By Al Coryell
Host/Moderator

“What’s with the map of Russia, and what the heck is a K-wave?”, you  ask.  To answer that question we travel back to March 4, 1892, to a small village just north of Moscow, Russia, where a young Russian boy is born to peasant parents…

The boy was extremely bright, and although he grew up in a cooperative agricultural community in pre-revolutionary Russia, his remarkable abilities for all things economic didn’t go unnoticed. He was given a scholarship to the University of St. Petersburg where he was personally tutored by the famous but controversial economics professor, Mykhailo Ivanovych Tuhan-Baranovsky. By the age of 25, he was appointed Minister of Supply for the last Russian government before the Bolshevik Revolution in 1917.

After the revolution, he founded the Institute of Conjuncture and nurtured it from a three person laboratory into a large and prestigious research facility employing more than 50 research scientists. He published his first book on the theory of major economic cycles in 1924 at just 32 years old. His theoretical work was so impressive that he was assigned by Joseph Stalin to design the first of Stalin’s Five Year Plans for the development of Soviet agriculture. Stalin’s expectation from the economics genius was a robust and powerful plan for the future of the Soviet Union. Instead, what Stalin received was a dark and dreary forecast of imminent global economic collapse that would result in world-wide chaos and disaster.

Stalin was so displeased he had the young man imprisoned for 8 years for crimes against the state. When his term was served, at the age of 46, he was re-tried for the same crimes, subsequently convicted and executed by firing squad by the Stalinist government. The unfortunate gentleman was Nikolai Dmitriyevich Kondratiev (or Kondratieff). And his only real crime was predicting the Great Depression almost a decade before it occurred.

I have mentioned Kondratiev waves before but I haven’t really talked about them. Their existence is controversial and there are proponents and detractors in both the Austrian and Keynesian camps. By definition, the Keynesians have to dismiss them because Keynesianism is supposed to make economic business cycles obsolete (we can see how well that’s working out for them). But even many Austrians, like Murray Rothbard, have argued against them. Perhaps they don’t actually exist, but the coincidental prediction of imminent depression by the following chart of Nikolai Kontratiev’s “Long Wave” or K-Waves as they have come to be called, can only be described as eerily uncanny.

I won’t bore you with the details of the makeup of K-Waves, just that the primary data points are related to wholesale prices which, as you can see in red in the chart above, have sky-rocketed since 1940. If you are interested in learning more about K-Waves, the Long Wave link above is very informative and an excellent starting point. But I will briefly describe the general theory of Kondratiev waves…

A Kondratiev economic cycle is divided into four “seasons”, spring, summer, fall and winter. The analogy of the seasons is consistent with what you would expect. Spring is a time of re-birth after a long hard winter, time to sow, plant and produce. Summer is lazy and full of doldrums. Autumn is a time to reap the harvest and store the results of the spring work and winter is a dangerous time when those that survive are the ones that successfully harvested what they produced and safely hunkered down against the bitter elements. 

The four seasons in a 50-60 year Kondratiev Wave are:

•Spring (20-25 years) – Inflationary phase with rising stock prices and increased employment and wages.
•Summer (3-5 years) – Stagflation phase with rising interest rates, rising debt and stock corrections. Imbalances lead to war.
•Autumn (7-10 years) – Deflation phase where falling interest rates lead to a plateau and stock prices increase sharply.
•Winter (3-5 year collapse and 12-15 year readjustment) – Depression phase with stock and debt markets collapsing and commodity prices increasing.

Those that argue for the validity of Kondratiev waves say we are just entering the Winter Phase. You can read more about what that means in terms of the stock market and subsequent economic recovery on the link above. For the time being, just note that the above chart indicates the winter has started and will perhaps bottom around 2016.

The next chart I want to show you is an Elliott Wave International graph of the Dow Jones Industrials Index plotted in current dollars and in constant dollars (i.e., dollars adjusted for inflation).

The upper chart is plotted in US fiat dollars. The lower chart is plotted in terms of the PPI (Producer Price Index) until 1999 and thereafter in gold (real money). The alternating periodicities of 16.6 and 16.9 years correspond with a cyclicity observed since the stock market crash of 1929 and, should it hold true for the current stock market crash, we should anticipate a bottoming of the stock market to occur around the year 2016 (unless, of course, the world ends when the Mayan calendar ends in 2012, in which case all bets are off).

You can see that at the market’s peak in 1999 it took almost 50 ounces of gold to buy one share of the Dow (bottom right hand scale). Today, in 2010, it only takes about 12 ounces. In real money terms, then, the Dow has already lost 75% of it’s value since 1999. This should help to explain to those who can’t understand why the price of gold is declining along with stock market, how gold can decline in price but still gain in value. In terms of “value”, gold has already increased 400% in the last 10 years (one ounce buys 4 times as much Dow stock today as it did then) and it continues to increase in value relative to the price of the stock market simply because the stock market is collapsing at a much faster rate than it is.

