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February 2015

What Can We Learn From The Past?


In this Capital Ideas we are going

to address the subject of cycles as they

pertain to the economy and financial
markets, explain why they persist and
offer some examples of longer-term cycles. Through this explanation of cycle
analysis, we hope to provide some guidance on where we might be in the current cycle and what we can expect in the
current market environment. While cycle
analysis is not a guarantee of what happens next, it should provide a view into
probable outcomes.


psychology at regular intervals. Cycles

are not exact, however, and history never repeats itself in exactly the same way
at exactly the same intervals.

Cycles show up in our everyday lives

in ways that most of us never notice.

For example, night turns to day and day
turns back into night, seasons slowly roll
from one to the next and life itself cycles
from beginning to end. Even sound and

Cycles can be applied to
markets and economies
through the study of mass
psychology and its repetitions.

light move in cyclical waves. While we

Because we dont place

can never tell very far in advance how

much weight on events

hot or cold it will be, how much daylight

that happened prior to our

we will have on a given day or how long

lifetimes, when we make

each of our lives will last, we can make

decisions, we are doomed

some judgments based on experience

to repeat the mistakes of

that can serve as references.

the past over and over.

History doesnt repeat itself, but it

does rhyme. ~ Mark Twain

how and when cycles will persist, why

The Decennial and Presi-

should we study them at all? The rea-

dential Cycles suggest a

So what is a cycle? According to

son for studying cycle analysis is so

favorable environment for

Merriam-Webster a cycle is defined

that we can have a gauge with which

stocks, while the Genera-

as an interval of time during which a

to anticipate upcoming events. Study-

tional Cycle suggests one

sequence of a recurring succession of

ing cycle analysis allows us to have reli-

more major sell-off before

events or phenomena is completed. In

able timeframes with which to anticipate

2017 or 2018.

practical terms, cycles are a measure-

shifts in mass psychology. Cycle analysis

ment of time in which history repeats,

also helps us determine the effects those

resembles or mirrors itself. When applied

shifts have on financial markets.

to markets, cycles reflect shifts in mass

So if we cannot determine exactly


There is nothing new on Wall Street
or in stock speculation. What has happened in the past will happen again,
and again, and again. This is because
human nature does not change, and
it is human emotion, solidly built


tions, and therefore make similar deci-

and similarly have underlying causes for

sions and experience similar events as

the regularly occurring economic events.

the generations that came before them.

For instance, there is a distinct presiden-

This decision making causes long 70-

tial cycle which is based on campaign

80 year lifetime cycles as well as shorter

promises, actual political agendas and

17-20 year generational cycles. Below is

more campaign promises.

a chart which shows how major events

such as wars have unfolded at regular

candidate who is running for office. He

intervals in American History.

is going to make grandiose promises

into human nature, that always gets

in the way of human intelligence.
~ Jesse Livermore1

Humans have an understandable

bias in placing the most weight on personal experience when making decisions. Because of this bias, we tend to
make decisions without the wisdom of
previous generations to help guide us
when making those decisions. This happens on a personal level, but more importantly this is true on a generational

In the book, The Fourth Turning,

historians William Strauss and Neil

Howe went back and studied the history of Anglo-American people all the
way back to the late 1400s. What they
found was that history repeated itself every four generations in the same order
what they called turnings and other
cycle analysts have called seasons.
They found that these four turnings repeated every 70-80 years, or about the
length of the average human life. This
suggests that as generations die off, the
following generations forget all of the
lessons learned by the previous genera-

Take, for example, a presidential


about the changes he will make once

American Revolution (1773-1794)

elected and the positive effects these

Civil War (1860-1865)

changes will have on the country. If he

World War II (1941-1946)

is running against an incumbent, the

Future Great War??? (2001-2026)

incumbent candidate will try to position

Source: The Fourth Turning

the economy and the country in a light

If we look at the current generations,

that makes people feel good about what

we can understand how Baby Boomers

has happened in the previous 2-4 years.

