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THE DOW REPORT
The Kondratieff Wave

Today, let’s review some of the items that commonly unfold as the K-wave winter sets in. The K- wave is an economic cycle of sorts that is said to be 56 years in duration but has varied from 47 to 60+ years. In November 1935 N.D. Kondratieff wrote in The Review of Economic Statistics, an article titled “The Long Waves in Economic Life.” In this article Mr. Kondratieff states, “The waves are not exactly the same length, their duration varying between 47 and 60 years.” The K-wave can be thought of as having an upside leg, a plateau and a downside leg. In the article by Mr. Kondratieff, he clearly ties the topping of the inflationary leg of the wave to the peaking of interest rates and commodity prices and the bottoming of the wave to the bottoming of interest rates and commodity prices. The upside or inflationary leg of the K-wave can be further divided into two phases. The first phase is marked by mild or beneficial inflation and is also often referred to as K-wave Spring. This was the period from the late 1940s to 1966. The second phase of the inflationary leg is marked by runaway inflation and this was the period from 1966 to 1981. This period is also known as K-wave Summer.

The third phase, or the “plateau” of the K-wave, is then marked by a stabilization of prices. This was the period of the very early 1980’s. Then comes the downside piece of the K-wave, which is marked by deflationary forces. This downside leg of the K-wave can also be divided into two phases. The first phase is marked by beneficial deflation while the second phase is marked by runaway deflation. History shows us that the trend for stocks is up as we move into the beneficial deflationary phase of the K-wave. This is the period known as K-wave Fall, which began in approximately 1982 and concluded in 2000. We are now in the last phase of the K-wave. This phase will conclude with runaway deflation and is known as K-wave Winter. This Winter season should bottom around 2010. Coincidentally, this also coincides closely with my timing for the Bear market bottom. From David Knox Barker’s book The K- Wave, is a brief list of the events that have historically marked the Winter season:

• “Trends During Winter: Stocks Down, Bonds Up, Commodities Down”

This downward trend for the stock market began in 2000. It is my belief that the price action seen in the stock market since October 2002 has simply been a counter trend move within the context of the longer-term trend as defined by the K-wave. The same is also true for the recent advance in commodities and the ongoing spike in interest rates.

• “Global Stock Markets Enter Extended Bear Markets”

This is true of the US markets as well as the French CAC, the German DAX, the Hong Kong Hang Seng and London’s FTSE. These trends began in 2000 as well. The Australian market topped in 2001 and the Japanese Nikkei topped in 1989. According to Dow theory, the entire advance from the October 2002 low is the bear market rally that will ultimately separate Phase I from Phase II of this great bear market. More on this below.

• “Interest Rates Spike In Early Winter Then Decline Throughout”

This interest rate spike began at the June 2003 top in bonds. This rise in rates should prove to be a counter trend phenomenon.

• “Economic Growth Slow or Negative During Much of Winter”

We have thus far only seen a glimpse of this. Since the October 2002 low in the stock market many believe that the slowdown is over. Actually, the real slowdown has not even begun. There is another more substantial slow down coming in the winter season.

• “Commercial and Residential Real Estate Prices Fall”

This obviously has not happened, YET. But it is beginning in some areas.

• “Social Upheaval and Society Becomes Negative”

With the Bullish sentiment now at record levels this has obviously not happened, YET.

• “Bankruptcies Accelerate and High Debt Eliminated by Bankruptcy”

This is only beginning as the average consumer is now holding record high levels of debt. Since the great liquidity infusion that Greenie introduced, debt levels have continued to swell. This debt will be purged from the system at some point in the future. You do not go through K-wave winter without purging the debt.

• “Banking System Shaken and New One Introduced”

This has not happened, YET!

• “Free Market System Blamed and Socialist Solutions Offered”

The Free Market System was not blamed for the 2002 decline. This will occur later in K-wave winter as we move into the third phase of this great bear market.

• “National Fascist Political Tendencies” 

Yes, but not to the degree that we will see in later winter.

• “Debt Level Very Low After Defaults and Bankruptcy”

This has obviously not happened. This comes after the purging of the debt.

• “Overcapacity/Overproduction Purged by Obsolescence and Failure”

We have not seen this to the degree that will occur in the winter season.

• “Trade Conflict Worsen”

Much more to come.

• “View of the Future at a Low Ebb”

For this one, I too point to the record high sentiment levels. This has not happened, YET.

• “New Work Ethics Develop Since Jobs are Scarce”

If I can assure you of one thing it is that this has not happened.

• “Greed is Purged from the System”

Again, I point to the record high sentiment levels. Also, very few understand that we are still in a bear market. Most are still in the same speculative mode of the 1990s. Just wait, the greed will be purged.

• “Real Estate Prices Find Bottom”

This has not even come close to happening. Prices are just beginning to top in a few areas now.

• “There is a Clean Economic Slate to Build On”

With record high levels of debt and a derivative bubble that has yet to burst, this has not happened.

• “Investors are Very Conservative and Risk Averse”

With the average investor still in the market speculating, this has not happened.

• “Interest Rates and Prices Bottom”

This has not happened with the longer term cycles.

• “A New Economy Begins to Emerge”

Most think that this is what has happened since the October 2002 recovery. But, in fact this “recovery” we have seen since 2002 is only a counter trend event that will ultimately prove to separate Phase I from the other phases of this bear market.

• “Stock Markets Reach Bottom and Begin New Bull Markets”

Robert Rhea described the Primary Bear Markets as having three phases. Rhea stated “A Primary bear market is the long downward movement interrupted by important rallies. It is caused by various economic ills and does not terminate until stock prices have thoroughly discounted the worst that is apt to occur. There are three principle phases of a bear market: Rhea goes on and states: “Each of these phases seems to be divided by a secondary reaction which is often erroneously assumed to be the beginning of a bull market. Such secondary movements seldom prove perplexing to those who understand the Dow theory. I can assure you that I have read and studied every scrap of Dow theory material from the great Dow theorists of the past and I have absolutely no doubt based on these writings where we are on this grand scale. I believe that the rally seen from October 2002 to present is the important rally that Rhea described above that will prove to separate phase one from phase two of this monster bear market. This would be very similar to the rally that occurred between November 1929 and April 1930, which also occurred in early K-wave Winter. Yes, it looks as if we are seeing an extended version of 1930. This makes sense given that the preceding bull market was much longer in the current case. If we back up and take a broader look at what is happening, we can also see that the inflationary cycle we have seen since early 2002 is a counter trend move that will be giving way to the forces of K-wave winter. By in large, the signs above all still lie ahead and should unfold as the winter season take hold.

Tim W. Wood

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