(This is Part 1 of a series.)
I believe that there is an historic shift going on in the financial world that will affect everyone reading this. In particular, I believe that it will affect your ability to take care of yourself in the coming years.
In the times that, in my opinion, we'll probably be going through, it is likely that panic will be widespread at certain points. If you can take care of yourself you'll be able to be an oasis of emotional and financial stability in the midst of turmoil.
If we can understand what is happening, and use that understanding wisely, we'll be able to be a source of emotional and financial stability to others—family, friends, neighbors, associates. This will be quite crucial during these times.
To begin: There are three markets that I often refer to as the interest-rate markets, since they are very dependent on interest rates. Those three markets are stocks, bonds and real estate.
There is some evidence, compiled by Barry Bannister among others and dating back to 1871, that the interest rate markets and the commodity markets move in inverse cycles. The shortest term was 9 years, the longest was 29, and the average was 18 years. The evidence is scanty in some places, but nevertheless very suggestive:
For instance, from 1877 to 1906 the stock market rose strongly while inflation was low and commodity prices declined. Then from 1906 to 1920 this cycle reversed; commodity prices rose strongly while stocks declined. This of course was the time of the military buildup to World War I and the war itself, a time when inflation
was rising strongly.
Then from 1920 to 1929 we have the famous bull market in stocks, a time when commodities did quite poorly by comparison. In the next period, from 1929 to 1949, stocks did poorly in real terms. Meanwhile, commodities were showing much greater relative strength. This was the time of the military buildup to World War II and the war itself, when commodities were greatly in demand.
Then from 1949 to 1966 the cycle reversed again. It was a time of low inflation, and capital flowed into financial assets. The interest rate markets all did very well, while commodities languished in relative terms.
During the period of time from 1966 to 1980, however, the cycle reversed again and the interest rate markets were damaged. In 1966, for instance, the Dow Jones Industrial Average was at about 1000. Yet in March of 1980, 14 years later, it was 730. Of course, that's before the effects of inflation. In real terms the DJIA did much worse.
During this same time the price of physical commodities —gold, silver, copper, crude, heating oil, gasoline, corn, wheat, soybeans and so on—rose strongly.
The price of corn, for instance, quadrupled during this period. The price of oil tripled. Gold went from $35 an ounce in 1966 to $875 an ounce in January of 1980. Silver went from about $1.50 an ounce to almost $50.
It was a time of inflation. The Consumer Price Index (CPI) eventually went over 15%. And since interest rates are highly dependent on the rate of inflation, they too—both long-term and short-term interest rates—eventually went over 15%.
In contrast, the period from 1980 to the new century was a good time for the interest rate markets—stocks, bonds, real estate. Both the inflation rate and interest rates were falling all during this time, and the interest-rate markets benefitted enormously.
For instance, the DJIA went from 730 in 1980 to 11,750 in early 2000. The Nasdaq went from less than 100 to over 5000 during this period. Both real estate and bonds rose steadily during the '80s and '90s decades.
Meanwhile, during this time of declining inflation and interest rates, physical commodities also declined. For instance, gold dropped from $875 an ounce in 1980 to $255 an ounce in 2001. And silver dropped from $50 an ounce in 1980 to $4 in 2001. Crude oil had declined to less than $12 a barrel by 1998. And so on.
Because of the stock market drop from early 2000, the Federal Reserve Board steadily lowered short-term interest rates until they reached a 45-year low of 1% in 2004. Naturally, bonds and real estate soared and the stock market partially recovered.
As detailed elsewhere in these pages, a gigantic money and credit bubble which had expressed itself in the stock market in the run-up to 2000 now expressed itself in the bond and real estate markets.
But the writing is on the wall for the interest-rate markets because short-term interest rates have been rising since June of 2004. And long-term rates appear to have reached a bottom in early February, less than a month ago, and have been rising since.
In this vein, the bond market has probably peaked in the past month (it's now March 4, 2005). Real estate's peak is probably not far behind, if it has not already occurred, since mortgage rates—which are heavily dependent on rates in the bond market—have also begun to rise.
Thus the interest-rate markets—stocks, bonds and real estate—are probably all peaking this year. From there, in my opinion, they will likely go into relentless declines, in real terms, for 10 to 15 years or more.
Such relentless declines (in inflation-adjusted terms) will naturally be punctuated now and then by sharp rallies, since markets tend to move in a zigzag fashion, but those rallies will most probably be only temporary respites in the larger decline.
(This is the end of Part 1. Go to Part 2.)
—jim sloman, 03.04.05
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