Tag Archives: stock market

FinSafe Welcomes the New Kind of Traders

Although the cryptocurrency topic seems to have firmly entrenched in headlines all across the world, the process of working in this market (especially for professional traders from traditional markets) remains somewhat of an experiment and a niche challenge for a few brave ones. However, one team claimed that they have found a way of moving the market closer towards new rules of the game, while also making cryptocurrency trading more attractive for traders with a traditional stock market background. This team is FinSafe – a professional crypto-trading platform which combines best practices and tools from both the traditional and crypto markets.

According to Victor Murga, CEO of FinSafe, to date the crypto-market has successfully survived the time of 100Xs, hopes for quick profits and continuous growth. With full certainty, we can say that we have passed the phase of the Gold Rush and are entering that part of the story where having ordinary luck is no longer enough. If you are a pro trader, you need to work and work hard.

However, while the market itself has already undergone changes, working conditions change very slowly. An average trader is working as if they live in 2016-17: scattered crypto-exchanges, the lack of convenient tools, and the dependence on the movement of the largest whales. On the other hand, traditional markets with established rules and approaches strive and prosper because traders have all the necessary tools for comfortable work. These people have real capital, but entering crypto-markets is simply uncomfortable and inconvenient for them.

FinSafe is here to change the current situation.

Unique Trading Proposition

Victor Murga, CEO of FinSafe

Due to several exclusive features, FinSafe proposes a solution radically different from other crypto projects. Firstly, no other solution on crypto market combines trading charts, indicators, cross exchange consolidated order book, smart order routing, market screener, real-time industry newsfeed, multi-screen (monitor) fully customizable layouts, fast order execution, and post-trading analytics. It’s our team’s main goal for the launch. According to the team’s statements, FinSafe is creating a truly unified tool that is equally convenient for both traders within crypto market and professionals from Wall Street. Traders will be working in an environment where the system provides relevant news, analytics, and key data, reducing the need to scour the internet for additional sources of information. Put simply, they will have just one piece of software that will replace everything they have ever used before.

Secondly, FinSafe will help crypto become more solid and credible currency in traditional traders’ eyes. How? Because of its stand-alone software. By connecting directly to the main exchanges like Binance, Bitfinex, Coinbase Pro, Huobi, HitBTC, Poloniex, Kraken, and Bitstamp, and integrating their APIs into FinSafe software, traders would be able to buy and sell their assets without the hassle of logging anywhere else but FinSafe platform. Besides, all operations can be visually monitored, helping traders to react if whales make a run on the market or other significant events that can affect trading profitability occur.



At the moment, FinSafe is focused on working in two areas. First is the development of a whole range of products, which are parts of the platform. For some of them, the company already has fully working MVPs. Others are in the conceptual phase.

The second direction is an SEC license. Once FinSafe has secured it, they will be ready for takeoff. Other licenses for the EU market can be acquired with less difficulty. Workaround will be created for the Asian region and the rest of the world as well.

Magnum opus: Humanity at crossroads

Every production phase or civilization or other human invention goes through a so called transformation process. Transitions are social transformation processes that cover at least one generation. In this article I will use one such transition to demonstrate that humanity is at a crossroads: up to a third world war or will humanity create new heaven on earth.

When we consider the characteristics of the phases of a social transformation we may find ourselves at the end of what might be called the third industrial revolution. Transitions are social transformation processes that cover at least one generation (= 25 years). A transition has the following characteristics:

  • it involves a structural change of civilization or a complex subsystem of our civilization
  • it shows technological, economical, ecological, socio cultural and institutional changes at different levels that influence and enhance each other
  • it is the result of slow changes (changes in supplies) and fast dynamics (flows)

Examples of historical transitions are the demographical transition and the transition from coal to natural gas which caused transition in the use of energy. A transition process is not fixed from the start because during the transition processes will adapt to the new situation. A transition is not dogmatic.

 

 

 

 

 

 

Figure: demographical transition

Four transition phases

In general transitions can be seen to go through the S curve and we can distinguish four phases (see fig. 1):

  1. a pre development phase of a dynamic balance in which the present status does not visibly change
  2. a take off phase in which the process of change starts because of changes in the system
  3. an acceleration phase in which visible structural changes take place through an accumulation of socio cultural, economical, ecological and institutional changes influencing each other; in this phase we see collective learning processes, diffusion and processes of embedding
  4. a stabilization phase in which the speed of sociological change slows down and a new dynamic balance is achieved through learning

A product life cycle also goes through an S curve. In that case there is a fifth phase:

  1. the degeneration phase in which cost rises because of over capacity and the producer will finally withdraw from the market.

The S curve of a transition

Figure: Four phases in a transition best visualized by means of an S – curve: Pre-development, Take off, Acceleration, Stabilization

Spreading process of transitions

The process of the spreading of transitions over civilizations is influenced by a number of elements:

  • physical barriers: oceans, deserts, mountain ranges, swamps, lakes
  • socio cultural barriers: difference in culture and languages
  • religious barriers
  • psychological barriers

The Neolithic transition was the most   transition for mankind. This first agricultural revolution (10000 – 3000 BC) forms the change from societies of hunter gatherers (20 – 50 people) close to water with a nomadic existence to a society of people living in settlements growing crops and animals. A hierarchical society came into existence. Joint organizations protected and governed the interests of the individual. Performing (obligatory) services for the community could be viewed as a first type of taxation. Stocks were set up with stock management, trade emerged, inequality and theft. Ways of administering justice were invented to solve conflicts within and between communities and war became a way of protecting interests.

The Neolithic revolution started in those places that were most favorable because of the climate and sources of food. In very cold, very hot or dry areas the hunter gatherer societies lasted longer. Several areas are pointed out as possible starting points: southern Anatolia, the basins the Yangtze Kiang and Yellow river in China, the valley of the Indus, the present Peru in the Andes or what is now Mexico in Central America. From these areas the revolution spread across the world.



The start of the Neolithic era and the spreading process are different in each area. In some areas the changes are relatively quick and some authors therefore like to speak of a Neolithic revolution. Modern historians prefer to speak of the Neolithic evolution. They have come to realize that in many areas the process took much longer and was much more gradual than they originally thought.

Three drastic transitions

When we look back over the past two centuries, we see three transitions taking place with far-reaching effects.

  1. The first industrial revolution

The first industrial revolution lasted from around 1780 tot 1850. It was characterized by a transition from small scale handwork to mechanized production in factories. The great catalyst in the process was the steam engine which also caused a revolution in transport as it was used in railways and shipping. The first industrial revolution was centered around the cotton industry. Because steam engines were made of iron and ran on coal, both coal mining and iron industry also flourished.

Britain was the first country that faced the industrial revolution. The steam engine was initially mainly used to power the water pumps of mines. A major change occurred in the textile industry. Because of population growth and colonial expansion the demand for cotton products quickly increased. Because spinners and weavers could not keep up with the demand, there was an urgent need for a loom with an external power unit, the power loom.

A semi-automatic shuttleless loom was invented, and a machine was created that could spin several threads simultaneously. This “Spinning Jenny”, invented in 1764 by James Hargreaves, was followed in 1779 by a greatly improved loom: ‘Mule Jenny’. At first they were water-powered, but after 1780 the steam engine had been strongly improved  so that it could also be used in the factories could be used as a power source. Now much more textiles could be produced. This was necessary because in 1750, Europe had 130 million inhabitants, but in 1850 this number had doubled, partly because of the agricultural revolution. (This went along with the industrial revolution; fertilizers were imported, drainage systems were designed and ox was replaced by the horse. By far the most important element of the agricultural revolution was the change from subsistence to production for the market.)

All those people needed clothing. Thanks to the machine faster and cheaper production was possible and labor remained cheap. The textile industry has been one of the driving forces of the industrial revolution.

