Note: "From Bust to Boom In the 1990s" was written and published by
Norman P. Poire in the summer of 1993. What follows is excerpted material from
chapters 1, 6, and 7 of that book that has been edited for conciseness and
readability while leaving the original message intact.

Copyright © 1993 by Norman P. Poire. All rights reserved.

When I want to understand what is happening today or try to decide what will happen tomorrow, I look back. - Oliver Wendell Holmes, Jr.

History is only a confused heap of facts. - Earl of Chesterfield.

The intellectual pioneers of the fifteenth, sixteenth, and seventeenth centuries laid the mathematical and scientific foundation for the greatest technological revolution in history. Men such as Copernicus, Galileo and Descartes risked their reputations and even their lives with what were at the time radical views about the way the world works.

When the genius of Sir Isaac Newton appeared, the time was right to mold these ideas into a practical theory - one that showed mankind that the universe around them was knowable. In the 1687 publication of his Mathematical Principles Of Natural Philosophy, Newton presented a world view that was linear, deterministic, highly predictable, and constant.

On such stability was built an endless stream of inventions and discoveries, led by James Watt's steam engine in 1775, that ironically brought about the greatest change mankind had ever witnessed. This industrial explosion reached its zenith in the 20th century as modern industrial heroes like Thomas Edison and Henry Ford expanded upon and perfected the technologies they inherited, leaving in their wake a standard of living that was undreamed of only a century before.

It should not be surprising that in the midst of this great change, thinkers would begin to challenge the very foundations of a stable scientific view. Charles Darwin was among the first to discard the idea that nature was unchanging. When he introduced his theory of the evolution of species, a new revolution had begun.

Now Einstein's relativity, Niels Bohr's quantum mechanics, and research in the field of chaos is dramatically reshaping our world view. This new world is non-linear, chaotic, statistical, and evolving. It is globally stable, yet locally unpredictable. Someday the works of these new pioneers will be unified in the minds of future geniuses, taking mankind to planes now unimaginable.

THE SCIENCE OF FORECASTING

Forecasting in an ideal Newtonian universe is a fairly straightforward process. For a given cause there is a known effect. Each input has a predictable output. A system behaves like the sum of its parts. If our prediction does not match the system behavior, then we break the system down into smaller and smaller units until we identify the unknown cause. In the Newtonian world, we view systems through a microscope. Our knowledge is increased through greater and greater specialization, each detail on its own being significant to our understanding.

As the 20th century draws to a close, we are nearing the limits of the microscopic approach. The digital computer allows us to analyze more and more complex systems adding dozens, hundreds, or even thousands of variables to our analytical models. No matter how many variables we add, though, some nonlinear phenomena simply cannot be broken down into linear equations. We are always left with those irritating ups and downs in the data that can only be described as random noise.

Science has been studying weather patterns for decades with increasingly sophisticated computer models, yet we still cannot make accurate temperature predictions beyond a few days. Weather, it seems, is an example of a globally stable but locally unpredictable system. It is the computer that will finally convince us to lay aside the microscope and take up the looking glass of the future - the telescope.

In the new world view, when a system misbehaves we step back and view the larger picture. We merge parts into a larger and larger system. What once was an occasional random excitation or noise in the data suddenly blossoms into an identifiable pattern. Each exception to the rule may be the key that unlocks an entirely new understanding of the system. No single phenomenon is dismissed out of hand as inconsequential, nor is it analyzed in isolation apart from the larger system.

So what does all this have to do with economics and investing which, after all, is what this book is about? If you believe the Earl of Chesterfield was right when he declared in the 18th century that history is merely a confused heap of facts, the answer to this question is: very little.

If, on the other hand, you have a sense that human activity moves with a certain rhythm in identifiable patterns, the answer is quite different. The premise of From Bust To Boom In The 1990s is that much of history, including economic history, is a complex arrangement of cyclic patterns. Unlike the regular and periodic patterns that lend much of the physical world to precise forecasting, economic patterns are nonlinear. What would deliver a benign output under one set of circumstances can result in a dramatic reaction under some other scenario. Like the weather, economics is a globally stable but locally unpredictable system.

THE CYCLES OF HISTORY

For all our complex and sophisticated computer models, economic forecasting today is barely more effective than a straight line extrapolation. What I present in this book is a new way to forecast the economy and its associated markets. Like Oliver Wendell Holmes, I draw inferences from history to help understand what is happening today and decide what will happen tomorrow. I look at the economy through a telescope and develop a model based on the new world view. This model won't predict day to day gyrations in the markets. But it can forecast major moves in stock, bond, and commodity prices and set statistically derived price objectives. And that's really what you want to know if all your life savings are tied up in a business or a house or anything else that is affected by the twists and turns of the economy.

