How to spot the difference between trends and cycles

Is it too late to sell after the downturn, or do the dip buyers make a mistake near the very top? The article is about what drives cycles, what distinguishes them from trends and how to see if a turn is close. Are you positioned for a continuation of the trend or for a manifestation of the underlying economic cycle?

Last year's few winners have shown weakness in December

Goldman Sachs of all shares, the invincible "vampire squid" has fallen 40 percent since the top of March. Facebook has fallen by 35 percent. Even Amazon has shrunk 25 percent. And we're not going to talk about General Electric that lost two thirds of its value this year, and that’s after minus 40 percent the year before.

A sale or a warning? Ask the “generals”

Does the downturn mean that it is "a sale"? Is the long upturn actually intact? Is the main rule still to buy the "dip"? Or has the trend perhaps turned to the negative? How to know when a trend begins or ends? How can you determine if there is a temporary interruption, an opportunity to come in cheap in a super trend or a shift to the second part in a naturally occurring cycle?

One of the signs you can watch for is that the generals turn home the last. The market gradually narrows when an upturn ages and approaches its end. The buyers are gathering in an ever smaller group of shares that "work" - the market generals. After a final strong move upward, like when Amazon and Apple reached over $ 1 trillion in market value, the generals turn down, which often means the market enters a longer decline phase.

Super trends that span many individual cycles

In the summer of 1981, the market rate of ten-year government bonds in the United States was 16 percent. It was the end of a 40-year period with rising interest rates. At the beginning of 1981, interest rates for 35 years fell to a bottom of 1.3 percent. You can call that two super trends or a super cycle. Almost no individual person can invest actively for such a 75-year period, so arguments about what happens in the long term will be of almost no significance. However, a lot of patience was required to ride the last 35-year trend all the way, for example. In 2003-2007, interest rates rose for a total of four years (from 3 percent to 5.3 percent, i.e., by almost 75 percent).

Cycles are created by lags, degree of borrowing and mood

Most of the things move in cycles. This applies in particular to market phenomena. That's because they're what George Soros calls "reflexive": what a player in the market does affects other people's judgment and action. This phenomenon applies to both the financial market and the real economy.

For example, different industries and regions may periodically attract or lose capital, which affects the competitive conditions and hence the margins. High winnings attract new players, which increases competition and lowers the margins over time. Before that, the increased activity can lead to better products as well as more interest from both consumers and investors in the stock market. High margins, high growth and high interest can give rise to a stock boom where temporary high profits are valued at unusually high multiples.

All together now

The process attracts new investors both in the real economy and on the stock exchange. In order not to miss the gravy train, borrowing is increasingly used. Even normally sensible value investors can be pulled in, and force themselves to accept higher prices and more risk.

New companies are attracted to opportunities and competition increases while equity investors' capital is spread over more companies on the stock exchange. When the margins and growth do not infuse the high expectations that the boom period has caused, investors are quick to sell their shares. Both profits and valuation multiples are lower than expected, which means that so-called "weak hands" sell more or less voluntarily to release capital for other necessary expenses, including repaying their loans.

On both Wall Street and Main Street, such a natural alternation occurs between euphoria and pessimism. It is further reinforced by the fact that the availability of loans gradually increases during the rise periods and decreases during downturns. This applies not only to, for example, Equity portfolios and companies, without housing loans, cars and studies, are also more easily accessible during the boom and can be used to fund both consumption and share purchases without employers having to pay higher wages (or can use employee stock options instead), why profit margins are further temporarily inflated.

The upturn sows the seeds for decline and vice versa

In this way cycles feed the next down cycle and vice versa. It is a completely natural process in feedback systems with imperfect information and a large and varied degree of delay. For the stock market part (S & P 500) the bikes have been around four years long from bottom to bottom during the thirteen cycles between 1953 and 2003.

Roughly in connection with the IT bubble and Greenspan's support, the cycles were exacerbated and worsened. Following the currency crisis in Asia and the LTCM crash in 1998, it took 5 years to the next bottom, and from there six years to the bottom of 2009. The next cycle took 7 years, but the decline was interrupted by extraordinary stimuli from not least China.

It will be difficult to repeat the rescue operation and extend the cycle once more when the underlying cycle soon manifests itself - and "wants" to finish what it started.

There are strong reasons for decline, and now also a number of signs that this normalization is under way in the near future

We are already in the worst December month of 87 years, with no Christmas rays, although October to April after an interim election in the US is usually the absolute best time to own shares throughout the presidential cycle. At the top of everything, in all decades since 1870 there has been a recession. It's not good for 2019, especially not in conjunction with other signals.

OK, so cycles have a strong theoretical foundation, where just like the top of a wave creates the trough and vice versa.

And right now we are on top of a very tall peak trying to break down since 2015, but kept up with history's biggest stimulus and debt build up. In addition, both the year-end, decade and presidential cycles suggest that we have negative times ahead of us.

It seems likely that we have a cyclical downturn in front of us for the next three years, both for the economy and the stock exchange. The downturn may further worsen if it turns out that interest rates, inflation and perhaps commodity prices establish a new supertrend upward.

How do we know if the trend has turned down. Nothing has been as profitable as buying the dips for the past ten years, so why should you give up now?

Tactical signs of an end to the cycle

In addition to the fact that fundamental variables such as margins, liabilities, valuation multiples, unemployment, wages and interest rates, and more, not to mention the pressure of money, are stretched to the extreme in one direction, and thus just waiting to be taken far in the opposite direction a lot of other characters.

For example, volatility has increased. The VIX was a long time close to 10, but has recently been closer to 25. A higher VIX is one of many signs of increased market uncertainty.

Another is the rotation from cyclical shares to traditionally more defensive, which is becoming increasingly clear. Strategic capital has already begun to shift from, for example, a workshop and trade to telecom and pharmaceuticals, as seen in relative development for different sub-indices.

The price of gold has also been a bit tricky beginning to find a new trend after the bottom of the end of 2015 and despite a stronger dollar index (DXY).

Even the crash oil price seems to confirm the turn of the bicycle downwards, but sometimes you have to look up with "fake friends". There are many more factors involved when oil prices are set than the business cycle and demand for energy.

Another potential sign, but has not really gained and confirmed a turn, is the interest rate on high yield or junk bonds as well as the proportion of those who set the payments.

The question, however, is why investors should wait and try to pinpoint the absolute peak on one of the longest and most powerful cycles in history, when the very foundation for it, the printing of money, has been pushed away. This applies not least to the weaker part of the fixed income market.