Belgium becomes the first industrialized country in continental Europe. Belgium is “in a state of industrial revolution” under the rule of Napoleon Bonaparte. The industrial centers were Ghent (cotton and flax industries), Verviers (mechanized wool production), Liège (iron, coal, zinc, machinery and glass), Mons and Charleroi. On the mainland, France and Prussia followed somewhat later. In America the northeastern states of the United States followed quickly. After 1870 Japan was industrialized as the first non-Western country. The rest of Europe followed only around 1880.

The beginning of the end of this revolution was in 1845 when Friedrich Engels, son of a German textile baron, described the living conditions of the English working class in “The condition of the working class in England“.

  1. The second industrial revolution

The second industrial revolution started around 1870 and ended around 1930. It was characterized by ongoing mechanization because of the introduction of the assembly line, the replacement of iron by steel and the development of the chemical industry. Furthermore coal and water were replaced by oil and electricity and the internal combustion engine was developed. Whereas the first industrial revolution was started through (chance) inventions by amateurs, companies invested a lot of money in professional research during the second revolution, looking for new products and production methods. In search of finances small companies merged into large scale enterprises which were headed by professional managers and shares were put on the market. These developments caused the transition from the traditional family business to Limited Liability companies and multinationals.

The United States (U.S.) and Germany led the way in the Second Industrial Revolution. In the U.S. there were early experiments with the assembly line system, especially in the automotive industry. In addition, the country was a leader in the production of steel and oil. In Germany the electricity industry and the chemical industry flourished. The firms AEG and Siemens were electricity giants. German chemical companies such as AGFA and BASF had a leading share in the production of synthetic dyes, photographic and plastic products (around 1900 they controlled some 90% of the worldwide market). In the wake of these two industrial powers (which soon surpassed Britain) France, Japan and Russia followed. After the Second Industrial Revolution ​​more and more countries, on more continents, experienced a more or less modest industrial development. In some cases, the industrialization was taken in hand by the state, often with coarse coercion – such as the five-year plans in the Soviet Union.

After the roaring twenties the revolution ended with the stock exchange crash of 1929. The consequences were disastrous culminating in the Second World War.

  1. The third industrial revolution

The third industrial revolution started around 1940 and is nearing its end. The United States and Japan played a leading role in the development of computers. During the Second World War great efforts were made to apply computer technology to military purposes. After the war the American space program increased the number of applications. Japan specialized in the use of computers for industrial purposes such as the robot.

From 1970 the third industrial revolution continued to Europe. The third industrial revolution was mainly a result of a massive development of microelectronics: electronic calculators, digital watches and counters, the compact disc, the barcode etc.

The acceleration phase of the third industrial revolution started around 1980 with the advent of the microprocessor. The development of the microprocessor is also the basis of the evolution and breakthrough of computing. This had an impact in

many areas: for calculation, word processing, drawing and graphic design, regulating and controlling machines, simulating processes, capturing and processing information, monetary transactions and telecommunications. The communication phase grows enormously at the beginning of the new millennium: the digital revolution. According to many analysts now a new era has emerged: that of the information or service economy. Here the acquisition and channeling of information has become more important than pure production.

By now computer and communication technology take up an irreplaceable role in all parts of the world. More countries depend on the service sector and less on agriculture and industry.

Effects of three industrial revolutions

The first (and second revolution) transformed an agricultural society into an industrial society where mechanization (finally) relieved man of physical labor. The craft industry could not compete with the factories that put products of the same or even better quality on the market at a lower price. The result was that many small businesses went bankrupt and the former workers went to work in the factories. The effects of industrialization were seen in the process of rapid urbanization of formerly relatively small villages and towns where the new plants came. These turned into dirty and unhealthy industrial cities. Still people from the country were forced to go and work there. Because of this a new social class emerged: the workers, or the industrial proletariat. They lived in overcrowded slums in poor housing with little sanitation. The average life expectancy was low, and infant mortality high. The elite accepted the filth of the factories as the inevitable price for their success. The chimneys were symbols of economic power, but also of social inequality. You see this social inequality appear after each revolution. The gap between the bottom and the top of society becomes very large. Eventually there are inevitable responses that decrease this gap. It could be argued that the Industrial revolutions have created the conditions for a society with little or no poverty.

The third revolution transformed an industrial society into a service society. Where mechanization man relieved of physical labor, the computer relieved him of mental labor. This revolution made lower positions in industry more and more obsolete and caused the emergence of entirely new roles in the service sector.

The emergence of a stock market boom

In the development and take-off phases of the industrial revolution many new companies emerged. All these companies went through more or less the same cycle simulataneously. During the second industrial revolution these new companies emerged in the steel, oil, automotive and electrical industries, and during the third industrial revolution the new companies emerged in the hardware, software, consulting and communications industries. During the acceleration phase of a new industrial revolution many of these businesses tend to be in the acceleration phase of their life cycle, more or less in parallel.

Figure: Typical course of market development:  Introduction, Growth, Flourishing and Decline

 

There is an enormous increase in expected value of the shares of companies in the acceleration phase of their existence. This is the reason why shares become very expensive in the acceleration phase of a revolution.

There was also an enormous increase in price-earnings ratio of shares between 1920 – 1930, the acceleration phase of the second revolution, and between 1990 – 2000, the acceleration phase of the third revolution.

Figure:  Two industrial revolutions: Shiller PE Ratio (price / income)
Splitting shares fuels price-earnings ratio

The increase in the price-earnings ratio is amplified because many companies decide to split their shares during the acceleration phase of their existence. A stock split is required if the market value of a share has grown too large, rendering the marketability insufficient. A split increases the value of the shares because there are more potential investors when they are cheaper. Between 1920 – 1930 and 1990 – 2000 there have been huge amount of stock splits that impacted the price-earnings ratio positively.

Date Company Split
December 31, 1927 American Can 6 for 1
December 31, 1927 General Electric 4 for 1
December 31, 1927 Sears, Roebuck & Company 4 for 1
December 31, 1927 American Car & Foundry 2 for 1
December 31, 1927 American Tobacco 2 for 1
November 5, 1928 Atlantic Refining 4 for 1
December 13, 1928 General Motors 2 1/2 for 1
December 13, 1928 International Harvester 4 for 1
January 8, 1929 American Smelting 3 for 1
January 8, 1929 Radio Corporation of America 5 for 1
May 1, 1929 Wright-Aeronautical 2 for 1
May 20, 1929 Union Carbide split 3 for 1
June 25, 1929 Woolworth split 2 1/2 for 1

Table 1: Share Splits before the stock market crash of 1929

 

Date Company Split
January 22,1990 DuPont 3 for 1
May 14,1990 Coca-Cola Company 2 for 1
May 22, 1990 Westinghouse Electric stock 2 for 1
June 1, 1990 Woolworth Corporation 2 for 1
June 11, 1990 Boeing Company 3 for 2
May 12, 1992 Coca-Cola Company 2 for 1
May18, 1992 Walt Disney Co 4 for 1
May 26, 1992 Merck & Company 3 for 1
June 15, 1992 Proctor & Gamble 2 for 1
May 5, 1993 Goodyear Tire & Rubber Company 2 for 1
March 15, 1994 AlliedSignal Incorporated 2 for 1
April 11, 1994 Minnesota Mining & Manufacturing 2 for 1
May 16, 1994 General Electric Company 2 for 1
June 13, 1994 Chevron Corporation 2 for 1
June 27, 1994 McDonald’s Corporation 2 for 1
September 6, 1994 Caterpillar Incorporated 2 for 1
February 27, 1995 Aluminum Company of America 2 for 1
September 18, 1995 International Paper Company 2 for 1
May 13, 1996 Coca-Cola Company 2 for 1
December 11, 1996 United Technologies Corporation 2 for 1
April 11, 1997 Exxon Corporation 2 for 1
April 14, 1997 Philip Morris Companies 3 for 1
May 12, 1997 General Electric Company 2 for 1
May 28, 1997 International Business Machine 2 for 1
June 9, 1997 Boeing Company 2 for 1
June 13, 1997 DuPont Company 2 for 1
July 14, 1997 Caterpillar Incorporated 2 for 1
September 16, 1997 AlliedSignal 2 for 1
September 22, 1997 Proctor & Gamble 2 for 1
November 20, 1997 Travelers Group Incorporated 3 for 2
July 10, 1998 Walt Disney Company 3 for 1
February 17, 1999 Merck & Company 2 for 1
February 26, 1999 Alcoa Incorporated 2 for 1
March 8, 1999 McDonald’s Corporation 2 for 1
April 16, 1999 AT&T Corporate 2 for 1
April 20, 1999 Wal-Mart Incorporated 2 for 1
May 18, 1999 United Technology Corporation 2 for 1
May 27, 1999 International Business Machine 2 for 1
June 1, 1999 Citigroup Incorporated 3 for 2
December 31, 1999 Home Depot 3 for 2

