New technology is a huge driver of economic progress. And military conflict has often been the catalyst for technological advancement. WWI enhanced aviation, WWII advanced the radio and nuclear technology and the Cold War accelerated space exploration, satellites, the microchip, the PC, mobile phones and the internet.

(As an aside, in his book ‘The Next 100 Years’, American Political Scientist and author, George Friedman suggests that a continued recovery in Russia could trigger a Cold War mark II towards the end of this decade, which could drive a new era of technological advancement.)

But without any major conflict on the horizon, and with Iraq and Afghanistan winding down, could we be in for a period of technological stagnation, exacerbated by a GFC hangover?

A long-term sideways market (similar to the 16-year period from 1966 to 1982) could develop if there is an extended phase of post-GFC deleveraging combined with a lack of new technology. Chart 1 below illustrates the ’66 – ’82 period but it should be noted we are not using the term ‘sideways’ in the manner that normally springs to mind, as the range from bottom to top was 87%!

Chart 1 – Dow Jones 1910-2011

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Using 2000 as the start of a sideways pattern would take us to around 2016 (in a very simplistic projection), which does fit in with the Cold War mark II timeline suggested.

Such a period of stagnation in the US could cause big problems for China. The book Boombustology, by Yale lecturer and global equities investor, Vikram Mansharamani Ph.Dposits that China is in a fairly advanced bubble, created in part by the Federal Reserve’s very low interest rate settings because of China’s economic ties and currency pegging. Some commentators even go so far as to say China will duplicate the malaise suffered by Japan over the last 20-years. Either way, a stumble by China would hit resources sectors in countries like Australia hard and would flow on to almost every other sector, including house prices.

The next US recession – whether it happens now or in a few years – could burst the Chinese bubble and cause a divergence between the Australian and US economies. Australia escaped recession in the wake of the GFC because of Chinese demand for our resources, but our time could come then.

During the ‘70s stagflation and the oil shock shot Gold and Silver to the high price levels we are seeing today. Back then this was because of high inflation. This time, at least for the moment, it is on expectations of high inflation caused by quantitative easing.

Chart 2 – Gold, Silver and Dow Jones 1973-2011

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There are similarities between then and now. To quote Mark Twain: “History doesn’t repeat itself, but it often rhymes”.

This ‘Sideways Argument’ is just one possible scenario and while the analysis is simplistic and some of the links tenuous, I think it is more likely than another collapse. I’d suggest traders who are expecting the Dow to fall to 5,000 are spending too much time on their calculators figuring out how much they might make from such a move and not enough time asking what catalyst/s could actually lead to it.

The market can reach new highs in the current move from 2009 and at that point – when many become bullish again – THEN I’ll be concerned about what is next for the market and the economy. More on this next time...

Happy Trading

Jordan Craw