The SENTIMENT THEORIST 24 May 08

Mukul Pal ASCH.THREE LINES. EXPERIMIENT

INTERMARKET CYCLES AND THE WORLD IN 2012

Intermarket cycles can change the way we look at asset
cycles. Starting from 30 year mirroring commodity and equity
cycles, inflation and deflation cycles, the subject also
redefines Sam Stovall’s sector rotation structure giving new
insights about the world order ahead.

It was not just investment gurus, but philosophers and

painters who talked about simplicity being solved
complexity and a very powerful investment approach. We
also had a Nobel Prize awarded to a simple thought that
there is no economics without psychology. Sentiment comes
before rationality and human beings are nice and dumb and
not profit maximizing smart souls. Crowds are accordingly
involved pprimaryy with instincts, biological
g drives, compulsive
p
behavior and emotions. Hence market success is less about
economic but more about psychological competence.

Many experiments regarding crowd behavior also prove that Fig 1

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an individual transforms into another being when he
becomes a part of the crowd, so much so that he completely
abandons the logical and rational thought. He does not think In 1955 Herbert Simon sought to unify the observations
but herds. Solomon Asch, Harvard conducted the matching of Zipf
p and others by y formulatingg a single
g common
li
lines experiment
i t (Fig
(Fi 1.).
1 ) Individuals
I di id l and d groups were explanatory model for many of the systems displaying
asked to match the length of a line with three other lines. power-law behavior, including language, population and
Individuals in isolation made a mistake less than 1 per cent. wealth. Stock markets around the world also work on a
However, when placed in a group that had been instructed power law. In 2003 in a paper submitted to
beforehand to claim the mismatched lines were actually the Econophysics, Kaushik Matia and I illustrated the Indian
same, 75% of participants agreed with the majority. This was price fluctuations exhibiting an intermediate form
true even when the actual difference between the lines was between Power Law and Gaussian behavior. This
very significant. Participants lacked the nerve to disagree aberration also did not last long when Sitabhra Sinha, re
with the majority.
majority Another interesting experiment i d the
examined h prices
i iin M
May 2006 fifinding
di the
h price
i
demonstrating the lack of rational thought was when a group fluctuations exhibiting a power law.
exercise was conducted by Stanley Milgram of Yale.
Individuals were ordered to inflict pain on an innocent victim ZIPF’S LAW

(who was acting) in the interests of an important cause. More

than 60% of the subjects were prepared to obey instructions
and administer the highest and most lethal dose of
electricity, even after the victim was, to all intents and
purposes
p p comatose.

And if all this infliction and pain seem closed door

experiments different from the stock markets, we have
numerous mathematicians and scientists proving the same
simplicity mathematically. It was George Kingsley Zipf, an
early twentieth century scientist who revolutionized our
understanding of power law and revealed their astonishing
presence throughout society and nature. Zipf's law (Fig 2.)
states
t t that
th t the
th mostt common word d used
d in
i language
l is
i a
constant factor (say two times) more common than the
second most common, and the second most common word
is twice as common as the third etc.
Fig 2
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MANDELBROT – M SET Fig 3
Another interesting aspect was that of Fractal
geometry, published in 1977 when Benoit Mandelbrot (M
SET fame Fig 3.),3 ) Mathematician,
Mathematician Yale proved that
Fractal Geometry was mathematical. His work extended
the area of late nineteenth century mathematicians like
Giuseppe Peano who demonstrated the completed
inadequacy of the common idea of dimension.

The subject of fractal geometry can not only calculate

coastline lengths but is used in Seismology and
Helioseismology and in a host of other scientific
applications today. The marine drive, Mumbai, coast line
carries fractal drums to safeguard the coast. It is
scientifically proven that rugged fractals are more efficient
in saving coastlines than concrete walls. The fractal
nature of the web is also behind Google's success.