Table 2: Share Splits during the period 1990-2000

 

Share Splits keep letting the Dow Jones Index explode

The Dow Jones Index was first published on May 26, 1896. The index was calculated by dividing the sum of all the shares of 12 companies by 12:

Dow12_May_26_1896 = (S1 + S2 + ………. + S12) / 12

On October 4, 1916, the Dow was expanded to 20 companies; 4 companies were removed and 12 were added.

Dow20_Oct_4_1916 = (S1 + S2 + ………. + S20) / 20

On December 31, 1927, two years before the stock market crash in October 1929, for the first time a number of companies split their shares. With each change in the composition of the Dow Jones and with each share split, the formula to calculate the Dow Jones is adjusted. This happens because the index, the outcome of the two formulas of the two baskets, must stay the same at the moment of change, because there can not be a gap in the graph. At first a weighted average was calculated for the shares that were split on December 31, 1927.

The formula looks like this: (American Can, split 6 to 1 is multiplied by 6, General Electric, split 4 to 1 is multiplied by 4, etc.)

Dow20_dec_31_1927 = (6.AC + 4.GE+ ……….+S20) / 20

On October 1st, 1928, the Dow Jones grows to 30 companies.

Calculating the index had to be simplified at this point because all the calculations were still done by hand. The weighted average for the split shares is removed and the Dow Divisor is introduced. The index is now calculated by dividing the sum of the share values by the Dow Divisor. Because the index for October 1st, 1928, cannot suddenly change, the Dow Divisor is initially set to 16.67. After all, the index graph for the two time periods (before and after the Dow Divisor was introduced) should still look like a single continuous line.  The calculation is now as follows:

Dow30_oct_1_1928 = (S1 + S2+ ……….+S30) / 16.67

In the fall of 1928 and the spring of 1929 (see Table 1) 8 more stock splits occur, causing the Dow Divisor to drop to 10.77.

Dow30_jun_25_1929 = (S1 + S2+ ……….+S30) / 10.77

From October 1st, 1928 onward an increase in value of the 30 shares means the index value almost doubles. From June 25th, 1929 onward it almost triples compared to a similar increase before stock splitting was introduced. Using the old formula the sum of the 30 shares would simply be divided by 30.

Figure: Dow Jones Index before and after Black Tuesday

 

The extreme rise in the Dow Jones in the period 1920 – 1929 and especially between 1927 – 1929, was primarily caused because the expected value of the shares of companies that are in the acceleration phase of their existence, was increasing enormously. The value of the shares is strengthened further by stock splits and as icing on the cake this value of the shares was  enlarged again in the Dow Jones Index, because behind the scenes the formula of the Dow Jones was adjusted due to stock splits.

During the acceleration phase of the third industrial revolution, 1990 – 2000, history has repeated itself. In this period there have again been many stock splits, particularly in the years 1997 and 1999.

Year DJIA Sum 30 Shares
in $
Dow

Divisor

Share

Splits

1990 2810 1643 0.586 5
1991 2610 1318 0,505 0
1992 3172 1782 0.559 4
1993 3301 1535 0.463 1
1994 3754 1675 0.447 6
1995 3834 1425 0.372 2
1996 5117 1770 0.346 2
1997 6448 2100 0.325 10
1998 7902 1985 0.251 1
1999 9181 2228 0.243 9
2000 11497 2317 0.201

Table 3: Summary DJIA, Dow Divisor and amount share splits between 1990-2000
The formula that was used on January 1, 1990 to calculate the Dow Jones:

Dow30_jan_1_1990 = (S1 + S2+ ……….+S30) / 0.586

The formula that was used on December 31, 1999 was to calculate the Dow Jones:

Dow30_dec_31_1999 = (S1 + S2+ ……….+S30) / 0.20145268

On December 31, 1999 on an increase of the 30 stocks again nearly three times as many index points, the same value increase on January 1, 1990.

Stock market indices are mirages

What does a stock exchange index like DJIA, S&P 500 or AEX mean?

The Dow Jones Industrial Average (DJIA) Index is the oldest stock index in the United States. This was a straight average of the rates of twelve shares. A select group of journalists from The Wall Street Journal decide which companies are part of the most influential index in the world market. Unlike most other indices the Dow is a price-weighted index. This means that stocks with high absolute share price have a significant impact on the movement of the index.

The S & P Index is a market capitalization weighted index. The 500 largest U.S. companies as measured by their market capitalization are included in this index, which is compiled by the credit rating agency Standard & Poor’s.

The Amsterdam Exchange index (AEX) is the main Dutch stock market index. The index displays the image of the price development of the 25 most traded shares on the Amsterdam stock exchange. From a weighted average of the prices of these shares, the position of the AEX is calculated.

In many graphs the y-axis is a fixed unit, such as kg, meter, liter or euro. In the graphs showing the stock exchange values, this also seems to be the case because the unit shows a number of points. However, this is far from true! An index point is not a fixed unit in time and does not have any historical significance.

An index is calculated on the basis of a set of shares. Every index has its own formula and the formula gives the number of points of the index. Unfortunately many people attach a lot of value to these graphs which are, however, very deceptive.

  • An index is calculated on the basis of a set of shares. Every index has its own formula and the formula results in the number of points of the index. However, this set of shares changes regularly. For a new period the value is based on a different set of shares. It is very strange that these different sets of shares are represented as the same unit.
    After a period of 25 years the value of the original set of apples is compared to the value of a set of pears. At the moment only 6 of the original 30 companies that made up the set of shares of the Dow Jones at the start of the acceleration of the last revolution (in 1979) are still present.
  • Even more disturbing is the fact that with every change in the set of shares used to calculate the number of points, the formula also changes. This is done because the index which is the result of two different sets of shares at the moment the set is changed, must be the same for both sets at that point in time. The index graphs must be continuous lines. For example, the Dow Jones is calculated by adding the shares and dividing the result by a number. Because of changes in the set of shares and the splitting of shares the divider changes continuously. At the moment the divider is 0.15 but in 1985 this number was higher than 1. An index point in two periods of time is therefore calculated in different ways:
    Dow1985 = (S1 + S2 + ……..+S30) / 1
    Dow2017 = (S1 + S2 + …….. + S30) / 0,146

In the nineties of  the last century many shares were split. To make sure the result of the calculation remained the same both the number of shares and the divider changed (which I think is wrong). An increase in share value of 1 dollar of the set of shares in 2017 results is 7.6 times more points than in 1985. The fact that in the 1990’s many shares were split is probably the cause of the exponential growth of the Dow Jones index. At the moment the Dow is at 21000 points. If we used the 1985 formula it would be at 2747 points.


  • The most remarkable characteristic is of course the constantly changing set of shares. Generally speaking, the companies that are removed from the set are in a stabilization or degeneration phase. Companies in a take-off phase or acceleration phase are added to the set. This greatly increases the chance that the index will rise rather than go down. This is obvious, especially when this is done during the acceleration phase of a transition.
    From 1980 onwards 7 ICT companies (3M, AT&T, Cisco, HP, IBM, Intel, Microsoft) , the engines of the latest revolution, were added to the Dow Jones and 5 financial institutions, which always play an important role in every transition.
    This is actually a kind of pyramid scheme. All goes well as long as companies are added that are in their take-off phase or acceleration phase. At the end of a transition, however, there will be fewer companies in those phases. The last 18 years were 21 companies replaced in the Dow Jones, a percentage of 70%.

