Monday, April 23, 2007

Theory suggests we're heading for a depression

ON 13 March 2003, the FTSE All-Share index hit 1,676.6, the IT-driven peaks of three years before a distant and frustrating memory.

Just a few days ago this key benchmark broke through to more than 3,380, a rise of 100 per cent.

True, this advance has not been without interruption, punctuated, in fact, by two particularly sharp corrections, in May last year and February this year, but these were as short-lived as that most spectacular of all "panics" in recent memory, that of October 1987.

To an extent, market trends are the source rather than as the result of opinion, extending onwards until reality is suspended, at which point, like that cartoon Coyote suspended over the canyon pedalling furiously, a glance below triggers nemesis.

Although I am no chartist, the structure of a market often follows a distinct pattern, an initial sharp reaction followed by an equally robust change in direction, which persuades the majority that the original trend has been re-established and then a more sustained secondary pattern which, in turn, carries the conviction of permanence.

In truth, there are two fundamental aspects of any market trend.

One is the belief by the majority that "this time is different" and two, that it is not.

In fact, the phrase "this time is different" is almost as depressing as Evelyn Waugh's dislike of "red or white?" or "shall we go straight in?"

Personally, I suffer a serious nervous reaction to the news from my IT department that "we have upgraded your systems".

The trouble with cycles is that one is never very sure when they started and, as a result, they can only really be judged retrospectively.

In 1923, Joseph Kitchen announced his discovery of a 41-month cycle, while the French economist Clement Juglar, who died in 1905, identified a seven to 11-year business evolution.

Perhaps the most famous was the Kondratieff theory on wave cycle, "discovered" by the Russian Professor Nikolai Kondratieff and whose cycles are supposed to last anything between 45 to 60 years.

Prof Kondratieff helped to develop the first post-revolutionary Soviet five-year plan.

In his findings, he suggested that there were four distinct phases: beneficial inflation; stagflation; beneficial deflation and deflation.

Unfortunately - for him - his work and conclusions were seen as a criticism of Joseph Stalin and he ended up dying in a gulag in 1938.

Based on his theories, however, there was a period of beneficial inflation between 1949 to 1966, stagflation between 1966 and 1982, and beneficial deflation between 1982 and 2000.

We are now in that fourth stage, a deflation cycle which should lead to a depression.

Prof Kondratieff was building on the premise promoted by Juglar, who suggested that growth periods usually ended in a spectacular collapse of the proverbial bubble, with the consequential need of a purging of the system to restore reason.

It seems to me that we are depressingly close to just such a climax, depressing, that is, for one who makes a living out of investment markets; as Butch Cassidy said to the Sundance Kid: "You know kid, for a gun fighter you're a helluva pessimist!"

The human condition is prone to irrational enthusiasm, which can overwhelm anything from a playground to a lynch mob.

Peering into the investment market pond today suggests that the entire piscatorial shoal is engaged in a cycle of mutual ingestation, which can only lead to an acute attack of indigestion.

I am not saying there are no investment opportunities to be had but, when you have central bankers still obsessed by inflationary pressures which are as much as anything else a consequence of political initiatives or acts of the Almighty - high oil prices (Iraq and tax) - high food prices (hot weather) - and not from avaricious wage demands or spectacular speculative consumption binges, then there are problems on the horizon for us all, and especially for those who succumb to banks lending mortgages on an income multiple of six.

As Euripides said: "Whom the Gods would destroy, they first make mad."

• Bryan Johnston is a director of Bell Lawrie in Edinburgh.

Last updated: 21-Apr-07 01:00 BST

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