The worldwide web is in the form of a bow tie (Fig.4)

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with four components, a core, inbound links, outgoing
links and the disconnected pages. Any way you slice the WEB AS A BOW TIE Fig 4
web, geographically, topic specific
clusters, organizationally or into groups of pages owned
by the same person, the bow tie shape emerges again
and again. This is the same fractal behavior in
nature, societies and price behavior that connects all of
us. This is also a reason why Elliott's wave principle and
Dow's theory has survived more than 125 years.

Fractal self affinity as Elliott said, is fundamental to nature

and all human activity leads to a socionomic process. It
follows a law, repeats in time, has a definite number and
pattern (Fig 6) and covers areas as diverse as Gold
prices, population movement, price of seats in stock
exchanges, patent applications, commodity
prices, epidemics real estate business, politics and the
pursuit of pleasure. We have also talked about Malthus
population curves redefined by Verhulst as S curves (Fig
5), another form of fractals.
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ELLIOTT WAVE FRACTAL Fig 6

THE S CURVE Fig 5

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IDEALIZED CYCLE Fig 7

All this fractaled nature of Economics, nature and
universe has a fixed periodicity linked with it i.e. there
are cycles running through them
them. Edward R Dewey
started the Foundation of Cycles early 1940’s when he
realized the uncanny similarity in data cycles found by
Hyde Clark in business activity (Fig 7.), Benner in
industrial prices and Seton in animal population cycles.

The 11 year sunspot cycles linked with human

excitability and stock markets. The nine year cycles
linked with religion and credit (Fig 7.), where rise of
deposits every nine years is inversely linked to the rise
in people going to church, 25 year volatility cycles (Fig
12), 17 year international battle cycles, dividend
cyclicality etc. Interest rate cyclicality is a reality that flies
in the face of believed truth that the central banker is in
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charge.
RELIGION Fig 7
The current linear research model (Fig 8) fails to VS. CREDIT
assume the cyclicality of the market. The model works
on an assumption of an economic growth that leads the
positive news which leads to price growth and
prosperity. Robert Prechter’s socionomic model was the
first to illustrate the social mood cyclicality.

The Alternative research cycle (Fig 10) considers the

social mood at the start of all human action and activity.
A positive mood reflects in productivity and creation
which reflects in markets and finally confirms as the
economic cycle turns up. The positive economic cycle
creates positive news and hence the self feeding Fig 8
feedback loops. On the other hand owing to social COPYRIGHT ORPHEUS CAPITALS
negative mood, it's the negative feedback loop which
works.
FIG. 9

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Fundamental meets Technical. Sam Stovall, chief global

strategist, S&P was recently invited to the MTA (Market
Technicians association). He was wondering why he
was invited as S&P already had a few CMT's. The
reason Sam was invited was because his sector
rotation structure (Fig 11) are the first steps of a
fundamental thought towards cyclicality, which is a
technician's domain. As we move ahead the thick line
between fundamental and technical starts to erode
erode.
John Palicka's Fusion analysis is another attempt to
bridge the two subjects.