The economy has moved into uncharted waters for the vast majority of forecasters who rely on outmoded econometric models. Only those who take the long view can anticipate what lies just ahead. Some of the experts themselves have admitted that they are baffled by the economy in recent years. The chairman of the Federal Reserve, Alan Greenspan, testified before Congress in late 1992 that he was facing a situation he had never seen in his entire career as an economist. After easing monetary policy 18 times, the economy was barely advancing and consumer sentiment was uncharacteristically low. In 1993 many economists are still scratching their heads over the most anemic recovery in post-war history.

Most economic forecasts fall into one of three camps: myopic, obsessive, or doom- and-gloom. The myopics are the majority of investors who project the most recent economic trend into the future. Their motto is "more of the same". Right now the myopics are calling for slow steady growth as far as the eye can see. As we approach a market top, this group will begin declaring a new era for stocks, inventing a variety of reasons why the old standards of measure no longer apply.

In the second camp are the obsessives. Their slogan is "never say die". These people are preoccupied with the last economic calamity - they constantly fight yesterday's battle. Their bogeyman right now is inflation and, believing as they do that Bill Clinton is a Jimmy Carter clone, are stockpiling gold and silver in anticipation of hyperinflation.

The last camp is made up of the doom-and-gloomers. Their slogan is "it's the end of the world as we know it". Right now they are convinced that debt is the evil responsible for all our economic woes and must be eliminated at all cost. Many doom-and-gloomers believe that unprecedented debt levels mean that we are on the precipice of a worse crisis than the Great Depression.

What all of these forecasts have in common is that they are made through the lens of a microscope. Ignoring the longer view, these forecasts are often an extrapolation of some period of recent history into the future. The obsessives are betting on an inflation trend that began in the late 1960s. The doom-and-gloomers hang on the latest series of negative economic data. Their pessimism is bolstered by researchers who have noticed parallels between the Great Depression of the 1930s and the current period and others who like to compare the U.S. to debt-ridden Third World countries. The myopics are the least complicated of the three, formulating their forecast from a moving average of the previous six months or so of economic performance.

THE TLC MODEL FORECASTS

The doom-and-gloomers are partly right. My research indicates that the U.S. economy has been in a depression since 1990 that will reach its low point in late 1994. But the magnitude of the slowdown will not approach that experienced during the Great Depression.

I have synchronized the TLC model with the spending wave of Figure 4-2 and present in Figure 6-1 a schematic that shows the cycle forecast out to the year 2030. The contraction period that began in late 1987 will give way to a great boom beginning in 1995. As the economy grows, debt as a percentage of GDP will shrink significantly. This recovery will most likely be fueled by cuts in taxes and controlled federal spending.

But the strongest force behind the boom will be the most powerful spending wave in U.S. history. Even after correcting for population growth, the baby boom of the 1940s and 50s appears to be the largest by far since 1800 (based on decennial birth data). This baby boom was transformed into a spending wave beginning in 1982 when it provided a solid base for the 1980s spending boom. It is scheduled for a pause in 1993 and 1994, contributing to the depression business shake-out, but will surge even more strongly by 1995.

After 2006 the spending wave will drop off dramatically until 2022. A severe recession is likely sometime in the first eight years of this period. But the years 2001 to 2030 will be dominated by the emergence of powerful new industries and product lines built on the innovations of the preceding 30 years - innovations that already are making enormous gains in productivity. The information revolution is in its infancy, and we are witnessing but a spark of the software explosion that lies ahead. These new industries will carry us into another great boom period from 2015 to 2030.

One final optimistic note. Look for inflation to gradually abate over the next decade or two. Recall that secular inflation runs in a 448 year cycle (review Figure 2-8). The secular inflation trend has been strongly positive since the beginning of the 20th century but sometime around the year 2010 this 112 year inflation half-wave will come to an end. More than likely the final contraction period of Figure 6-1 will mark the beginning of a three century long inflation-free period.

THE NEXT SEVEN YEARS

As this book goes to print in July 1993, stock prices are flat, gold prices are rising, and long bond yields are falling toward 30 year lows. The Fed appears to be in a holding pattern but a flattening yield curve more than likely means they are taking a less aggressive role. Companies have been cutting costs to the bone since the depression began in 1990. Now three years later, in the face of falling profits, the industrial giants of the past are in danger of becoming industrial dinosaurs. Many Dow Jones staples like IBM, Sears, General Motors, and Proctor & Gamble have announced unprecedented layoffs and price cuts. The great growth industry of the 1980s, the computer industry, is clearly suffering from overcapacity with companies like Apple, Intel, and Microsoft facing competitive pressures.