who have been hit twice in the last 14

These promises make people feel good,

years by 50% sell offs in the stock market

and this boost in confidence naturally

might be quite uneasy about putting their

results in an increase in spending and

investment funds into the stock market,


especially with retirement so near for

most of the age group. Similarly, people

president pushes the unpopular items

from Generation X may be uneasy about

on his agenda that will negatively af-

diving back into the housing market after

fect the country and the economy in

being burned so severely in the financial

the first 2 years of his term because he

crisis. Many people in these age groups

knows that he has to have things mov-

lost their homes or were forced to own a

ing in a positive direction when it is time

house where the mortgage was greater

for the next election. This will cause a

than the value of the home. Taken a step

negative mood among the people who

further, those who experienced the Great

will be less inclined to spend and invest

Depression are probably more likely to

during these first 2 years of the term.

save and take out less debt.

Because of these repeated actions and

By looking at markets through this

timeframes we can see definite, repeat-

long lens, you can begin to see how the

able presidential cycles. These are just

life experiences of each generation affect

two of the vast number of cycles across

decision making when it comes to poli-

all timeframes that exist in the markets

tics, economics and financial markets.

and economy.

Cycles also exist on shorter timeframes

After the election is over, the new




Figure 1: Presidential Cycle Median Returns 1928-2014

I think its very hard to come up with a

persuasive case that equities will over
the next 17 years perform anything like
they performed in the last 17 years.
~ Warren Buffett2

The longer the cycle, the more bear-

ing it seems to have on the markets. As

timeframes get shorter, outside influences can override cycles to the point that
daily market fluctuations can be seemingly chaotic. For this reason, we will
focus on the Presidential, Decennial and
Generational Cycles in this section.

As mentioned above, the Presiden-

Source: BofA Merrill Lynch Global Research, Bloomberg

tial Cycle lasts 4 years and is based

on the actions of the President and the

strongest year in the 10 year Decennial

80 years since it was first discovered.

publics response to those actions. We

Cycle. The Decennial Cycle is a 10 year

are currently beginning year 3 of the

market cycle that uses the average return

rently in the beginning of decennial year

current Presidential Cycle, which is the

for each year of the decade. Unlike the

five, which is by far the strongest year in

strongest year in the cycle with a positive

Presidential Cycle, which repeats directly

the cycle. Since 1886, the Dow Jones

return 80.95% of the time and a mean

because of the actions of Presidents and

Industrial Average year 5 returns have

S&P 500 return of 17.27% according

their tendencies to enact tougher legisla-

been positive 91.67% of the time with

to data going back to 1928.3 As shown

tion during certain parts of their terms

a median increase of 28.82%. Since

in the chart below, the strong returns

for political reasons, there are no direct

1935, the S&P 500 year 5 returns have

typically begin in November of year 2

causal relationships that can be pointed

been positive 100% of the time with a

and continue into June of year 3. This

to for the Decennial Cycle. Although

median increase of 28.56%.5 The stron-

suggests that we are currently in the

no one has been able to determine the

gest portion of the cycle tends to last

middle of the strongest period of the 4

causes of the Decennial Cycle, the pat-

from approximately November of year 4

year cycle.

tern was first documented in 1932 when

through early into year 6.

Not only are we in the middle of

Edgar Lawrence Smith wrote about it in

the strongest period in the 4 year Presi-

his book Tides and Affairs of Men. The

Cycle. This cycle tends to last about 17

dential Cycle, we are also beginning the

cycle has continued to hold up over the

to 18 years and has been noticed in

As shown in figure 2, we are cur-

Lastly, we turn to the Generational



Figure 2: S&P 500 Decennial Pattern: 1928-2014

Looking at the chart below, some

people would argue that we have broken

out to new highs and thus have entered
a new secular bull market which should
last for another 10-12 years. This would
be highly unusual since that would
mark the end of the generational cycle in
2009, making it the shortest one since
at least 1900.