Overview modifications Dow Jones from 1997:

21 winners in  —   21 losers out, a figure of 70%

March 19, 2015: Apple replaced AT & T. In order to make Apple suitable for the Dow Jones, there was a share split of Apple seven for one on June 9, 2014

September 23, 2013: Hewlett-Packard Co., Bank of America Inc. and Alcoa Inc. replaced Goldman Sachs Group Inc., Nike Inc. and Visa Inc.
Alcoa has dropped from $40 in 2007 to $8.08. Hewlett- Packard Co. has dropped from $50 in 2010 to $22.36. Bank of America has dropped from $50 in 2007 to $14.48.
But Goldman Sachs Group Inc., Nike Inc. and Visa Inc. have risen 25%, 27% and 18% respectively in 2013.

HP is trading at an approximate price of $22, BoA at $14 and Alcoa at $8 (sum total of $44). These shares will be replaced by Goldman Sachs at $164, Nike at $67 and Visa at $184 (sum total of $415) which is 9.4 times more. This means that the new sum of the 30 stocks have a value of $2,349 (1978 – 44 + 415) and, therefore we expect that the Dow Divisor will be adjusted from 0.130216081 to 0.154631 to get back to the original 15,191 index points (15,191 x 0.154631 = $2,349).

Given the above, had the three old shares increased by 10% each in price in the past the Dow 30 would have increased by 33.8 points in total (10% x 44 divided by 0.130216081 = 33.79 points) assuming there was no change in the price of the other 27 stocks.

As of September 23rd, however, a corresponding 10% increase in the price of each of the new shares would contribute 268.4 points to the rise of the Dow 30 (10% x 415 divided by 0.154631 = 268.38) or 7.94 times more points.

The influence of the 3 losers was: $44 of $1,978. This is 2.2% of the Dow Jones Index.
The influence of the 3 winners becomes: $415 of $2,349. This is 17.67% of the Dow Jones Index.

September 20, 2012: UnitedHealth Group Inc. (UNH) replaces Kraft Foods Inc.
Kraft Foods Inc. was split into two companies and was therefore deemed less representative so no longer suitable for the Dow. The share value of UnitedHealth Group Inc. had risen for two years before inclusion in the Dow by 53%.

June 8, 2009: Cisco and Travelers replaced Citigroup and General Motors.
 Citigroup and General Motors have received billions of dollars of U.S. government money to survive and were not representative of the Dow.

September 22, 2008: Kraft Foods Inc. replaced American International Group. American International Group was replaced after the decision of the government to take a 79.9% stake in the insurance giant. AIG was narrowly saved from destruction by an emergency loan from the Fed.

February 19, 2008: Bank of America Corp. and Chevron Corp. replaced Altria Group Inc. and Honeywell International.
Altria was split into two companies and was deemed no longer suitable for the Dow.
 Honeywell was removed from the Dow because the role of industrial companies in the U.S. stock market in the recent years had declined and Honeywell had the smallest sales and profits among the participants in the Dow.

April 8, 2004: Verizon Communications Inc., American International Group Inc. and Pfizer Inc. replace AT & T Corp., Eastman Kodak Co. and International Paper.
AIG shares had increased over 387% in the previous decade and Pfizer had an increase of more than 675& behind it. Shares of AT & T and Kodak, on the other hand, had decreases of more than 40% in the past decade and were therefore removed from the Dow.

November 1, 1999: Microsoft Corporation, Intel Corporation, SBC Communications and Home Depot Incorporated replaced Chevron Corporation, Goodyear Tire & Rubber Company, Union Carbide Corporation and Sears Roebuck.

March 17, 1997:  Travelers Group, Hewlett-Packard Company, Johnson & Johnson and Wal-Mart Stores Incorporated replaced Westinghouse Electric Corporation, Texaco Incorporated, Bethlehem Steel Corporation and Woolworth Corporation.

Figure: Changes in the Dow Jones over the last two industrial revolutions

 

Figure: Exchange rates of Dow Jones during the latest two industrial revolutions. During the last few years the rate increases have accelerated enormously.

Central banks hold out stock exchanges?

Calculating share indexes as described above and showing indexes in historical graphs is a useful way to show which phase the industrial revolution is in.

The third industrial revolution is clearly in the saturation and degeneration phase. This phase can be recognized by the saturation of the market and the increasing competition. Only the strongest companies can withstand the competition or take over their competitors (like for example the take-overs by Oracle and Microsoft in the past few years). The information technology world has not seen any significant technical changes recently, despite what the American marketing machine wants us to believe.

During the pre development phase and the take-off phase of a transition many new companies spring into existence. This is a diverging process. Especially financial institutions play an important role here as these phases require a lot of money. The graphs showing the wages paid in the financial sector therefore shows the same S curve as both revolutions.

Figure: Historical excess wage in the financial sector

Investors get euphoric when hearing about mergers and take overs. Actually, these mergers and take overs are indications of the converging processes at the end of a transition. When looked at objectively each merger or take over is a loss of economic activity. This becomes painfully clear when we have a look at the unemployment rates of some countries.

New industrial revolutions come about because of new ideas, inventions and discoveries, so new knowledge and insight. Here too we have reached a point of saturation. There will be fewer companies in the take off or acceleration phase to replace the companies in the index shares sets that have reached the stabilization or degeneration phase.

In a (threatening) recession, the central bank tries to stimulate the economy by lowering interest rates. Loans are thus cheaper, allowing citizens and businesses to spend more. In the event of sharply rising unemployment and falling prices, however, this does significantly less. This is also the case as the official interest rates are lower, or even fall to essentially zero. Regardless of the interest rate (big) loans are not concluded and expensive purchases will be delayed. Further rate cuts or even an interest rate of zero may not lead to an increase in economic activity and falling demand leads to further price declines (deflation). The central bank may decide in that case to increase the money supply (quantitative easing). A larger money supply actually leads to price increases and disruption of the deflationary spiral. In the past the printing presses would be turned on but nowadays the central bank buys government bonds, mortgage bonds and other securities and finances these transactions by increasing the personal balance. There are no extra physical bank notes printed. The mechanism works by means of central banks buying bonds in the market or directly from banks. Banks are credited for the purchase amount in the accounts held with the central bank. In this way, banks obtain liquidity. In response to this liquidity banks can then provide new loans.

Figure: The quantitative easing policy of the Fed (US central bank) and its effect on the S & P 500

Due to the combination of interest rate policy and quantitative easing by central banks a lot of money has flowed the stock markets since 2008 and has in fact created a new, fictional bull market. This is evident in the price-earnings ratio chart (Shiller PE Ratio), which has risen again since 2008. But central banks now have no more ammunition to break the deflationary spiral.  At the end of the 2nd industrial revolution in 1932 the PE Ratio dropped to 5. Currently, this ratio, partly due to the behavior of central banks, is 23.

Figure: Two industrial revolutions: price-earnings ratio (PE ratio Shiller)

Will history repeat itself?

Humanity is being confronted with the same problems as those at the end of the second industrial revolution such as decreasing stock exchange rates, highly increasing unemployment, towering debts of companies and governments and bad financial positions of banks.

Figure: Two industrial revolutions and the debt of America

Transitions are initiated by inventions and discoveries, new knowledge of mankind. New knowledge influences the other four components in a society. At the moment there are few new inventions or discoveries. So the chance of a new industrial revolution is not very high. History has shown that five pillars are indispensable for a stable society.

Figure: The five pillars for a stable society: Food, Security, Health, Prosperity, Knowledge.

At the end of every transition the pillar Prosperity is threatened. We have seen this effect after every industrial revolution.