A deflationary liquidation is just a few months from becoming a reality. This, of course, is a predictable consequence of the technology life cycle. The information revolution has produced technologies that have created enormous efficiencies while eliminating entire communication chains within corporations. This will have a very positive impact on long term economic growth. In the meantime, middle management staffs have been decimated, releasing countless professionals into an economy that is unable to absorb them. Many of these people are being forced into entrepreneurial roles they otherwise would never have considered. While painful to many, this too will pay dividends for the economy in the long run.

In all my research, I have found one indicator that consistently predicts a downturn in the economy. Whenever M2 money supply corrected for population falls over a twelve month period, a stock market correction follows. With the economy in its present stage of the cycle, a fall in money supply always triggers a business liquidation. Both the 1876 to 1878 and the 1929 to 1932 shake-outs were preceded by negative rates of M2 growth. The year-over-year growth in M2 per capita since 1980 has been steadily declining and actually moved into negative territory in February of 1993. Since it normally takes at least six months for money supply changes to make their way through the economy, this indicator (if it continues negative) forecasts a shake-out sometime after August.

PROFITING FROM BUST TO BOOM

The TLC model would have signaled in February a move from 50 percent bonds (treasury or AAA corporate) and 50 percent stocks to 50 percent bonds and 50 percent cash in the investment portfolio. This investment mix should remain until the start of the expansion wave sometime in late 1994. At that time, 100 percent of the portfolio should be invested in stocks.

The trading portfolio should currently be divided between gold and stocks. You should sell completely out of stocks when the 30 year bond closes above 6.75 percent or when the Fed raises the discount rate, whichever comes first. Gold should peak after the stock market but continue your position in gold beyond this time only if you know what you are doing since timing will be critical. The safest time to take a short position or to buy stock index put options (if you are so inclined) is after the 30 year bond closes above 7.25 percent and the Fed raises the discount a second time. Move completely out of your short position into cash when the S&P 500 index falls to the 300 area unless you have reliable short term indicators.

Anticipate a final market bottom in mid to late 1994 . . . when the market does turn it will be explosive. It is likely that stocks will double in price the first two years of the recovery.

Two and a half centuries ago the Scottish philosopher David Hume made the case that observations by themselves cannot logically prove a general rule. Just because we see the sun rise day after day does not guarantee that it will shine again tomorrow, and indeed modern science tells us that some day the sun will burn out.

By the same logic, we cannot know if the technology life cycle, the Kondratieff long wave, and the spending wave will continue on ad infinitum. In fact, there is a chance that we have witnessed the zenith of the Kondratieff long wave's power. Booms and busts in agricultural economies are almost entirely weather driven. Excess capacity is something that industrial economies with high capital expenditures are subject to.

The 20th century marked the height of industrialization in the U.S. economy. The information economy will be less capital intensive, more service oriented, and less subject to the Kondratieff effect. The Great Depression was probably the worst calamity of its type the U.S. will ever experience. (Japan, on the other hand, is at the height of its industrial revolution in the current depression and they will experience a severity similar to ours 60 years ago).

The market forecaster must deal with constantly evolving patterns as technology changes the mix of dominant cycles. As with any science in its early stages of development, the pioneers of social forecasting today appear more like artists than they do scientists. Deciphering patterns from economic data requires a mixture of hard data, logic, and intuition.

The dissolution of one or more of the three dominant economic cycles is not likely to occur overnight but rather slowly over a number of decades. Using them now to guide our business and investment decisions will allow us to gain an incredible advantage over those who do not. Even so, we must keep in mind that none of these cycles is regular and periodic like the motion of the planets around the sun. Every recurring wave of each cycle is unique and every combination of cycles is different from the one before. How then might the forecasts I have made go awry?

Without a doubt the greatest threat to the predictions I made in chapter six involves the timing of the spending wave. As I write this, interest expense as a percentage of personal income is at a nine year low, money is cheap, and labor costs in the U.S. manufacturing sector are lower than they are in either Japan or Germany. Meanwhile, Baby Boomers are ready to move into the largest homes of their spending cycle and the average age of automobiles on the road has been growing and now approaches nine years. This all points to pent up consumer demand, the ability to buy, and the ability to produce at lower cost. If the spending wave effect starts sooner than expected, the final shake-out could be so mild as to be nothing more than a normal market correction.

But for now there is no evidence that this is occurring. Virtually all companies have cut costs to the bone yet many find themselves in the midst of a price war as consumer confidence is falling again. Corporate restructuring and lay-offs this year exceed the levels of last year, creating a sense of anxiety that has made consumers overly cautious. The Depression Of 1990 began with weak fundamentals and high consumer psychology. Now consumer psychology is low while many economic fundamentals are gaining strength. At some point the depression will end in a Great Boom, fueled by the baby boom spending wave. Meanwhile, place your bet on the TLC model and its forecast that the S&P 500 will see 300 before the bull market begins.

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