The Convergence of Extraordinary Forces

 Toucalit Benton
Most people contend the current economic malaise that we're experiencing has something to do with the housing sector of the economy. I believe this notion is an adept recognition of the symptom rather than an acknowledgment of the true problem.

My views is that the banks are the problem and have been since the beginning. After all, homes could not have been bought if the easy financing wasn't available. Furthermore, homes could not have been built if it were not for the financing provided to the homebuilders through the capital markets and the banks. This lead me to the conclusion that the ebb and flow of bank deposits would be an indication of the overall pulse of the economy and the stock market.

To this end I have conjured up the Demand Deposits at Commercial Banks provided by the Board of Governors of the Federal Reserve System. In the chart below the increase in the Demand Deposits indicated a general instability in the banking system. The decline in the Demand Deposits indicates a high level of confidence in the banking system. While these ideas seem useful there seems to be an attempt to show correlation as causation which can be just as dangerous as mistaking the symptom as the problem. We forge ahead regardless.

The chart above shows that since September 2006 there is a parabolic increase of demand deposits at banks. This reflects part of the "flight to safety" that many are describing in the financial press. Flight to safety occurs when savers realize that investments carry unforeseen amounts of risk. According to David Marantette, parabolic moves up or down can only last for so long. The exhaustion of such moves can be attributed to entropy or the second law of thermodynamics.

Entropy is the change of energy from an orderly state to a state of dissipation or death. The parabolic rise in the last two years will have to break down at some point. In the case of Demand Deposits, what we should expect to happen is for the index to dramatically decline in an equally violent fashion. A good example can be found in the low of December 2000 until the peak of September 2001. That parabolic move was followed by a violent decline in the index from October 2001 until September 2002. The September 2002 bottom was offset by a violent rise until August 2003. After the August 2003 peak we see an "orderly" diffusion of the energy expelled during the period from December 2000 until August 2003.

If the stock market is a leading indicator for the economy then it would appear that the Dow Jones Industrial Average anticipated the end of the volatility in the Demand Deposits by hitting bottom in October 2002. From October 2002 the Dow Jones Industrial Average increased from the level of 7286. 27 to the high of 14,164.53 in October of 2007, an increase of 94%.

Not only does entropy seem to be at work with the Demand Deposits, cycles seem to be playing a prominent role in the action of this index. Of the last cycle bottoms since 1959 the average cycle lasted about 5.6 years. Half of the cycle bottom, to find where the top would occur, is equal to 2.8 years. If projected from the September 2006 low, we would expect the most recent rise to peak around June of 2009. The next bottom in the index projected to take place around April 2012.

Finally, seeing this index nearly triple it's move beyond the normal peak from periods past leads me to think reversion to the mean. At the very least this index should fall to the level of the previous high. The current level is at 59% year-over-year percentage change while the previous peak was at 13.6%, a decline of 76%.
The impact of all this information is that starting in June 2009 the stock market will either hit bottom and go higher or trade in a wide range until April 2012. Afterwards the market would head lower in a fashion similar to what we've seen in the last 2 years. Touc.

Toucalit Benton

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Domain: Electronics
Category: Business
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