Expansion Is ALWAYS Followed by Contraction

The rhythm of life is as old as time itself.

About 900 years ago a text called The Yoga Spandakarika was written by an Indian philosopher and scholar named Vasagupta.

In Sanskrit the word “spanda” can be translated as vibration or tremor and refers to the pulsation of life that exists within each of us.

The Yoga Spandakarika teaches that everything in our world IS vibration, pulsing at different levels of frequency.

Our bodies are a perfect repository for this never-ending throb of life force. Every time it beats, your heart contracts, causing a wave of pressure that pushes fresh blood into your arteries. Between these contractions it briefly expands to allow more blood to come in.

As long as you’re alive, this pattern never changes.

‘Contraction and Expansion: The Rhythm of Life’, Julie Smerdon

Down through the ages, the competing forces of…

  • too much, too little
  • too high, too low
  • too fast, too slow
  • too restrictive, too lax

Have been working towards achieving…

Balance. Equilibrium. Equality. Happy medium.

We live in a world constantly working towards maintaining balance…the never-ending throb of life.

The pendulum never stops swinging.

Life — and its many moving parts — is a continual process of yin and yang.

When something gets out of balance there’s always a corrective process.

There are times when an imbalance is corrected immediately, and other times it can take years, even decades, for the pendulum to move in the opposite direction.

We know, accept, and recognise the need for the principle of balance in our lives.

Yet, when it comes to investment markets — be it shares, property, bonds, or cryptos — we somehow want an exclusion zone to be applied on this principle.

Asset prices should never contract. Expansion should be followed by some more expansion and then even further expansion. Never pausing to contract.

Of course, that does not happen.

Even in our living memory, the market’s expansionary phases do contract…dotcom boom followed by the tech wreck and US housing bubble followed by the GFC.

What comes after the parabolic rise of the everything bubble? Continued expansion?

S&P 500 Index

Source: Macrotrends

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The expansion of the everything bubble suffered a momentary contraction in March 2020. But (courtesy of the Fed) Wall Street recovered and expanded to even higher highs.

Many see no end to this expansionary trend…it’ll continue pushing on without ever pausing to catch its breath.

And I can understand why.

A 25-year-old in 2009 would not have been overly affected by the contracting forces of the GFC.

That same person is now 37. All they’ve ever seen in their adult life is rising markets…shares, property, and cryptos.

You can appreciate why a whole generation of investors believe the Fed is omnipotent. In their investing lifetime, the Fed (appears to have) rendered market cycles redundant. Any dip in market trajectory is quickly countered by a more aggressive stimulus response. The Fed is the financial industry’s helicopter parent.

The equalising forces of risk-on and risk-off have been rendered obsolete.

A relic of an era that no longer exists.

It’s now…game ON.

As reported by Axios in June 2021:

You can analyze Robinhood as a mobile gaming company. It makes an app that you can download to your phone, and then you can play a game on the app. As with many mobile games, there are in-app purchases, and you can end up spending a lot of money on the Robinhood game. The game is of course a stock-trading game. The purchases are stocks.

If you’re thinking ‘those silly kids are gambling not investing, I’m OK Jack.’ Sorry to disappoint you, but you’re sadly mistaken.

What happens on Robinhood, ends up in your ‘hood’.

Those fast-fingered ‘buy and sell’ orders influence market pricing…look at Tesla’s share price.

The gaming of popular shares triggers signals with passive investing algorithmic trading programmes…pushing indices higher.

That ‘steady-as-she-goes’ balanced super fund the majority are invested in — with a 65%-plus exposure to Australian and international shares — is influenced by the actions of novice punters half a world away.

HOODWINKED! Why Australia’s ‘miracle’ economy is a farce

Everything in markets is connected

A flurry of activity by an overly excited OR panicky few has pushed the market’s valuation pendulum from one extreme to the other for more than a century.

Market pricing ALWAYS happens at the margin.

On any given day, less than 0.5% of shares are traded. That wafer-thin trading activity sets the price for the remaining ‘buy and hold’ 99.5%.

Double the trading volume — due to a wave of rampant speculation or panicked selling — and you get violent price swings.

This following chart — dating back to 1900 — shows how the average of four long-term valuation indicators pendulum has swung above and below the MEAN.

Periods of excess exuberance have all been countered by an equal and opposite force of fearful selling.

Balance has always been restored.

Average of The Four Valuation Indicators

Source: Advisor Perspectives

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After 1990, you can see the Fed’s fingers on the market’s scales of balance.

The excesses — dotcom boom, US housing bubble, and everything bubble — have been more excessive. And the corrective forces, less corrective.

Pressure is building.

The energy required to maintain the momentum behind this force of extreme optimism is considerable.

The higher the average climbs, the greater the equal and opposite force of pricing fatigue becomes.

Unless, of course, you think balance will never, ever be restored again…leaving the valuation pendulum in a permanent state of elevation and suspension.

That thinking not only violates the laws of physics, but also common sense.

This next chart shows how the S&P Composite Index (adjusted for inflation) for the past 150 years has expanded and contracted around the long-term trend (red line):

Real S&P Composite

Source: Advisor Perspectives

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The contraction process that occurred after the two previous bubbles — dotcom and US housing — restored balance by taking the S&P back to trend.

The current bout of market expansion has ballooned to an unprecedented 178% above trend.

Getting back to trend requires a market contraction of 64%.

This is a force far greater than the one we saw in 2000/02 and 2008/09.

And that 64% correction is ONLY to get back to trend.

What if the downside momentum — fuelled by fast-fingered, indebted, and panicked sellers — push it BELOW trend?

Wall Street could contract by 70% or more.

I know, that sounds totally impossible…bordering on derangement. The consensus view is the Fed won’t let that happen. We’ll see.

The Fed’s policies have worked in an environment where social mood has been decidedly upbeat.

When the psychology of the mob switches from positive to negative, the pendulum on the Fed’s powers will swing from omnipotent to impotent.

The absolute certainty of market expansion and contraction can be found in The Yoga Spandakarika, described by Julie Smerdon:

As long as you’re alive, this pattern never changes.


Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion

PS: Vern is also the Editor of The Gowdie Letter and The Gowdie Advisory — investment services designed to help everyday Australians avoid the financial pitfalls of a volatile economy and make informed decisions to grow their wealth for generations to come.

Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

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