The pillar Prosperity of a society is about to fall again. History has shown that the fall of the pillar Prosperity always results in a revolution. Because of the high level of unemployment after the second industrial revolution many societies initiated a new transition, the creation of a war economy. This type of economy flourished especially in the period 1940 – 1945.

Now, societies will have to make a choice for a new transition to be started.
Without knowledge of the past there is no future.

 

Wim Grommen

References:

  • Geschiedenis Werkplaatssite van Wolters-Noordhoff en Wikipedia
  • Prof J. Rotmans, e.a. (2000), “Transities & Transitiemanagement: de casus van een emissiearme energievoorziening”
  • Dow Jones Industrial Average Historical Components, S&P Dow Jones Indices McGraw Hill Financial
  • Dow Jones Industrial Average Historical Divisor Changes, S&P Dow Jones Indices McGraw Hill Financial
  • W. Grommen, (november 2007), “Nieuwe beurskrach, een kwestie van tijd?”, Technische en Kwantitatieve Analyse,  (20 – 22)
  • W. Grommen, (January 2010), “Beurskrach 1929, mysterie ontrafeld?”, Technische en Kwantitatieve Analyse,  (22 – 24)
  • Grommen, (March 2011), “Huidige crisis, een wetmatigheid?”, Hermes, 49, (52 – 58)
  • Grommen, (January 2013), paper “The present crisis, a pattern” gepresenteerd op International Symposium The Economic Crisis: Time For A Paradigm Shift
  • W. Grommen, (November 2014), “The Dow Jones Industrial Average , A Fata Morgana”, TRADERS’ Magazine,  (14 – 18)
  • Grommen, (April 2015), “Stock Splitting And The Market Crash 1929”, ValueWalk
  • Grommen (August 2015), “Stock Market Boom and Crash, the Cause and Effect of Extreme Market Movements” , TRADERS’ Magazine, (28 – 30)

 

Stock Market Crash, A Historical Pattern? by Wim Grommen

40 Australian economists urge debt forgiveness for Greece

Digital Transformation – Digital Leadership

 

 

New stock market crash inevitable

New stock market crash inevitable

Every production phase or society or other human invention goes through a so-called transformation process. Transitions are social transformation processes that cover at least one generation. In this article I will use one such transition to demonstrate the position of our present civilization and and that a new stock market crash is inevitable.

 

When we consider the characteristics of the phases of a social transformation we may find ourselves at the end of what might be called the third industrial revolution. Transitions are social transformation processes that cover at least one generation (= 25 years). A transition has the following characteristics:

  • it involves a structural change of civilization or a complex subsystem of our civilization
  • it shows technological, economical, ecological, socio cultural and institutional changes at different levels that influence and enhance each other
  • it is the result of slow changes (changes in supplies) and fast dynamics (flows)

 

A transition process is not fixed from the start because during the transition processes will adapt to the new situation. A transition is not dogmatic.

 

Four transition phases

When we consider the characteristics of the phases of a social transformation we may find ourselves at the end of what might be called the third industrial revolution.

The S curve of a transition

 

Figure: Four phases in a transition best visualized by means of an S – curve:
Pre-development, Take off, Acceleration, Stabilization.

In general, transitions can be seen to go through the S curve and we can distinguish four phases (see fig. 1):

  1. a pre-development phase of a dynamic balance in which the status does not visibly change
  2. a take-off phase in which the process of change starts because of changes in the system
  3. an acceleration phase in which visible structural changes take place through an accumulation of socio cultural, economical, ecological and institutional changes influencing each other; in this phase we see collective learning processes, diffusion and processes of embedding
  4. a stabilization phase in which the speed of sociological change slows down and a new dynamic balance is achieved through learning

 

A product life cycle also goes through an S curve. In that case there is a fifth phase:

  1. the degeneration phase in which cost rises because of over capacity and the producer will finally withdraw from the market.

 

When we look back into the past we see three transitions, also called industrial revolutions, taking place with far-reaching effect:

  1. The first industrial revolution (1780 until circa 1850); the steam engine
  2. The second industrial revolution (1870 until circa 1930); electricity, oil and the
    car
  3. The third industrial revolution (1950 until ….); computer and microprocessor

 

The emergence of a stock market boom

In the development and take-off phases of the industrial revolution many new companies emerged. All these companies went through more or less the same cycle simulataneously. During the second industrial revolution these new companies emerged in the steel, oil, automotive and electrical industries, and during the third industrial revolution the new companies emerged in the hardware, software, consulting and communications industries. During the acceleration phase of a new industrial revolution many of these businesses tend to be in the acceleration phase of their life cycle, more or less in parallel.

Figure: Typical course of market development:  Introduction, Growth, Flourishing and Decline

 

There is an enormous increase in expected value of the shares of companies in the acceleration phase of their existence. This is the reason why shares become very expensive in the acceleration phase of a revolution.

There was also an enormous increase in price-earnings ratio of shares between 1920 – 1930, the acceleration phase of the second revolution, and between 1990 – 2000, the acceleration phase of the third revolution.

 

Figure:  Two industrial revolutions: Shiller PE Ratio (price / income)

Splitting shares fuels price-earnings ratio

 The increase in the price-earnings ratio is amplified because many companies decide to split their shares during the acceleration phase of their existence. A stock split is required if the market value of a share has grown too large, rendering the marketability insufficient. A split increases the value of the shares because there are more potential investors when they are cheaper. Between 1920 – 1930 and 1990 – 2000 there have been huge amount of stock splits that impacted the price-earnings ratio positively.

 

Date Company Split
December 31, 1927 American Can 6 for 1
December 31, 1927 General Electric 4 for 1
December 31, 1927 Sears, Roebuck & Company 4 for 1
December 31, 1927 American Car & Foundry 2 for 1
December 31, 1927 American Tobacco 2 for 1
November 5, 1928 Atlantic Refining 4 for 1
December 13, 1928 General Motors 2 1/2 for 1
December 13, 1928 International Harvester 4 for 1
January 8, 1929 American Smelting 3 for 1
January 8, 1929 Radio Corporation of America 5 for 1
May 1, 1929 Wright-Aeronautical 2 for 1
May 20, 1929 Union Carbide split 3 for 1
June 25, 1929 Woolworth split 2 1/2 for 1

Table 1: Share Splits before the stock market crash of 1929

 

Date Company Split
January 22,1990 DuPont 3 for 1
May 14,1990 Coca-Cola Company 2 for 1
May 22, 1990 Westinghouse Electric stock 2 for 1
June 1, 1990 Woolworth Corporation 2 for 1
June 11, 1990 Boeing Company 3 for 2
May 12, 1992 Coca-Cola Company 2 for 1
May18, 1992 Walt Disney Co 4 for 1
May 26, 1992 Merck & Company 3 for 1
June 15, 1992 Proctor & Gamble 2 for 1
May 5, 1993 Goodyear Tire & Rubber Company 2 for 1
March 15, 1994 AlliedSignal Incorporated 2 for 1
April 11, 1994 Minnesota Mining & Manufacturing 2 for 1
May 16, 1994 General Electric Company 2 for 1
June 13, 1994 Chevron Corporation 2 for 1
June 27, 1994 McDonald’s Corporation 2 for 1
September 6, 1994 Caterpillar Incorporated 2 for 1
February 27, 1995 Aluminum Company of America 2 for 1
September 18, 1995 International Paper Company 2 for 1
May 13, 1996 Coca-Cola Company 2 for 1
December 11, 1996 United Technologies Corporation 2 for 1
April 11, 1997 Exxon Corporation 2 for 1
April 14, 1997 Philip Morris Companies 3 for 1
May 12, 1997 General Electric Company 2 for 1
May 28, 1997 International Business Machine 2 for 1
June 9, 1997 Boeing Company 2 for 1
June 13, 1997 DuPont Company 2 for 1
July 14, 1997 Caterpillar Incorporated 2 for 1
September 16, 1997 AlliedSignal 2 for 1
September 22, 1997 Proctor & Gamble 2 for 1
November 20, 1997 Travelers Group Incorporated 3 for 2
July 10, 1998 Walt Disney Company 3 for 1
February 17, 1999 Merck & Company 2 for 1
February 26, 1999 Alcoa Incorporated 2 for 1
March 8, 1999 McDonald’s Corporation 2 for 1
April 16, 1999 AT&T Corporate 2 for 1
April 20, 1999 Wal-Mart Incorporated 2 for 1
May 18, 1999 United Technology Corporation 2 for 1
May 27, 1999 International Business Machine 2 for 1
June 1, 1999 Citigroup Incorporated 3 for 2
December 31, 1999 Home Depot 3 for 2

Table 2: Share Splits during the period 1990-2000

 

Share Splits keep letting the Dow Jones Index explode

The Dow Jones Index was first published on May 26, 1896. The index was calculated by dividing the sum of all the shares of 12 companies by 12:

Dow12_May_26_1896 = (S1 + S2 + ………. + S12) / 12

On October 4, 1916, the Dow was expanded to 20 companies; 4 companies were removed and 12 were added.

