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?Hanging Ten? on the Kondratieff Wave By Stephen J. Butler

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In surfer jargon, “hanging ten” means you have ten toes draped over the surfboard’s edge as you roar down a giant wave. Nikolai Kondratieff, a Russian economist exiled to Siberia, spent twenty years longing for sunny skies and a nice warm beach. He theorized that economic forces repeated themselves, and he traced a steady pattern of fifty-five year boom and bust cycles. 

The Communist authorities had trouble with the boom part, because they desperately wanted to believe that capitalism was dead.  Siberia, they decided, would be a good place for Comrade Kondratieff to revisit those charts and graphs in peace and quiet. 

The recent market turmoil has lifted Kondratieff’s theory from obscurity. In mid-March Larry Summers, former Secretary of the Treasury, suggested that “the current slowdown is unlike any other in the last fifty years.”  Mr. Summers, newly-appointed as President of Harvard, deserves our attention. Is his reference to fifty years a coincidence, or is he a modern-day apostle of Kondratieff?  Put another way, is the U.S. economy hanging ten on a Kondratieff wave?

The Russian’s hypothesis was that economic, social, and cultural forces create business cycles that repeat through generations.  The cycle’s apparent lengthening is due to increased life expectancy.  Technology has driven most economic surges – whether it be railroads, telephones, airports or the Internet. The blowout and decline, in every case, has resulted from over-borrowing that fueled speculative excess.  This has lead to a “renunciation of debt” and a deflationary period marked by a recession that typically lasts about ten years. 

Summers and others are pointing out that this recession (they talk as if it is definitely here) isn’t the product of inflation nor higher interest rates. Instead, a roaring stock market poured money into technology.  This activity, like the seed crystal in a rain cloud, lifted all other sectors, from Rust Belt suppliers to consumer goods manufacturers.  The technology industry, which comprises over 30% of the S&P 500, became a feeding trough for other businesses gorging on the computer and communications equipment they felt they needed. 

Kondratieff described a boom’s collapse as characterized by “renunciation of debt.”  In other words, companies that can’t repay their loans go bankrupt. After inflicting a great deal of pain, the system cleanses itself over about a ten year period. 

While U.S. banks may not be in trouble, I’m reminded of what Mr. Levitz of Levitz Brothers Furniture once said about the stock market:  “Going public is a great way to borrow money.  You don’t have to pay interest on it and you don’t have to pay it back.”   He viewed the equity markets as a replacement for his banker.

In essence, the explosion of mutual fund popularity has prompted equity investing to replace bank savings accounts in the public mind. Mutual funds have done an end run around the banks. Savers who once used banks to insulate themselves from risk have now effectively “loaned” money directly to the business community. 

Most investors don’t see this as risk money.  We have faith that our S&P 500 index fund shares will always be worth at least what we invested if we wait long enough.  If Kondratieff were here today, he would describe the bursting stock market bubble as just another expression of “loan renunciation.”

What does this mean for retirement savers?  For those of us still in a typical mutual fund or group of stocks that have lost 25%, it helps to remember the euphoria when those investments gained 10% or more in single quarters over the past several years -- and over 20% per year for three years in a row.  Hold that thought. If we are ten years or more from retirement, think about the terrific values gained by purchasing funds as we dollar cost average into these depressed markets.

In a doomsday scenario, the market may drop to 50% of its early 2000 value.  Some portfolios have lost this much and more.  Someone who had $100,000 has lost $50,000. However, annual contributions from this point forward of $10,000 per year earning an average annual return of 10%, coupled with gains on the remaining $50,000, will lead to a total account balance of $300,000 in ten years.

 Clearly, it would have been better if we hadn’t lost the $50,000. But if we hadn’t taken the risk to get there, we wouldn’t have had the $100,000 to begin with.  This is the time to be philosophical. 

Another silver lining is the dividend stream.  When companies have major reductions in their stock prices, the dividends they pay amount to a much greater percentage return.   At the market peak last year, dividends amounted to only about 1.3%.  Suddenly, they are approaching 2-3%.  Persons tempted to move into a money market fund would be better off staying put if rate of return is the primary concern.  Moving to cash protects against further downside, but it closes the door on the road to recovery. 

Remember, upward movements in markets quite often occur in short, unpredictable bursts.  Most people who move to cash are traumatized to begin with, so they hesitate to move back into the market until after major gains have occurred.  In other words, they get back in just in time for the next “correction.” 

Here’s a rule of thumb. If your inbound future contributions are at least 25% of your current account balance, the current downturn is working to your advantage.  

If we believe in the Kondratieff Wave, we can easily believe that this could be The Big One. Even Alan Greenspan can’t help us now because interest rates have nothing to do with this downturn. 

The nice aspect of the wave theory is that there are always more coming.  If we wipe out on this one, we can keep paddling around until the next set comes in.  For every investment type, there is a perfect wave out there sooner or later.  If we keep our investments diversified across different investment types, we’ll catch more perfect rides.

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