Fig 10
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Fig 11

3 5 COPPER – DOLLAR TERMS

EARLY ECONOMIC CYCLE MIDDLE ECONOMIC CYCLE LATE ECONOMIC CYCLE

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Stovall’s sector rotation identified five economic cycle
stages in the market viz. early expansion, middle
expansion late expansion
expansion, expansion, early contraction and late
contraction. The market sectors move within these five
stages. Technology and Transportation perform in the
early expansion, capital goods in the middle expansion
stage, basic materials, energy, and consumer staples in
the late expansion stage, utilities in the early contraction
stage. And financials and consumer cyclicals in the late
contraction stage.
Father of Intermarket analysis John Murphy, connects
defines the four broad asset classed viz.
bonds, currencies, equities, and commodities and there
linkages. How bonds leads equity markets and how
commodity upcylces are inverse of equity cycles.
VIX - VOLATILITY CYCLES
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Just like all other fractals, a link runs through market
cycles which Tony Plummer defines in his book on
Forecasting Financial markets
markets. Plummer classifies the
broad economic cycles into TRIADS with Base, trend
and terminal cycles. Cycles are seen from low to low
and not from high to high, as bullish market bias extends
markets longer pushing the cycle top ahead of the
symmetrical high. Bear markets correct faster. This is
why the bear cycle tops are translated (biased) towards
the left and lie before the symmetrical cycle tops.
Plummer identifies behavioral traits linked with the
respective base, trend and terminal cycles. Base cycles
are characteristic of Indolence, recuperation and
rejection. And trend cycles are characteristic of
confidence, change and deception. Fear, resistance and
accusation are characteristic of final terminal cycles. All
these cycles have a three wave pattern labeled as 1-2-3
up and a-b-c down (Fig 7).
Fig 12
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These triads build the economic cycles and exhibit a
power laws behavior. Kitchen cycles (Fig 13.) last from 3
to 5 years and on average are 3 3.33
33 years long.
long These
are knows as inventory cycles are closer to the popularly
know US presidential cycles. The only cycles
conventional economists believe to work. Next comes
the Juglar cycle, which last for 7 to 11 years and
average around 10 years. These are also knows
popularly as the decade cycles. Juglar cycles, which are
also known as the capital investment cycles, are three
times Kitchen cycles. Then next power law that is three
times Juglar cycles take us to Berry cycles also known
as the infrastructure cycles. Berry cycles last for 25 to 30
years averaging around 30 years. We have seen 25
year cycles in commodities, gold and silver ratio,
volatility etc. A step ahead on power law takes us to the
Strauss and Howe cycles (crisis cycles) of 90 to 99
years. Plummer makes an interesting observation about
Kondratyev cycles while classifying the triads from 3.33
years to 90 years. Kondratyev is not an economic cycle
as Kondratyev saw prices rising and falling in long
waves. Not all Kondratyev lows are major depressions
because not all Strauss and Howe lows will coincide
with a Kondratyev low.
SOURCE. ECONOMIST
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6
Strauss and Howe crisis alternate between deflation and
accelerating inflation. This is why Plummer believes we
have finished the deflation Strauss and Howe metacycle
in 1946 and now we are in the inflationary cycles that
should push till 2030 marked by the world war III. A rough
calculation and one can see that India's first war of
independence and US civil war of 1857 had an uncanny
similarity. This we at Orpheus believe was the second 90
year metacycle. The first starting somewhere in 1720, the
start of capitalism. Hence we are indeed in the revolution
cycle which ends the 270270-300
300 years of economic activity
near 2030. We are not sure how inflationary things may
get or whether we are indeed heading for hyperinflation
and destruction of real money, the pointers more indicate
at the latter than the former. The intermediate pause
before the last 30 year cycle starts should be around
2012-2014. This should be marked by economic growth
accompanied by continued rise in commodity prices, Gold
at 3000 dollars and Oil p potentially
y much higher.
g New
sectors to watch should be the alternative energy and
biotech till 2020 and beyond.
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Intermarket cyclicality is a subject coined by us at
Orpheus. This subject not only redefines SAM Stovall's
sector rotation
rotation. But it also attempts to extend market
cyclicality from an intermarket perspective. Since cycles
work on Triads, Sam's sector rotation sectors can be
reclassified in three broad sectors viz. early economic,
mid economic and late economic cycle sector (Fig 11).
Early Economic i.e. Financials, Information Technology