Dow20_Oct_4_1916 = (S1 + S2 + ………. + S20) / 20

On December 31, 1927, two years before the stock market crash in October 1929, for the first time a number of companies split their shares. With each change in the composition of the Dow Jones and with each share split, the formula to calculate the Dow Jones is adjusted. This happens because the index, the outcome of the two formulas of the two baskets, must stay the same at the moment of change, because there can not be a gap in the graph. At first a weighted average was calculated for the shares that were split on December 31, 1927.

The formula looks like this: (American Can, split 6 to 1 is multiplied by 6, General Electric, split 4 to 1 is multiplied by 4, etc.)

Dow20_dec_31_1927 = (6.AC + 4.GE+ ……….+S20) / 20

On October 1st, 1928, the Dow Jones grows to 30 companies.

Calculating the index had to be simplified at this point because all the calculations were still done by hand. The weighted average for the split shares is removed and the Dow Divisor is introduced. The index is now calculated by dividing the sum of the share values by the Dow Divisor. Because the index for October 1st, 1928, cannot suddenly change, the Dow Divisor is initially set to 16.67. After all, the index graph for the two time periods (before and after the Dow Divisor was introduced) should still look like a single continuous line.  The calculation is now as follows:

Dow30_oct_1_1928 = (S1 + S2+ ……….+S30) / 16.67

In the fall of 1928 and the spring of 1929 (see Table 1) 8 more stock splits occur, causing the Dow Divisor to drop to 10.77.

Dow30_jun_25_1929 = (S1 + S2+ ……….+S30) / 10.77

From October 1st, 1928 onward an increase in value of the 30 shares means the index value almost doubles. From June 25th, 1929 onward it almost triples compared to a similar increase before stock splitting was introduced. Using the old formula the sum of the 30 shares would simply be divided by 30.



Figure: Dow Jones Index before and after Black Tuesday

 

The extreme rise in the Dow Jones in the period 1920 – 1929 and especially between 1927 – 1929, was primarily caused because the expected value of the shares of companies that are in the acceleration phase of their existence, was increasing enormously. The value of the shares is strengthened further by stock splits and as icing on the cake this value of the shares was  enlarged again in the Dow Jones Index, because behind the scenes the formula of the Dow Jones was adjusted due to stock splits.



During the acceleration phase of the third industrial revolution, 1990 – 2000, history has repeated itself. In this period there have again been many stock splits, particularly in the years 1997 and 1999.

Year DJIA Sum 30

Shares in $

Dow

Divisor

Share

Splits

1990 2810 1643 0.586 5
1991 2610 1318 0,505 0
1992 3172 1782 0.559 4
1993 3301 1535 0.463 1
1994 3754 1675 0.447 6
1995 3834 1425 0.372 2
1996 5117 1770 0.346 2
1997 6448 2100 0.325 10
1998 7902 1985 0.251 1
1999 9181 2228 0.243 9
2000 11497 2317 0.201

Table 3: Summary DJIA, Dow Divisor and amount share splits between 1990-2000
The formula that was used on January 1, 1990 to calculate the Dow Jones:

Dow30_jan_1_1990 = (S1 + S2+ ……….+S30) / 0.586

The formula that was used on December 31, 1999 was to calculate the Dow Jones:

Dow30_dec_31_1999 = (S1 + S2+ ……….+S30) / 0.20145268

 

On December 31, 1999 on an increase of the 30 stocks again nearly three times as many index points, the same value increase on January 1, 1990.

Stock market indices are mirages

 

What does a stock exchange index like DJIA, S&P 500 or AEX mean?

The Dow Jones Industrial Average (DJIA) Index is the oldest stock index in the United States. This was a straight average of the rates of twelve shares. A select group of journalists from The Wall Street Journal decide which companies are part of the most influential index in the world market. Unlike most other indices the Dow is a price-weighted index. This means that stocks with high absolute share price have a significant impact on the movement of the index.

The S & P Index is a market capitalization weighted index. The 500 largest U.S. companies as measured by their market capitalization are included in this index, which is compiled by the credit rating agency Standard & Poor’s.

The Amsterdam Exchange index (AEX) is the main Dutch stock market index. The index displays the image of the price development of the 25 most traded shares on the Amsterdam stock exchange. From a weighted average of the prices of these shares, the position of the AEX is calculated.

In many graphs the y-axis is a fixed unit, such as kg, meter, liter or euro. In the graphs showing the stock exchange values, this also seems to be the case because the unit shows a number of points. However, this is far from true! An index point is not a fixed unit in time and does not have any historical significance.

An index is calculated on the basis of a set of shares. Every index has its own formula and the formula gives the number of points of the index. Unfortunately many people attach a lot of value to these graphs which are, however, very deceptive.

  • An index is calculated on the basis of a set of shares. Every index has its own formula and the formula results in the number of points of the index. However, this set of shares changes regularly. For a new period the value is based on a different set of shares. It is very strange that these different sets of shares are represented as the same unit.
    After a period of 25 years the value of the original set of apples is compared to the value of a set of pears. At the moment only 6 of the original 30 companies that made up the set of shares of the Dow Jones at the start of the acceleration of the last revolution (in 1979) are still present.
  • Even more disturbing is the fact that with every change in the set of shares used to calculate the number of points, the formula also changes. This is done because the index which is the result of two different sets of shares at the moment the set is changed, must be the same for both sets at that point in time. The index graphs must be continuous lines. For example, the Dow Jones is calculated by adding the shares and dividing the result by a number. Because of changes in the set of shares and the splitting of shares the divider changes continuously. At the moment the divider is 0.15 but in 1985 this number was higher than 1. An index point in two periods of time is therefore calculated in different ways:
    Dow1985 = (S1 + S2 + ……..+S30) / 1

Dow2009 = (S1 + S2 + …….. + S30) / 0,15

In the nineties of  the last century many shares were split. To make sure the result of the calculation remained the same both the number of shares and the divider changed (which I think is wrong). An increase in share value of 1 dollar of the set of shares in 2015 results is 6.6 times more points than in 1985. The fact that in the 1990’s many shares were split is probably the cause of the exponential growth of the Dow Jones index. At the moment the Dow is at 16000 points. If we used the 1985 formula it would be at 2400 points.

  • The most remarkable characteristic is of course the constantly changing set of shares. Generally speaking, the companies that are removed from the set are in a stabilization or degeneration phase. Companies in a take-off phase or acceleration phase are added to the set. This greatly increases the chance that the index will rise rather than go down. This is obvious, especially when this is done during the acceleration phase of a transition.
    From 1980 onwards 7 ICT companies (3M, AT&T, Cisco, HP, IBM, Intel, Microsoft) , the engines of the latest revolution, were added to the Dow Jones and 5 financial institutions, which always play an important role in every transition.
    This is actually a kind of pyramid scheme. All goes well as long as companies are added that are in their take-off phase or acceleration phase. At the end of a transition, however, there will be fewer companies in those phases. The last 18 years were 21 companies replaced in the Dow Jones, a percentage of 70%.

