I try to take a longer term approach to investing and if you read my post on Kondratiev and the follow up post on K-waves, then you know that I give some credence to his theories. It only makes sense that bubbles arise out of human emotion and the bust that follows would cause those same individuals to swear off investing in that particular asset class for several years.
In fact, I read an article last night about the lack of interest in stock mutual funds following this recent “lost decade” and someone made the comment that investors were leaving the market and not coming back.
Because I believe that K-waves are real and the description of winter corresponds to the situation that is occurring now, then looking toward assets that do well in spring would seem to be the logical choice. Also because the K-waves are typically 40-60 years in length, it would seem that most of the seasons would be about 10-15 years in length as well.
The gold bull (gold does well in Kondratiev’s winter) started in 2001 so I would estimate that we are more than halfway through the gold bull at this point. I will be offering further comments about gold in a future post.
Preparing for Spring
Since it is a little late to really be thinking about winter, I think the best thing is to begin thinking about spring. So what investments do well in spring? Well, think about the bubbles that burst in the last decade. Stocks and real estate come to mind. These are the investments that should do well as the business cycle begins to spring to life and gather momentum.
Personally, I think I have about 4-7 more years before these investment classes begin to take off. So I plan to pay off as much debt as possible as quickly as possible to improve my balance sheet in order to purchase more real estate when prices are low. I already have some rental houses from the past decade and would like to own several more but credit is tight so I will need to have a pristine balance sheet when credit begins to loosen up.
In my area, there is still quite a bit of real estate supply available so I think it will take some time to work through it all. If interest rates increase, that will only make it more difficult for those who would marginally be able to afford to purchase in the first place. My market will always have renters so I don’t think it will be a big issue. I just want to make sure that the real estate I purchase will have positive cash flow.
As far as stocks go, I will continue to invest in stocks through my retirement plans since I have a long term horizon of almost 30 more years. I suppose there isn’t anything fancy of magical about my investment thesis over the next decade. My plan is to continue to save as much as possible in order to pay off some debt and add to my real estate holdings while continuing to invest in stocks through the 401(k).
I do not, however, plan on investing in bonds since interest rates have almost nowhere to go but up. Bonds have done well for 20 years so it is time for their season to end. Will it be this year or next or maybe 2013? I can’t be sure but I do know that when interest rates start to rise, bonds will fall and the $1 trillion that have flooded bond funds over the last decade will begin to leave and need a home. I believe that home will be stocks and real estate. And spring will be just warming up.
If you read my last post about K-waves, you know what to expect from this post. If not, then you really should read about Nickolai Kondratiev and K-waves for a better understanding regarding today’s topic. After all, Stalin had him killed for his work.
I will start out by outlining the characteristics of the various seasons: spring, summer, autumn, and winter. Then I will delve into the various investments that might be most appropriate for the expected conditions. Just like certain activities and clothing is more suitable for summer versus winter, the same holds true during these economic “seasons”.
Kondratiev actually proposed three phases to the cycle, but his work has been expanded to include a fourth phase to help it correspond to the seasons of the year. I think this is a great way to remember them as well.
The spring phase is all about gradual expansion and growth. It is characterized by mild inflation and technological innovation leading to new opportunities of entrepreneurship.
Interest rates start from historically low levels due to the previous winter economics. Credit slowly begins to build and expansion slowly begins to take hold. As a result, inflation slowly picks up as the money supply begins to expand following its contraction.
Optimism begins to fill the air and investment in this new technology begins to quicken. There is usually peace in the world and no major wartime efforts going on either so that countries can focus on the technology of the day.
Think about the period after World War II and the growth of communication technology from television to satellite to the internet. The most recent beginning of spring was identified in 1949.
Summer is a time of slowing growth and often even some economic recession. The recent spring has led to high consumer confidence and the bullishness leads to a stock market peak at the beginning of summer. Summer ushers in a period of stagnation.
Credit continues to expand primarily to companies and leads to high inflation that peaks at the end of summer. The stock market grinds lower to bottom at the end of summer. There is often a major conflict at the beginning of summer that corresponds with the stock market peak.
The most recent summer began in 1966 which saw the Vietnam War and the Nifty Fifty of the NYSE which were peaking in the late 60’s and early 70’s. Of course the 1970’s saw “stagflation” with no growth and high inflation. The stock market ground to a low in the early 80’s and gold peaked in 1980.
Autumn is a time for euphoria. Coming out of the summer doldrums, consumer confidence begins to build and credit to individuals begins to expand greatly. Inflation begins to fall along with interest rates and a massive bull market in stocks begins.
The falling inflation, bountiful credit, and plentiful jobs leads to higher levels of consumer confidence which develop into euphoria leading to asset bubbles. Also the declining interest rates results in massive expansion of debt such that by the end of autumn debt is at historic levels.
The euphoric peak in the stock markets announces the onset of winter as it did in 1929 and 2000. Autumn is usually a time of peace as well with no major armed conflicts which help to add to the euphoria.
Winter is characterized by the bursting of bubbles. Credit contracts and then virtually disappears as balance sheets require repair. Interest rates decline as does inflation such that fears of deflation begin to emerge.
Consumer confidence takes a major hit leading to concern, fear, and despair. Obviously, unemployment is high and jobs are scarce. Interest rates are lowered in an attempt to stimulate the economy.
There are often fiscal crises resulting in bankruptcies, banking crises, and even international currency crises like in 1931-1934. Repudiation of debt is significant. The bear market in stocks is on a parallel with the previous bull market. Armed conflict occurs.
