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The Long-Term Equities Outlook

July 8, 2002

With each passing month, the bear market that began approximately in the first quarter of 2000 is making its presence more fully known on Wall Street and the economy with no sign of let-up in sight. Most investors are subject to the vagaries of the dominant market forces and possess little knowledge of the cycles that shape the market; therefore, they are doomed to suffer the consequences of their ignorance. Fortunately, we are not left without tools to comprehend the market forces confronting us and the bear market currently raging. These tools are in the form of master market cycles, a careful examination of which we will discuss in the paragraphs that follow. Our goal is to present a streamlined overview of the 10-12 years ahead and the possibilities that will unfold as the long-term cycles continue to exert their influence over the market.

Ultimately, the stock market is governed by the master market cycle. This is the key to discerning long-term equities market trends, as well as long-term economic trends. The master market cycle of 120 years, known as the "Super Cycle" or "S-Cycle," is a composite of three component cycles. These three cycles bottom simultaneously every 120 years in three increments of 40 years each (the dominant long-term cycle), making a total of 120 years. The S-Cycle can also be sub-divided into two 60 year components and four 30 year components (the subordinate cycle). The 120-year S-Cycle is the starting point of all long-term stock cycle research.

The S-Cycle last bottomed in 1894 at a time when America was emerging from a pronounced industrial depression. Its bottom hailed the transition from a predominantly agrarian economy to a fully industrial economy. It also marked the advent of the industrial revolution in its full swing and roughly coincided with the introduction of mass transit in the form of the automobile, not to mention great efficiencies and improvements in other areas of industry. It also marked the official start of the long-term bull market in equities, a trend that more or less continued unabated for the next 100 years.

Commenting on the nature of the components of the 120-year S-Cycle, Samuel J. Kress of SineScope had this to say: "The dominant's bottom [40 years] is highly visible, but the subordinate's bottom [30 years] is relatively subtle. Conversely, where the dominant's top is typically skewed to the last 8%-12% of its duration, the subordinate's top is always and precisely at mid point, or 15 years from its bottom. The subordinate's peak in 1999/2000 is the fourth [four being the number of completion in cycle methodology] since 1894/5. Its previous or third peak in 1969/70 was 5 years before the 1973/1974 bear market of 50%. Resultantly, this latter approach is consistent with the TERMINAL high that materialized the first quarter of 2000, while the former approach is consistent with the first major decline of approximately 20% from June through September of 2001. In both instances, the unprecedented, potentially devastating long-term bear market has now been underway for over 1 year."

Another important consideration in the analysis of the long-term economic/equities outlook is the economic super cycle known as the "K-Wave," named after its discoverer, the Soviet economist Nikolai Kondratieff. Kondratieff tracked wholesale commodity prices back hundreds of years to determine regular rhythmic peaks and valleys in long-term price trends. Since wholesale commodity prices include no value added, they represent the most causal approach to identifying the real supply/demand balance in the economy. Here is how one commentator describes the K-Wave:

"The K-Wave is the manifesto of economic determination. It is the ultimate boom/bust condition. The cycle is caused by the beginning acquisition and the ending liquidation of debt. Debt creates a false or created incremental demand in addition to intrinsic, real demand. When debt assumption becomes excessive, the system becomes illiquid. At that time, debt must be reduced to alleviate the pressures of illiquidity….Once debt is liquidated, the system reliquifies, debt is reacquired, and the economic super cycle begins anew."

The K-Wave must be distinguished from the S-Cycle in that the former is not a true market cycle in the sense of having a definite bottom. Unlike the S-Cycle, the K-Wave's duration is variable and according to Ian Gordon, editor of the Long Wave Analyst , Vancouver, B.C., can be as short as 40 years or as long as 70 years. This is why the K-Wave is termed a "wave" as opposed to a cycle. The K-Wave is unique in that it is the only long-term economic rhythm that can be heavily manipulated at both peaks and valleys by government or central bank intervention. Needless to say, the U.S. government/banking establishment has been extremely active in recent years with their interventionist policy, therefore we can expect a longer-than-normal K-Wave this time around before we see the next bottom. A 55-year duration would see the K-Wave bottoming in 2004/5. A 60-year duration would see a K-Wave bottom around 2010, and a 65-year bottom would witness a 2014 K-Wave bottom. Kress of SineScope favors the latter timeframe as the most likely time for a bottom, as does another cycle expert, P.Q. Wall.

Kress points out that, "The current K-Wave is the fourth [four being the number of completion] since our country gained its independence in 1776." Never before in our country's history have both the K-Wave and the S-Cycle peaked simultaneously. This once-in-a-lifetime, unprecedented condition has potential commensurate ominous, profound and far-reaching meanings."

Just how severe is the downside potential over the next decade of this long-term bear market? Economically, the fourth S-Cycle has the potential t return to its end of the third or the late 1940s/early 1950s, based on the configuration of dominant long-term cycles. As Kress points out, "The equity market can revert back to its level at the previous dominant cycle." This cycle previously bottomed in 1974 at Dow Jones 550. And since each new S-Cycle heralds a major and long-lasting change in the character of the nation and its economy, we can envision the 2010-2014 timeframe bringing about the complete transition in America from being a capitalist-oriented manufacturing economy to a socialist-oriented service economy.

The coming 10-12 year period will witness a long, agonizing bear market that will undoubtedly wipe out the wealth of vast multitudes. At the same time, however, new fortunes will be created but in smaller proportion to those who are losing money. The configuration of dominant long-term and interim market cycles points to a mostly sideways or lateral trading range in equities developing after the projected 2004 wash-out bottom of the current bear market leg. Samuel Kress suggests that a model for predicting the market's overall trading pattern for the next decades is found in the master interim cycle of 40-weeks, the weekly equivalent of the long-term master market cycle, the S-Cycle. Its first final hard down phase since the terminal high occurred last year. The fifteen week decline that occurred from the first week of June until mid-September of 2001 is equivalent to the market's long-term potential decline of 12-15 years from the terminal high in 2000 until the ultimate bottom between 2010-2014. See chart of S&P 500 during June 1-September 7, 2001 for a depiction of this pattern. Kress divides the coming years in the long-term bear market into three distinct approximate 5-year periods. The first period, 2000-2004, should be the initial bear market, a value adjustment; the second, 2005-2009, should be a lateral market with a downside bias, no real growth or stagflation; the third, 2010-2014, should be the second bear market and more severe than the first, culminating with a massive economic and market collapse.

Writes Kress, "The decline should begin to accelerate in 2001 with each succeeding year developing into cascade proportions. Try to visualize this condition-thousands of mutual funds exist controlling billions of dollars of trillions of shares. Once the average investor realizes the economics and markets are collapsing, they will no doubt redeem their fund shares. To honor redemptions, fund managers will be forced to sell mega shares in hundreds of companies-to whom?"

So what can the average investor do to protect his financial assets in the coming hard times? Here are some suggestions: 1. Cash equivalents: U.S. Treasuries continually rolled over; 2. Gold equivalents: Prime quality gold coins, top-quality gold and silver stocks and precious metal mutual funds; 3. Bull market and bear market index funds such as the Rydex Nova/Ursa and Tempest/Titan series.

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy.  The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment.  He is also the author of numerous books, including “2014: America’s Date With Destiny.” You can view all of Clif's books here. For more information visit www.clifdroke.com.


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