally in before another crash (maybe another decade rally or so?). So its quite possible in my life time I will get too witness two huge crashes if "secular cycles" are indeed true. That would be a honor bestowed from the markets and life itself... haha


    LOL, a few weeks after i blog about it it shows up in standard media. Though this idea has been circling on the blogosphere for even a longer period im sure...


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