An alternative view would be to look

at the returns of the S&P 500 on an inflation adjusted basis since these are the
real returns that the stock market produces after the cost of inflation has been
removed. This view shows that the stock
Source: BofA Merrill Lynch Global Research, Bloomberg

market has actually produced no returns

to shareholders at all since the peak in

stocks as well as real estate. Even War-

or 2018. If this is the case, the door has

2000. It also shows that the stock mar-

ren Buffett referred to subdued stock re-

been left open for one more violent sell-

ket is still within the trading range es-

turns for a 17 year cycle during a speech

off to mark the end of this generational

tablished at the beginning of the current

published in 1999 by Fortune. The pat-


generational bear market. Looking at

tern tends to oscillate between secular

bull and bear markets. During the secular bear periods, markets tend to sell

Figure 3: Nominal S&P 500 Historical

off violently for a year or two and then

spend several years recovering only to
sell off violently again over and over for
a whole generation. During the secular
bull periods, markets tend to continuously rise with short, violent sell-offs after which the market quickly recovers to
new highs.

Arguably we are nearing the tail end

of a secular bear market which started

in 2000 with the Tech Bubble. Being
that these long-term cycles tend to last
between 17 to 18 years, we will likely
not see the end to this cycle until 2017

Source: BofA Merrill Lynch Global Research, Bloomberg


prior secular bear markets suggests that


Figure 4: S&P 500 Inflation Adjusted Historical

they ended near an inflation adjusted

low after consolidating previous gains
for at least 17 years.


While cycle analysis cannot give us

specific dates or exact turning points for

the markets, it can give us some basic
guidelines to look for based on the path
and timeframes that the markets have
exhibited in the past. We have chosen
to focus on three longer-term cycles
because short timeframes have less influence on the markets. As we can see

Source: BofA Merrill Lynch Global Research, Bloomberg

from the two shorter cycles (Decennial

and Presidential) we are in the middle of
a bullish period which should provide a
favorable backdrop to stocks through the
end of 2015. The bad news is that the



longer-term, generational cycle suggests

Ryan Jones is an Equity Analyst and Assistant Vice President for Regions In-

that we should see one more sell-off

vestment Management in Birmingham Alabama. Mr. Jones joined the firm in

before this cycle leaves us. Thankfully,

January 2013 and is currently responsible for

once we transition to the generational

analyzing the Consumer Discretionary sector

bull cycle around 2017 or 2018, we

for the Equity Team. His industry experience

should have an environment where

began in 2010. Prior to joining the team,

stocks can provide very nice returns for

Mr. Jones was a corporate finance/pension

nearly two decades.

analyst for Rock-Tenn Company. Mr. Jones

earned a B.S. in Mechanical Engineering from
Auburn University and an M.B.A. in Finance
from Emory University.



1: Richard Smitten, Jesse Livermore Worlds Greatest Stock Trader (New

York: John Wiley & Sons, 2001), 314
2: Warren Buffett, Mr. Buffett on the Stock Market The most celebrated of
investors says stocks cant possibly meet the publics expectations. As for
the Internet? He notes how few people got rich from two other transforming
industries, auto and aviation. Fortune November 22, 1999
3: Stephen Suttmeier, The strongest part of the Presidential Cycle begins
now Bank of America Merrill lynch Chart Blast September 29, 2014
4: Martin J. Pring, Technical Analysis Explained Fifth Edition (New York: McGraw-Hill Education, 2014), 509
5: Stephen Suttmeier, Years ending in 5 are the strongest year of the decade Bank of America Merrill Lynch Chart Talk January 13, 2015
6: Warren Buffett, Mr. Buffett on the Stock Market The most celebrated of
investors says stocks cant possibly meet the publics expectations. As for
the Internet? He notes how few people got rich from two other transforming
industries, auto and aviation. Fortune November 22, 1999


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