The O'Brien Column: Generational cycle offers latest threat to market bulls

Friday 31st March 2000

The US sharemarket should be bringing pathological bears, general doomsayers and proponents of various market theories out of their recent hiding places.

Some appeared but were scarcely noticeable against the background of euphoria accompanying new records for market indices and soaring prices for technology companies that sometimes had no trading history, no earnings and price/ earnings multiple of more than three figures if there was an earnings record.

Investors have talked about companies in the "old" economy and those in the "new." That distinction is important when assessing the US market and where it could go.

Companies related to the old economy dominate the Dow Jones and Standard & Poor's 500 indices, while technology companies of the new economy drive the Nasdaq index.

The Dow Jones average index of 30 industrial stocks gained 25.25% in 1999, closing the year at 11497.12, and set a new all-time high of 11722.98 on January 14. That was a respectable performance.

There was a 9.5% increase in the S&P500 last year, with the index ending the year at 1469.23. It also went higher this year before easing back. Again, a respectable performance.

The Nasdaq index was the extraordinary performer. It put on 85.4% last year to reach 4069.28 on December 31, before screaming ahead to an all-time peak of 5048.62 on March 10.

Variations between the indices show the US market cannot be treated as an entity, unlike past years when observers concentrated on the Dow Jones with a secondary glance at the S&P500.

The variation could contain a warning for investors because they signal market volatility in relation to particular sectors and companies within sectors. They also signal a developing concentration on blue sky, as opposed to corporations with real activities and real earnings that depend on and are part of the real economy.

The combination of new records, indices moving at levels below the records and a rush to a sector with many airy-fairy stocks should be ringing warnings, for historical reasons.

Investors should not be slaves to history, because markets are dynamic, past events generate changes to the regulatory and market operating climates, and the structure and sophistication of economies and their watchdogs become more complex from generation to generation.

But some things don't change, particularly the propensity for individuals, or groups of individuals, to act similarly to their predecessors.

A quick look at past periods of the US sharemarket has a lesson for investors anywhere, given the influence of Wall Street on other markets. Figures quoted for the Dow Jones relate to the index at the particular time, not the recast numbers after changes to its composition.

In 1929 the Dow closed at 386.10 on September 3, a then all-time high, not reached again until 1954. It moved around for a while and then plunged 86% to bottom in July, 1932.

The Dow Jones broke 500 for the first time in 1956 as part of the overall bull market of 1946-65, reaching 521, but lost 20% by the end of the following year before resuming its climb.

The phenomenon of record, bubble, plunge was seen again in early 1966 when there was "excitement about the Dow Jones almost reaching 1000." The index got to 995, wandered up and down below the high and slumped to end 1966 20.6% below the high.

Then came 1987. The Dow was at an all-time high of 2722 a few weeks before the crash, culminating in a cut of 508 points, or 22.6% on Monday, October 19. That was the end of the 1980s bull market which was based on excess, greed, blue-sky euphoria and a belief it would go on forever.

Economies, operating climates and market structures may have become more sophisticated but those human factors lurk today as much as in 1929, before that date and after it.

Another reason investors may be wary about the market and its future over the next 18 months is a 14-15-year generational cycle, which has nothing to do with wave theories of other esoteric ideas about cyclical markets.

Its basis is the fact that markets have dipped, roughly, in 14-15-year periods. There is nothing magical nor sublimely sophisticated about the idea. It is generational where, particularly since the 1960s, those coming up always know more than those who went through the last crisis and/or slump. Anyone who is going to do anything in financial markets will have either done most of it, or be well on the way, by age 35 and probably earlier.

A person who will be 35 in 2001 was 21 in 1987, would not have experienced directly the hard financial mistakes of 14 years ago and could be doomed to make them on their way to the next big shakeout.

There is consolation in the point the Dow Jones has had an average annual compound growth rate of 13.7% since 1987 and 7% since 1965, after ironing out the ups and downs and subject to the index's changed composition. The index would come again after a shakeout.

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