 

Overview modifications Dow Jones from 1997:

 

21 winners in  —   21 losers out, a figure of 70%

March 19, 2015: Apple replaced AT & T. In order to make Apple suitable for the Dow Jones, there was a share split of Apple seven for one on June 9, 2014

September 23, 2013: Hewlett-Packard Co., Bank of America Inc. and Alcoa Inc. replaced Goldman Sachs Group Inc., Nike Inc. and Visa Inc.
Alcoa has dropped from $40 in 2007 to $8.08. Hewlett- Packard Co. has dropped from $50 in 2010 to $22.36. Bank of America has dropped from $50 in 2007 to $14.48.
But Goldman Sachs Group Inc., Nike Inc. and Visa Inc. have risen 25%, 27% and 18% respectively in 2013.

September 20, 2012: UnitedHealth Group Inc. (UNH) replaces Kraft Foods Inc.
Kraft Foods Inc. was split into two companies and was therefore deemed less representative so no longer suitable for the Dow. The share value of UnitedHealth Group Inc. had risen for two years before inclusion in the Dow by 53%.

June 8, 2009: Cisco and Travelers replaced Citigroup and General Motors.
 Citigroup and General Motors have received billions of dollars of U.S. government money to survive and were not representative of the Dow.

September 22, 2008: Kraft Foods Inc. replaced American International Group. American International Group was replaced after the decision of the government to take a 79.9% stake in the insurance giant. AIG was narrowly saved from destruction by an emergency loan from the Fed.

February 19, 2008: Bank of America Corp. and Chevron Corp. replaced Altria Group Inc. and Honeywell International.
Altria was split into two companies and was deemed no longer suitable for the Dow.
 Honeywell was removed from the Dow because the role of industrial companies in the U.S. stock market in the recent years had declined and Honeywell had the smallest sales and profits among the participants in the Dow.

April 8, 2004: Verizon Communications Inc., American International Group Inc. and Pfizer Inc. replace AT & T Corp., Eastman Kodak Co. and International Paper.
AIG shares had increased over 387% in the previous decade and Pfizer had an increase of more than 675& behind it. Shares of AT & T and Kodak, on the other hand, had decreases of more than 40% in the past decade and were therefore removed from the Dow.

November 1, 1999: Microsoft Corporation, Intel Corporation, SBC Communications and Home Depot Incorporated replaced Chevron Corporation, Goodyear Tire & Rubber Company, Union Carbide Corporation and Sears Roebuck.

March 17, 1997:  Travelers Group, Hewlett-Packard Company, Johnson & Johnson and Wal-Mart Stores Incorporated replaced Westinghouse Electric Corporation, Texaco Incorporated, Bethlehem Steel Corporation and Woolworth Corporation.
Figure: Changes in the Dow Jones over the last two industrial revolutions

Figure: Exchange rates of Dow Jones during the latest two industrial revolutions. During the last few years the rate increases have accelerated enormously.

 

Will the share indexes go down any further?

Calculating share indexes as described above and showing indexes in historical graphs is a useful way to show which phase the industrial revolution is in.

The third industrial revolution is clearly in the saturation and degeneration phase. This phase can be recognized by the saturation of the market and the increasing competition. Only the strongest companies can withstand the competition or take over their competitors (like for example the take-overs by Oracle and Microsoft in the past few years). The information technology world has not seen any significant technical changes recently, despite what the American marketing machine wants us to believe.

During the pre development phase and the take-off phase of a transition many new companies spring into existence. This is a diverging process. Especially financial institutions play an important role here as these phases require a lot of money. The graphs showing the wages paid in the financial sector therefore shows the same S curve as both revolutions.

Figure: Historical excess wage in the financial sector

 

Investors get euphoric when hearing about mergers and take overs. Actually, these mergers and take overs are indications of the converging processes at the end of a transition. When looked at objectively each merger or take over is a loss of economic activity. This becomes painfully clear when we have a look at the unemployment rates of some countries.

New industrial revolutions come about because of new ideas, inventions and discoveries, so new knowledge and insight. Here too we have reached a point of saturation. There will be fewer companies in the take off or acceleration phase to replace the companies in the index shares sets that have reached the stabilization or degeneration phase.

In a (threatening) recession, the central bank tries to stimulate the economy by lowering interest rates. Loans are thus cheaper, allowing citizens and businesses to spend more. In the event of sharply rising unemployment and falling prices, however, this does significantly less. This is also the case as the official interest rates are lower, or even fall to essentially zero. Regardless of the interest rate (big) loans are not concluded and expensive purchases will be delayed. Further rate cuts or even an interest rate of zero may not lead to an increase in economic activity and falling demand leads to further price declines (deflation). The central bank may decide in that case to increase the money supply (quantitative easing). A larger money supply actually leads to price increases and disruption of the deflationary spiral. In the past the printing presses would be turned on but nowadays the central bank buys government bonds, mortgage bonds and other securities and finances these transactions by increasing the personal balance. There are no extra physical bank notes printed. The mechanism works by means of central banks buying bonds in the market or directly from banks. Banks are credited for the purchase amount in the accounts held with the central bank. In this way, banks obtain liquidity. In response to this liquidity banks can then provide new loans.

Figure: The quantitative easing policy of the Fed (US central bank) and its effect on the S & P 500

Due to the combination of interest rate policy and quantitative easing by central banks a lot of money has flowed the stock markets since 2008 and has in fact created a new, fictional bull market. This is evident in the price-earnings ratio chart (Shiller PE Ratio), which has risen again since 2008. But central banks now have no more ammunition to break the deflationary spiral.  At the end of the 2nd industrial revolution in 1932 the PE Ratio dropped to 5. Currently, this ratio, partly due to the behavior of central banks, is 23. The share prices can still go down by a factor 4

Figure: Two industrial revolutions: price-earnings ratio (PE ratio Shiller)

 

Will history repeat itself?

Humanity is being confronted with the same problems as those at the end of the second industrial revolution such as decreasing stock exchange rates, highly increasing unemployment, towering debts of companies and governments and bad financial positions of banks.

Figure: Two industrial revolutions and the debt of America

 

Transitions are initiated by inventions and discoveries, new knowledge of mankind. New knowledge influences the other four components in a society. At the moment there are few new inventions or discoveries. So the chance of a new industrial revolution is not very high. History has shown that five pillars are indispensable for a stable society.

Figure: The five pillars for a stable society: Food, Security, Health, Prosperity,
Knowledge.

 

At the end of every transition the pillar Prosperity is threatened. We have seen this effect after every industrial revolution.

The pillar Prosperity of a society is about to fall again. History has shown that the fall of the pillar Prosperity always results in a revolution. Because of the high level of unemployment after the second industrial revolution many societies initiated a new transition, the creation of a war economy. This type of economy flourished especially in the period 1940 – 1945.

Now, societies will have to make a choice for a new transition to be started.
Without knowledge of the past there is no future.

 

Wim Grommen

References:

  • Geschiedenis Werkplaatssite van Wolters-Noordhoff en Wikipedia
  • Prof J. Rotmans, e.a. (2000), “Transities & Transitiemanagement: de casus van een emissiearme energievoorziening”
  • Dow Jones Industrial Average Historical Components, S&P Dow Jones Indices McGraw Hill Financial
  • Dow Jones Industrial Average Historical Divisor Changes, S&P Dow Jones Indices McGraw Hill Financial
  • W. Grommen, (november 2007), “Nieuwe beurskrach, een kwestie van tijd?”, Technische en Kwantitatieve Analyse,  (20 – 22)
  • W. Grommen, (January 2010), “Beurskrach 1929, mysterie ontrafeld?”, Technische en Kwantitatieve Analyse,  (22 – 24)
  • Grommen, (March 2011), “Huidige crisis, een wetmatigheid?”, Hermes, 49, (52 – 58)
  • Grommen, (January 2013), paper “The present crisis, a pattern” gepresenteerd op International Symposium The Economic Crisis: Time For A Paradigm Shift
  • W. Grommen, (November 2014), “The Dow Jones Industrial Average , A Fata Morgana”, TRADERS’ Magazine,  (14 – 18)
  • Grommen, (April 2015), “Stock Splitting And The Market Crash 1929”, ValueWalk
  • Grommen (August 2015), “Stock Market Boom and Crash, the Cause and Effect of Extreme Market Movements” , TRADERS’ Magazine, (28 – 30)

Stock Market Crash, A Historical Pattern? by Wim Grommen

5 Rules For Investing by Warren Buffett

15 of Steve Jobs most inspiring quotes

China could push U.S. interest rates higher

The wrecking ball swinging through the Chinese stock market has sent investors around the world scurrying for cover in the safe haven known as the U.S. Treasury market.

