The Nature of Timing Models
The nature of time has always been a puzzling and intriguing subject. Jules Verne gave us bold glimpses of time portrayed as another dimension through which man may one day travel back and forth. Einstein explored the question of time in his Theory of Relativity. Time to the investor is often the most critical component of decision making that can overpower all other considerations. While time may be the most important aspect of investing, it is also the least understood.
There are numerous critics of those individuals who chose to explore the element of time in economic and market forecasting. A classic example is the debate concerning Kondratieff’s work which has come to be known as Long-Wave Theory or the K-Wave.
Critics of Kondratieff live in fear of his theory being correct. For if long-waves of economic activity exist, then the implication is that the future is perhaps predetermined. That conjures up internal fears that go against the very belief that man is superior because he possesses the divine quality of free will. Timing models and cycle theory DO NOT take away the free will of mankind, nor does it suggest that the future of an individual is predetermined. Any psychologist can explain the collective behavior of a mob. While the individual within the group may be sympathetic to the actions of the mob, he still possesses free will to either leave or remain part of the crowd.
Such fears about cyclical theory are unfounded. Scientific research has proven beyond a shadow of a doubt that the universe is governed by the influence of cycles. Not only is our planet dependent upon a regular cyclical journey around the sun that provides us with the four seasons, but the sun itself is nothing more than a thermodynamic system dependent upon a cycle of pulsating energy.
Physics has proven that unless a cycle existed within the energy system of the sun, its light would have died a long time ago. In the field of electronics man has harnessed two forms of electricity; direct current (DC) and alternating current (AC). We have come to learn that DC cannot be transmitted over long distances because it is impossible to maintain DC at a constant energy output. All of our households, offices and computers are designed to operate on AC, which is electrical energy output generated with a particular cycle.
In biology we learn that life itself is based upon cycles. Our heart does not pump at a steady uninterrupted rate. Instead, it pulsates and thereby insures a longer life span. Every night our body needs sleep to rejuvenate and enable us to face yet another day fulfilling a cycle of energy consumption.
We have all read about the so-called “business cycle” which is used to explain the ups and downs of our collective economic activity. Prosperity is followed by recession only to be followed by still another cycle of prosperity. Paul Volcker, former chairman of the US Federal Reserve, wrote a book (“Rediscovery of the Business Cycle”) in which he identifies a duration of 8 years.
At Princeton, we have conducted in-depth research, observations and actual implementations of timing models for more than 20 years. We are considered to be one of the foremost experts in this field and our chairman serves as a director on the Foundation for the Study of Cycles, which was founded in the 1940’s by the economist whom Herbert Hoover charged with investigating the Crash of 1929.
The thrust of our work into market timing began with the simple observation that all economic and market activity displayed a greater amount of time consumed by bull markets than bear markets. We found that bull markets over the last 300 years tended to average 7 years while bear markets averaged 2 years. The great bull market of the Roaring ‘20s began from a low in the US stock market formed in 1921 and rose almost steadily until 1929. The famous crash resulted in nearly a 90% decline which established its low in mid 1932. Indeed, a look at most of the famous panics in history will reveal that the stronger the bear market, the shorter the duration.
Therefore, our initial observations clearly revealed that ALL bear markets, without exception, take place in shorter periods of time than bull markets. This statistical fact was the first key to understanding market timing. Its existence was based on human nature itself. We all tend to gain confidence in something at a much slower pace than when we lose it.
Our timing models are the result of an intensive case study into the statistical differences between the nature of bull and bear markets. Both can be quantified and the analytical findings employed to reduce the odds of error by highlighting the most probable path. We run these models on our computers on all levels of price activity from intraday to yearly. This enables us to identify and provide our clients with specific periods in time when highs and lows should most likely occur well in advance of the event. We employ our timing analysis not only on all levels of price activity within a specific market, but also interface these models with global economic and market activity. For example, it is impossible for the British pound to fall to par against the US dollar without some effect on all other world markets and currencies.
Like a stone thrown into a pond, a ripple effect creating waves is generated in all directions. In a large pond, it might appear that the waves eventually disappear, becoming smaller as they stretch outward from the point of origin. However, a subtle current prevails silently beneath the surface for a distance beyond what we can actually see. The global economy interacts in the same manner. For every event that unfolds in Europe, some counter effect takes place even in Australia. As for the United States, given its size in excess of 25% of the total world economy, it is often said that when the US sneezes, the rest of the world gets the flu. Global correlation of economic and market activity is the key to consistent long-range forecasts. While every nation strives to maintain a trade surplus, it is a fact of life that for every nation that enjoys a trade surplus, another must endure a trade deficit. The global economy is a vast network of interrelationships delicately balanced between the two trends of boom and bust. When the US share market peaked in 1966, the German share market bottomed. When European share markets peaked in 1927- 1928, the shift in capital flows to North America resulted in a doubling of the Dow Jones Industrials. As all nations cannot maintain a trade surplus simultaneously, neither can they simultaneously experience prosperity. Our research into global trends has often revealed that a bear market in one nation results in a bull market for another.
As you watch our forecasts unfold, you will come to realize that cycles can be measured and quantified in the same manner as price or even supply and demand. To ignore the statistical differences between uptrends and downtrends is to flirt with certain financial disaster.