and Discretionary. Mid economic i.e. industrials and Late
economic consisting of Energy, Materials, Staples and
Utilities. As we head into the terminal kitchen cycle and
Juglar cycle low in 2010-2012 the late economic cycle
should outperform the market.
This means Energy, utilities, staples and materials
sector stocks has more upside left. According to
intermarket cycles, the 30 year Berry cycles is linked to
equity cycles. That means equity markets grow and
decay in about 25-30 years cycles. This is what the
gold-silver ratio (the metals maze) and volatility cycles
highlight (25 yr cyclicality). This 30 year equity cycle is
inverse of the 30 year commodity cycles. This means
when equity rises, commodities fall and vice versa.
1975-80 was a commodity market top and an end of
equity bear market in US.
And 2000 was an equity market top in US and a start of
a commodity boom.
boom The current commodity boom
should end in the 2024-2030 (Strauss and Hauss)
metacycle low with potential highs in the 2012-2015 time
windows. It is in this time frame equity markets should
make the decade low. Intermarket cycles can extend the
cycle explanations to regional allocations between Asia
and the west, between inflation and deflation and
between interest rate and yield cycles.
Sector rotation remains a key intermarket strategy for
portfolio allocation but in terms of early economic, mid
economic and late economic than what is classified by
Sam Stovall's five stage economic cycle approach.
Commodity and equity intermarket also suggests that
materials, metals, chemicals, staples and Pharma could
be defensive and relative performers. Our XTR products
cover global sector rotation and intermarket cycles for
emerging markets including India and Romania and for
global sector indices.
Intermarket cyclicality can also help move in and out of
large and small cap sector stocks. The subject can also
help create low correlation combination portfolios to
better overall portfolio return to risk profile.
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7
The current multi decade cycle is inflationary and of rising
interest rates. Many emerging markets are between the
late expansion and early contraction stage. This means
that the sectors which will outperform are the
Energy, Staples, materials and utilities. This should
happen for atleast a primary (more than 9 months) time
frame. The late economic sector cycle is in sync with the
ongoing 30 year commodity cycle (Fig 14.), which started
in 1998-2000 and should top in 2012-2015.
This is another reason why food
food, material and commodity
prices will continue to rise. However, we should not forget
that this commodity cycle is a 1-2-3 structure up. And we
have had no retracement of primary degree till now. The
very reason a sharp retracement is pending before the
CRB (Reuters Commodity Index) regroups again and
heads higher. The real depression activities will start then.
The world in 2012 will be a strangerg p place with the lower
billion of the world struggling for food and the top billion
still getting richer. The hedge funds (the one’s that
survive) which will create news then will be the ones
doing Long Water – Short Oil strategies. The world
beyond 2012 will be ruled by global macro funds, market
psychology will gain more prominence, fractal forecasting
might be taught at YALE, Cycles will get their place in
statistics as the relentless cyclical change pushes ahead.
And all this while we will wonder about the randomness of
the world we live in, unaware of the simple structures that
got us so far.
TONY PLUMMER: FORECASTING FINANCIAL MARKETS
COLOURS OF INFINITY: ARTHUR C CLARKE
INTERMARKET ANALYSIS: JOHN MURPHY
ECONOMIST: ANGRY CHINA, MAY 3-9, 2008
THE METALS MAZE
MAZE: THE SENTIMENT THEORIST,
THEORIST APR 2008
CASE OF CYCLES: EDWARD R DEWEY
VIX CYCLES: ORPHEUS CAPITALS RESEARCH
THE S CURVE: PIERR FRANCIOS VERHULST
SOLOMON ASCH THREE LINE EXPERIMENT
ZIPF’S LAW: GEORGE KINGSLEY ZIPF
RECLASSIFYING SECTOR ROTATION: ORPHEUS CAPITALS
Mukul is an MBA and member of MTA since 2006. He has
worked for the Bombay Stock Exchange and many leading
brokerage houses and banks in India and abroad in senior
research positions before starting on his own in 2005. In his
current profile, he leads a team of research analysts covering
global assets and emerging markets to generate institutional
research. Orpheus Capitals research is published internationally
on Reuters and Thompson platforms. The Global Alternative
Research Company is located in Romania. Their coverage
includes emerging markets like India and Eastern Europe. The
company also
l covers M Metals,
t l F
Forex, A
Agro anddE
Energy.
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RESEARCHER PERIOD (YEARS) AVERAGE RELATIONSHIPS

KITCHEN 3 T0 5 3.33
JUGLAR 7 TO 11 10 3*KITCHEN
KUZNETS 20 TO 25

BERRY 25 TO 35 30 3*JUGLAR/9*KITCHEN

KONDRATYEV 45 TO 60

STRAUSS AND HOWE 85 TO 99 90 3*BERRY/9*JUGLAR

Fi 13
Fig
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Fi 14
Fig
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