Out of the ashes of the winter depression, a new technological advance begins, and the cycle begins anew.
When I first read about this eight years ago, I was utterly speechless. I couldn’t believe it. It seemed as if every period in history going back to the Revolutionary War could be outlined and placed into these various seasons. Of course, there were tables and graphs to do just that. I would encourage you to do some more research on your own but I have included one such table along with the link reference to begin that research. Then I will go into the investments for each season.
Reference: Institute for Practical Finance, Inc.
Investing for All Economic Seasons
As you can see from the table above, there are certain investments that might do well in each season, but let’s think logically about what may be worth investing in now that we know each season’s characteristics.
- Spring is a period of growth and optimism coming out of the bursting of stock market and real estate bubbles so it would make sense that investing in stocks and real estate at the lows would be a good choice. Interest rates are low so bonds would be a poor choice.
- Summer is characterized by inflation and so gold, commodities, and real estate are good choices. Stocks grind away for years at a time so decreasing allocation to stocks is a good idea. Gold usually peaks at the end of summer as do interest rates. The end of summer is a good time to purchase bonds or other interest rate investments.
- Autumn is the season for bubbles so real estate and stocks are a good place to be as long as you can sell at or near the top at the end of autumn. Gold is bottoming and going through its bear market so moving out of stocks and real estate over the years is a good idea.
- Winter is when the debt and financial crises hit as well as deflation. It is a good time to be in gold, commodities, and cash as investors are looking for tangible investments since confidence in paper is low. Cash is good because of the likelihood of deflation. Maintaining wealth is a good strategy for winter so that capital is ready for spring again.
Well this post has gotten a little bit long. I have more topics that I would like to cover in the same vein so I am going to pause right here and save it for my next post. In my next post, I want to cover my investing thoughts at this time.
In the meantime, I would love to hear your thoughts so far. Do you think that we are in Kondratiev’s winter? What implications might this have? Any idea when spring is coming? As always, thank you so much for reading!
Nikolai Kondratiev (1892-1938) was a Russian economist suggested that capitalist economies undergo long cycles lasting from 40-60 years of booms followed by depression. These cycles are now referred to as “Kondratiev waves” or “K-waves”. Most academic economists don’t acknowledge the existence of K-waves. Personally, I find the lack of acceptance somewhat puzzling, but let me explain a little more about my investment philosophy and allow you to come to your own conclusions.
I have always had some interest in economics and investing although I am not formally trained in that discipline. I remember when the Dow crossed 1,000 for the last time. I remember Black Monday. I remember Warren Buffett saving Solomon Brothers. But I was too young and poor to invest during those days.
I didn’t start investing until 1999, and it wasn’t long until I lost money in the dot-com bust. So, I started doing more research and learning more and more. I bought a little real estate which I still own. I also started reading a lot about oil and gold and inflation.
It was during my readings on gold that I ran across the name of Kondratiev. His theories intrigued me and seemed to make inherent sense. I started placing some of my investments in energy and precious metals. I have been following gold since it traded below $400 per ounce. But, let’s get back to those K-waves.
Kondratiev observed that capitalistic economies seemed to have periods of expansion and growth followed by stagnation and then recession and that the completion of a full cycle lasted between 40 and 60 years with an average of about 50.
There are several possible explanations that have been proposed over the years although it has been difficult for economists to prove that K-waves even exist.
- Technological innovation–This explanation states that the long waves result from innovations that lead to new industries and markets which get built up. Investment gets over allocated to this sector which then stabilizes, stagnates, and is then replaced by a new innovation. Think railroads in the mid-1800’s and the internet in the 1990’s.
- Credit cycles–This explanation will probably hit very close to home. Banks lend money taking excessive risks during the boom times until they come to an end. Then debt has to be washed out of the through restructuring and bankruptcy during which contraction of credit occurs until public and private balance sheets are repaired.
- Demographics–This explanation relates to the typical life cycle of an investor. We all start out by working and saving scraping by to make ends meet. We eventually have surplus savings and can begin to invest in the latest, greatest thing during our peak earning years. Then we get a little more conservative and start focusing on capital protection and income generation.
Personally, I think combining these 3 explanations into a coherent process is a very logical step. It is investors with excess savings that help to fuel and identify the next technological innovation arising out of the ashes of the previous boom.
In the early 1980’s when equities were declared dead, the personal computer was born ushering in the computer age. Companies like Microsoft and Apple were born culminating in a 20 year bull market in stocks that ended with the dot-com bust.
Also in 1980, gold was peaking at the end of its secular bull market and just starting its 2 decade descent until central banks began selling gold thinking that it was no longer needed in an enlightened non-barbarous time.
Now the pendulum has begun to swing back in the other direction and with each 20-25 year swing, history begins to rhyme. Back and forth, back and forth with meter just like a sonnet, each line rhyming with those that come before but telling its own story.
My grandparents told me stories of the Great Depression. I will tell mine of the Great Recession and the Housing Bubble. And so each generation will have its story to tell because human nature, greed and fear, never change.
In my next post, I will break down the “seasons” that have been ascribed to Kondratiev’s long waves and highlight the investments that might be appropriate to each. In the meantime, I would encourage you to read a little more about K-waves and think for yourselves.
Just because the established wisdom is established doesn’t make it true. It often takes years before the observations of one scientist are explained by another. Look at the development of germ theory over hundreds of years that has led to our current understanding. Or simply remember that at one time the world was thought to be flat and the center of the universe.