The Drei D Market Cycle
When examining the structure any cyclic (periodic) data set, first find some very odd, but conspicuous, repeating characteristic. If the characteristic is sufficiently odd, it will occur only once per cycle and clearly divide the periodic data into separate cycles. For stock market price data (inflation adjusted), the delusional mania price peak that marks the climax of a secular bull market is such a characteristic. The delusional peaks of ’29, ’66 and ’00, clearly delimit the last two generational market cycles.
Closer examination of these cycles revel two other points of interest. From the delusional peak, prices plunge while P/Es compress. This may occur in a straight line – like ’29 to ’32, or with a pause – as in the (inflation adjusted) ’66 to ’74 data. In either case the plunge overshoots the fair value, and stops only when a P/E of 7 to 10 is reached. If the mania peak can be labeled Delusion, then the end of the P/E compression plunge can be called Despair.
From the Despair point, the market oscillates sideways at a low P/E level for many years. This period saps the enthusiasm of even the most ardent bulls. Finally, when the demographics are right, from a local minima, a new secular bull (a long period of higher highs and higher lows) begins. Given the market emotion prevailing when this turn comes, this inflection point can be labeled Disgust. Thus we have the three most significant inflection points of the generational market cycle - Delusion, Despair and Disgust.
For a period of time, the market can have one of three movements – up, down or sideways. All three movement trends are exhibited in the generational cycle. From Disgust to Delusion, the trend is up, and the market is said to be in a secular bull (e.g. ’49 to ’66 and ’82 to ’00). From Delusion to Despair, the market is in the P/E compression plunge (down) stage of a secular bear (e.g. ’29 to ’32 and ’66 to ’74). If one is going to divide market price history into secular bull and secular bear phases, then the enthusiasm decay (sideways) phase between Despair and Disgust, must also be included in the secular bear period (e.g. ’32 to ’49 and ’74 to ’82).
For reasons that are unclear, many forget about the Despair to Disgust second phase of a secular bear. While not as spectacular as the dizzying plunge of the first phase, its significance should not be underestimated. Its duration is of equal or greater length than the plunge period, and it is in this phase that true capitulation occurs. While the overall trend of this phase is sideways, the continuing oscillations leading to hope that is repeatedly dashed, is what leads to complete disgust. During this phase mutual fund redemptions soar, market participation plunges and the last diehard LTB&H bulls give up. All necessary preconditions for the next secular bull.
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