The cycle lane
Economies and markets may be at the mercy of long-term forces
Sep 9th 2010
THE financial world seems to be obsessed with the short term. Fund managers are usually judged on their performance over a three-month period. The television news highlights daily moves in stockmarkets. Lots of hedge funds think in terms of milliseconds.
But some commentators take the opposite tack, arguing that history is subject to “long waves” that cause economies and markets to change direction at regular intervals. Roger Babson, an investment adviser who predicted the 1929 crash, claimed the markets were driven by Newton’s third law of motion: every action has an equal and opposite reaction. Mind you, he also wrote a pamphlet entitled “Gravity—Our Number One Enemy”.
It seems plausible that certain forces—new technologies or discoveries, demography, changes in climate—will have an effect over an extended period. But the idea that these cycles are preordained to run for a set number of years or months is much more difficult to accept. It is an odd kind of historical determinism, in which individuals are all just extras in a massive film production, doomed to stand on the sidelines as the script plays out.
The recent rebound in global food prices has revived talk of a “commodity supercycle” in which raw-materials prices will be high for a prolonged period. Low prices in the 1980s and 1990s led to a lack of investment and the abandonment of marginal sites. Eventually this caused a shortage and rising prices. Such prices will eventually encourage greater production and efforts to find new sources of supply. This cycle will surely be variable in length: you would expect agriculture to adjust more quickly than mining.
Given that the global economy was largely agricultural until 1850, it was logical for the commodity cycle to drive overall activity. But the switch to a manufacturing-based economy brought no end to the pattern of booms and busts.
Various academics have argued that industrial economies also have a regular cycle, fuelled by stocks, capital investment or technological change, and lasting anywhere from three to 60 years. As with commodities, the driving force seems to be the shift from feast to famine as firms overinvest and overproduce, driving down profits and prices until a crisis occurs.
In his book “SuperCycles” Arun Motianey, an economist, argues that price shocks slowly feed through the global economy rather as a python absorbs its dinner. Lower commodity prices boost the profits of intermediate-goods producers, leading to overinvestment and then a fall in their prices. In turn, this boosts the profits of goods manufacturers, with a similar effect.
Mr Motianey thinks the trigger for this cycle is the adoption of new monetary arrangements, such as the gold standard of the 1870s and the anti-inflation policies adopted by Paul Volcker at the Federal Reserve, among others, from the early 1980s.
The Volcker years also saw the beginning of the great equity bull market of 1982-2000, one of several huge stockmarket cycles in the 20th century. Demography played its part. The baby boomers created a huge bulge in the workforce and in the pension system. The “cult of the equity” emerged in the late 1950s as corporate-pension-fund managers realised, first, that shares had outperformed government bonds over the long run and, second, that the long-term nature of their liabilities meant they could ride out the short-term volatility of stockmarkets.
As Robert Buckland, a Citigroup strategist, points out, this process was self-fulfilling. As investors bought equities, valuations (and thus prices) rose, enticing them to put more money in the stockmarket. Between 1952 and 2006, American pension funds increased their equity weighting from 17% to 69%.
The process is now reversing. Since 2000 equities have substantially lagged government bonds. And as the baby boomers retire, pension-fund members are becoming beneficiaries rather than contributors. Pension funds are thus searching for both security and income, a combination that favours bonds. Accounting rules have brought pension-fund volatility onto the corporate balance-sheet, encouraging the trend. There is even talk of the “cult of the bond”.
As Chris Watling of Longview Economics points out, the worry is that several long-term cycles seem to be moving in a hostile direction for Western economies, with commodity prices rising, populations ageing and the debt spree unwinding. That is not necessarily bad news for financial markets next month, or even next year. But it does suggest that a very awkward decade lies ahead.
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