Copyright © 2001 by Norman P. Poire. All rights reserved.

An empirical analysis of stock index prices reveals overwhelming evidence of the existence in the U.S. stock market of a seven-year wave that is part of a larger investment cycle. This investment cycle is synchronized with the widely known Kondratieff wave that various researchers claim is 50 to 60 years in duration.

I like to track the Kondratieff wave (a.k.a. the K-wave) using a seven-year moving average of the CPI inflation rate shown below in Figure 1. It clearly shows four inflation peaks over the two-century period in 1814, 1865, 1920, and 1980. The first three K-waves fall in the years of the Industrial Revolution while the fourth is the first wave of the Second Information Revolution that began in 1939 with the invention of the electronic digital computer.

Figure 1

In my article entitled The Next Technology Boom I present a cycle of Growth Innovations that also lasts 50 to 60 years. These Growth Innovations dominate the economy for a period lasting approximately 56 years while they go through the integration and domination phases of their growth cycles. Three emerged during the Industrial Revolution: the textile factory in 1800, the passenger railroad in 1853, and the automobile in 1913.

Growth Innovation cycles move in tandem with the K-wave. Roughly ten years following the emergence of one of these powerful new technologies, the economy moves into one of its inflation peaks. Textiles in 1800 led to an inflation spike in 1814, railroads in 1853 begat the 1865 Civil War extreme, automobiles in 1913 preceded the WWI 1920 top, and computers in 1970 brought on the 1980 peak.

In the stock market, these inflation spikes mark the end of a seven-year wave I label the Inflation wave. This is followed by three more seven-year periods called Deflation, Contraction, and Expansion. Since three K-wave and Growth Innovation cycles fit within a 168-year technology revolution, they must be on average 56 years each, or eight seven-year waves in length.

Four more waves, then, follow the Inflation-Deflation-Contraction-Expansion series. These four waves I label Overcapacity, Growth1, Growth2, and Stagnation. Because each K-wave varies in overall duration, the length of the waves also varies depending in which K-wave it falls. The wave lengths are determined by dividing the interval between inflation peaks by eight.

Working through the data, the results in Table 1 are obtained for each wave period. The Inflation-Deflation-Contraction-Expansion sequence clearly has a down-up-down-up impact on equity prices. The Overcapacity-Growth1-Growth2-Stagnation cycle effects a down-up-up-down influence on stocks.

Back-to-back positive waves (Growth1-Growth2) occur as a rapidly growing Growth Innovation approaches market domination. For automobiles, the years 1949 to 1965 fell into these two periods while for railroads it was the years 1894 to 1906.

The only time two consecutive seven-year periods yield negative returns is with the Stagnation-Inflation pairing. This is a time when a dominant Growth Innovation reaches its maturity stage and the economy is struggling to reallocate resources to a new up-and-coming technology. This occurred from 1907 to 1920 when autos were overtaking railroads and from 1966 to 1980 when computers were making waves.

Table 1. Average Stock Performance of Each Seven-year Wave
(Real S&P 500 Index Annual Averages)

The following chart demonstrates how differently stocks behave from K-wave to K-wave. Figure 2 shows stock performance during the three Industrial Revolution K-waves. The plots are normalized by setting the low point of each cycle to a value of 1. As much as is often made of the Roaring 20s, stock performance during that mania never were able to drive prices to the levels achieved in the first K-wave cycle of the Industrial Revolution when the textile factory Growth Innovation was in full force.

Figure 2

Clearly the onset of the Industrial Revolution reverberated throughout all of society. When the factory supplanted artisans and craftsmen, it induced productivity gains that propeled the economy and the stock market like never before and never since. Not until recently has any innovation come close to making that kind of impact on the world. With the advent of the digital explosion, technology is once again radically changing the landscape. It should not be surprising, then, that today's cycle shares much in common with the textile innovation cycle.

A comparison of stock price performance during the two K-waves shows remarkable similarities. The overall shape of the curves are more like each other than like either the railroad or the automobile K-waves. The price appreciation in today's K-wave is double that of either of the prior two. As impressive as today's 18-year bull market has been, it still falls over 30 percent short of the one that began when the war ended in 1812. Using yearly averages, that one appreciated 730% compared with 550% today.

Figure 3

That amazing era, however, ended badly in 1835. That was 166 years ago as a seven-year Expansion wave ended and gave way to a particularly nasty Overcapacity wave that lopped nearly 70 percent off of equity values. In fact, the seven years from 1835 to 1842 represent the worst seven-year period in the history of the U.S. stock market. By my count, 2001 marked the end of another Expansion wave and the beginning of a downwardly biased Overcapacity wave.

Posted August 2001

Edited May 2002

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