Sandpiper Arbitrage
Entry for 2017-06-10


Everything goes in cycles, so investing should be perfectly simple.

As spring follows winter, bull markets follow bear markets, interest rates go up, and then down. Recessions are followed by recoveries, which are followed by growth and inflation, followed by recession. A commodity grows scarce, prices rise, producers jack up production to reap the rewards, supply soon exceeds demand, and prices go down.

According to the Foundation for the Study of Cycles, copper and pig iron prices have followed a 9.2-year cycle ever since 1784, as have the abundance of partridges and grasshoppers, the water level of Lake Michigan, the thickness of tree rings, the rise and fall of business failures, and the prices of railroad stocks.

If you know how to use a calendar, you should be rich in no time. If not, you should ignore the cycles. Buy and hold. Follow the example of the ideal long-term investor, the tree: tap into something solid, invest for keeps, and then just stand firm, year after year, accumulating dividends. A successful tree doesn't have to time the seasonal cycles, merely to endure them. Each successive turn around the sun adds to its capital base.

Investing in Waves

For traders and short-term investors, however, this model won't do. The ideal trader is not a tree; it's a sandpiper, working the beach at Carmel or Sanibel Island.

You've seen them: those nimble wading birds who never actually wade because they're always one step ahead of the water. The sandpiper darts in behind the receding wave and gobbles up whatever small crustaceans the wave has left stranded, then scurries back out onto the beach ahead of the next incoming surge.

It's a form of arbitrage. The sandpiper knows everything that matters about market timing and is not confused by fundamentals. He zigs when he should zig. To be a successful sandpiper or a successful short-term investor, timing the waves is the only talent you need.

When a wave of high interst rates is about to recede, you can invest in bonds and other fixed-rate securities to reap high yields throughout the following trough of low interst rates. When the next wave of high rates is imminent, you can sell the bonds, borrow at low rates, and use the money to sell short on interest-sensitive stocks. What could be easier?

All you have to know about the next wave is, when is it coming and how big is it? Two facts, that's all, and the sandpiper, with a brain the size of a lentil, masters them with apparent ease; so you can imagine how much better the human investor can do with a huge, highly developed cerebral cortex, a veritable floodtide of information and assistance, and at least 6,000 years of research into cycles.

Seasons and Cycles

It's all been worked out: the tides and the tradewinds, tree rings, biorhythms, 17-year locusts, seven lean years and the seven year itch. The ancient Egyptians calculated the 28-day lunar cycle as well as the annual solar cycle, and they built the pyramids with manpower available because of seasonal unemployment, a product of the agricultural cycle, which in turn was caused by the flooding cycle of the Nile.

Since then, astronomers have identified an 11-year sunspot cycle. Zoologists have computed a 3.8-year lemming cycle. Historians have found a 17.7-year war cycle and a 510-year civilization cycle. Paleogeologists have unearthed a 500,000-year cycle of reversals in the earth's magnetic field and a 26,000,000-year catastrophe cycle.

That's how frequently the earth is bombarded with comets or meteors which raise so much dust and vapor that sunlight is blocked and half to two-thirds of all species are wiped out. A week or so before the next catastrophe would be a good time to sell beachfront properties, sell short on solar energy stocks, and use the money to go long on agricultural commodities. Imagine where the price of pork bellies will be when there are only six pigs left on earth.

However, the next catastrophe is not due until the year 130002006, so it's on shorter cycles than the astute investor should concentrate.

The seminal work on business cycles was done between the world wars and has since been revised every 3.9 years. In 1939, Joseph Schumpeter of Harvard published an exhaustive study of economic cycles, including a three- to four-year business cycle (called the Kitchin cycle) and a 10-year cycle (the Juglar cycle) consisting of three Kitchin cycles (no relation to your kitchen or your jugular).

In recent years, money manager Anthony Gaubis has translated the Juglar cycle into a decennial market cycle with three 40-month rotations in each decade. He says the market moves up in years ending with a 5 or an 8 and in the second half of every year ending in 2. See how easy this is?

A Cycle For Every Taste

If common stocks are not to your liking, there's an 18.2-year cycle in real estate, a 5.5-year gold cycle, a 5.91-year cycle in cotton prices, and a 6-year cycle in the rare coin market.

If you'd rather put your money into municipal bonds, Treasury bonds, oil and gas partnerships, helicopter leasing tax shelters, currency futures, antiques, or limited edition decorator plates, I'm sure you can find a plethora of cycle theories for each.

If anything, your problem will be an embarrassment of riches. In addition to the basic cycles of nature and business, every industry and every stock has its own cycles, and the market as a whole has daily (some say hourly) cycles. Hundreds of market technicians are busy interpreting these patterns and issuing forecasts so wildly divergent that you can likely find expert support for any premonition you will ever have.

The rare exceptions are those occasions when almost all of the analysts agree on where the market is headed. Then, at least, you know what to do -- the opposite.

The Tidal Wave

Then, too, like the sandpiper, you'll have to contend with the possibility that there may be crashing waves as well as routine eddies and breakers. One of the cycles Schumpeter noted in the 1930s was a gigantic half-century boom and bust cycle postulated a decade earlier by Russian economist Nikolai Kondratieff -- the economic equivalent of the tidal wave.

The Kondratieff long-wave cycle was controversial to begin with and has been neglected for most of its 80 years. (There's a cycle cycle, during which cycle theories are ignored, then revered.) It was dusted off in the late 1970s and highly publicized by hard-money investment advisors who regard the worldwide financial system as a house of cards and are always looking for the telltale signs of impending collapse.

In Kondratieff, they found a 50-year cycle that seemed to foretell that 1979 would be a replay of the 1929 stock market crash and ensuing depression. Their antidote was to get out of the stock and bond markets; open a Swiss bank account; buy gold, silver, and non-urban real estate, emergency provisions, a cabin in the hills, and a gun to ward off less prescient investors who would be wiped out in the crash and then come looking for undeserved food.

The Fudge Cycle

When doomsday failed to arrive on schedule, the 50-year cycle was reinterpreted as a 52-year cycle, then 55, finally 60. Then the Kondratieff interpreters decided that the cycle isn't working because the Fed has screwed it up by creating money out of thin air.

The long-wave cycle received wider acclaim here than in Kondratieff's homeland, where the Russian Association of Social Science Research grudgingly published the original papers along with articles by other economists, denouncing the whole idea as a capitalistic heresy. Kondratieff spent his last years in a labor camp.

A reasonably adept sandpiper would have seen that one coming.

Why all this hairsplitting and obfuscation when, in fact, cycles are so rudimentary that even junebugs can master them, as can locusts, grunions, wooly-bear caterpillars, the swallows of Capistrano and the buzzards of Hinckley, Ohio?

I asked a senior consultant from one of the nation's leading econometrics firms to clear up the confusion: "Can't you give me a firm prediction on when interest rates will begin their next cycle?"

"Sure."

"And you can tell me how high they'll go?"

"Certainly. Which do you want?"

"Both."

"Sorry," he said. "Our motto is -- Give them a number, or give them a date; but never give them both."

I like Muhammed Ali's motto better -- Float like a butterfly, sting like a bee -- which inspired my own: "Surf like a sandpiper; invest like a tree."