The primary things to take away from the above chart are, one, that the Dow Jones Industrial Average has been deflating in “value” since 1999, even though it continued to increase in price for another 8 years largely due to the Federal Reserve’s monetary inflation which was necessary to keep up with the massive deficit spending of Congress and the federal government. (see my series of articles on Deflation vs. Inflation for an explanation if that’s not clear). Two, the apparent 16 year periodicity, if it holds true, indicates that the stock market will bottom in the early part of 2016.

So much for K-waves and the constant dollar Dow. In a minute, I will tie all these things together including this next chart of the Stock Market Crash of 1929.

[Click on chart to popup a larger image]

As I have it labeled it on the chart, the 1929 stock market crashed in a typical Elliott Wave a-b-c retracement fashion between September of 1929 and April of 1933. I created this chart on a  scale of 8 days per period, meaning each bar in the chart represents 8 days of market action.

There are four moving averages shown and color-coded as indicated; a 21 day, 55 day, 144 day and 233 day average. Some of you will recognize the significance of that number series as members of the Fibonacci sequence. I personally find the “look” of Fibonacci moving averages preferable to the more typically accepted 20 day, 50 day, 150 day and 200 day moving averages. Just a personal quirk. It has no bearing on what I am about to demonstrate.

I also show Bollinger bands, a volatility indicator developed by John Bollinger in the early 1980s, and widely accepted in the technical analysis community as an indicator of relatively overbought/oversold conditions in the stock market. Read the link if you want more detail.

Back in October of last year, I wrote an article titled “Is today’s stock market doing a ‘dead cat bounce’?“, in which I showed a chart comparing the pattern of the decline of today’s stock market to the pattern of the stock market crash of 1929 and suggested it looked very similar to the beginning of the 1929 crash. Well, now that waves a and b are complete, I find that the charts not only look visibly similar, but they are technically similar as well:

[Click on chart to popup a larger image]

I have labeled this chart just as I labeled the 1929 stock market crash above, in a typical Elliott Wave a-b-c retracement fashion starting at the October of 2007 crest of the Dow Jones Industrial Average. I created this chart at a scale of 32 days per period, meaning each bar in the chart represents 32 days of market action. At the apex of the bear market rally, i.e., the end of wave b, I inserted a copy of the 8 day c wave period from the above 1929 crash chart. At present, a comparison of the lengths of time to traverse the a and b waves between today’s market and the 1929 market calculates to a ratio of approximately four to one (4:1), thus the 32 day vs. 8 day comparison. (32/8 = 4:1)

As in the 1929 chart, there are four moving averages shown and identically color-coded; a 21 day, 55 day, 144 day and 233 day average, along with a pair of Bollinger bands. The resulting extrapolations/projections are striking to say the least.

In 1929, the a wave collapsed from $386 dollars to $195 dollars, a total of $191 dollars, or almost 50% of its value in a single drop. In 2007, the a wave collapsed from $14280 dollars to $6440 dollars, a total of slightly more than 50% of it’s value in a single drop.

In 1930, the b wave rallied back from $195 dollars to $297 dollars regaining approximately 53.5% of the value it had lost. In 2010, the b wave rallied back from $6440 dollars to $10767 dollars regaining approximately 55% of the value it lost.

As interesting as those comparisons are, even more uncanny is the comparison of the moving averages and Bollinger band properties. Looking at the dashed inserted area copied from the 1929 chart, you can see that the Bollinger bands, the 55 day and the 233 day moving averages are a nearly identical fit and the 21 day average is very close. Only the 144 day average is slightly askew due simply to a difference in the internal price fluctuation between the 55 and 233 day averages. While the visual and technical continuity are quite astonishing, the predictive implications are just as amazing…

Remember that the K-waves and the constant dollar Dow charts both pointed to the stock market bottoming around 2016? Well, note that the bottom of the inserted portion of the 1929 chart appears to bottom in the early part of the year 2016.

And finally, Robert Prechter’s group at Elliott Wave International predict that the Dow will bottom at around $400 dollars. Note that a projection of the bottom of the inserted chart section points to approximately $400 dollars.

As you can see, today’s market collapse and the 1929 Stock Market Crash are incredibly similar. That so many common properties would line up so amazingly closely seems more than coincidental. Elliott Waves are fractals and so it should really be no surprise that similar wave patterns of different degree could be so closely matched. Still, the similarities are far from confirmation of future behavior and the markets are free to move as they please within the known bounds of Elliott Wave rules.

One big caveat is the red a-b-c cycle degree count I show here. It deviates from the generally accepted count of most experts who expect the current stock market to collapse in a five wave pattern of primary degree. That count is shown in blue and assumes that the entire move down from October 2007 will be one big wave -c- of cycle degree and presumes, further, that cycle wave -a- was the decline from 2000 to 2003 and cycle wave -b- was the rally to the market high in October 2007.

It will probably be at least a year before we see enough definition to determine what this decline will actually look like, whether it will follow the blue path or the path similar to the 1929 stock market, or even something totally unexpected… which, of course, is usually what happens. The best indication we can look for will be how quickly the stock market reaches the 3000 level. If it happens before the end of 2011 then the blue path is most likely. In the mean time… we wait and see what the markets have in store. As goes the old cliché, only time will tell.