The result: Even as U.S. stocks take a beating, a key rate that influences the cost of many consumer loans briefly fell below 2% for the first time in four months. Investors were snapping up Treasuries, pushing up prices and pushing down yields.

In the short run, lower yields make it cheaper for Americans to buy big-ticket items such as new cars or refrigerators or to take out mortgages to buy a home. Businesses also benefits by paying less to borrow.

Current Problems Associated with the End of the Third Industrial Revolution

By Wim Grommen, a teacher in mathematics and physics and later a trainer of programmers in Oracle software. He has also studied and written about transitions, social transformation processes, the S-curve and transitions in relation to market indices. Originally presented at an international symposium in Valencia: “The Economic Crisis: Time for a Paradigm Shift”

 

ABSTRACT

This paper advances a hypothesis of the end of the third industrial revolution and the beginning of a new transition. Every production phase or civilization or human invention goes through a so- called transformation process. Transitions are social transformation processes that cover at least one generation. In this paper I will use one such transition to demonstrate the position of our present civilization. When we consider the characteristics of the phases of a social transformation we may find ourselves at the end of what might be called the third industrial revolution. The paper describes the four most radical transitions for mankind and the effects for mankind of these transitions: the Neolithic transition, the first industrial revolution, the second industrial revolution and the third industrial revolution.

The Dow Jones Industrial Average (DJIA) Index is the only stock market index that covers both the second and the third industrial revolution. Calculating share indexes such as the Dow Jones Industrial Average and showing this index in a historical graph is a useful way to show which phase the industrial revolution is in. Changes in the DJIA shares basket, changes in the formula and stock splits during the take-off phase and acceleration phase of industrial revolutions are perfect transition-indicators. The similarities of these indicators during the last two revolutions are fascinating, but also a reason for concern. In fact the graph of the DJIA is a classic example of fictional truth, a fata morgana.

History has shown that five pillars are essential in a stable society: Food, Security, Health, Prosperity and Knowledge. At the end of every transition the pillar Prosperity is threatened. We have seen this effect at the end of every industrial revolution. Societies will have to make a choice for a new transition to be started.
1 INTRODUCTION

Every production phase or civilization or other human invention goes through a so-called transformation process. Transitions are social transformation processes that cover at least one generation. In this paper I will use one such transition to demonstrate the position of our present civilization. When we consider the characteristics of the phases of a social transformation we may find ourselves at the end of what might be called the third industrial revolution. Transitions are social transformation processes that cover at least one generation (= 25 years).

A transition has the following characteristics:

– It involves a structural change of civilization or a complex subsystem of our civilization

– It shows technological, economical, ecological, socio cultural and institutional changes at different levels that influence and enhance each other

– It is the result of slow changes (changes in supplies) and fast dynamics (flows)

Examples of historical transitions are the demographical transition and the transition from coal to natural gas which caused transition in the use of energy. A transition process is not fixed from the start because during the transition processes will adapt to the new situation. A transition is not dogmatic.
2 TRANSITIONS

In general transitions can be seen to go through the S curve and we can distinguish four phases (figure 1):

1. A pre development phase of a dynamic balance in which the present status does not visibly change

2. A take off phase in which the process of change starts because of changes in the system

3. An acceleration phase in which visible structural changes take place through an accumulation of socio cultural, economical, ecological and institutional changes influencing each other; in this phase we see collective learning processes, diffusion and processes of embedding

4. A stabilization phase in which the speed of sociological change slows down and a new dynamic balance is achieved through learning

A product life cycle also goes through an S curve. In that case there is a fifth phase:
the degeneration phase in which cost rises because of over capacity and the producer will finally withdraw from the market.

Figure 1. The S curve of a transition

Four phases in a transition are best visualized by means of an S curve: Pre-development, Take-off, Acceleration, Stabilization.

The process of the spreading of transitions over civilizations is influenced by a number of elements:

• Physical barriers: oceans, deserts, mountain ranges, swamps, lakes

• Socio-cultural barriers: difference in culture and languages

• Religious barriers

• Psychological barriers

When we look back over the past, we see four transitions taking place with far-reaching effects.
2.1 THE NEOLITHIC TRANSITION

The Neolithic transition was the most radical transition for mankind. This first agricultural revolution (10000 – 3000 BC) forms the change from societies of hunter gatherers (20 – 50 people) close to water with a nomadic existence to a society of people living in settlements growing crops and animals. A hierarchical society came into existence. Joint organizations protected and governed the interests of the individual. Performing (obligatory) services for the community could be viewed as a first type of taxation. Stocks were set up with stock management, trade emerged, inequality and theft. Ways of administering justice were invented to solve conflicts within and between communities and war became a way of protecting interests.The Neolithic revolution started in those places that were most favorable because of the climate and sources of food. In very cold, very hot or dry areas the hunter gatherer societies lasted longer.

Several areas are pointed out as possible starting points: southern Anatolia, the basins the Yangtze Kiang and Yellow river in China, the valley of the Indus, the present Peru in the Andes or what is now Mexico in Central America. From these areas the revolution spread across the world. The start of the Neolithic era and the spreading process are different in each area. In some areas the changes are relatively quick and some authors therefore like to speak of a Neolithic revolution. Modern historians prefer to speak of the Neolithic evolution. They have come to realize that in many areas the process took much longer and was much more gradual than they originally thought.
2.2 THE FIRST INDUSTRIAL REVOLUTION

The first industrial revolution lasted from around 1780 tot 1850. It was characterized by a transition from small scale handwork to mechanized production in factories. The great catalyst in the process was the steam engine which also caused a revolution in transport as it was used in railways and shipping. The first industrial revolution was centered around the cotton industry. Because steam engines were made of iron and ran on coal, both coal mining and iron industry also flourished.



Britain was the first country that faced the industrial revolution. The steam engine was initially mainly used to power the water pumps of mines. A major change occurred in the textile industry. Because of population growth and colonial expansion the demand for cotton products quickly increased. Because spinners and weavers could not keep up with the demand, there was an urgent need for a loom with an external power unit, the power loom.

A semi-automatic shuttleless loom was invented, and a machine was created that could spin several threads simultaneously. This “Spinning Jenny”, invented in 1764 by James Hargreaves, was followed in 1779 by a greatly improved loom: ‘Mule Jenny’. At first they were water-powered, but after 1780 the steam engine had been strongly improved so that it could also be used in the factories could be used as a power source. Now much more textiles could be produced. This was necessary because in 1750, Europe had 130 million inhabitants, but in 1850 this number had doubled, partly because of the agricultural revolution. (This went along with the industrial revolution; fertilizers were imported, drainage systems were designed and ox was replaced by the horse. By far the most important element of the agricultural revolution was the change from subsistence to production for the market.). All those people needed clothing. Thanks to the machine faster and cheaper production was possible and labor remained cheap. The textile industry has been one of the driving forces of the industrial revolution.

Belgium becames the first industrialized country in continental Europe. Belgium was “in a state of industrial revolution” under the rule of Napoleon Bonaparte. The industrial centers were Ghent (cotton and flax industries), Verviers (mechanized wool production), Liège (iron, coal, zinc, machinery and glass), Mons and Charleroi. On the mainland, France and Prussia followed somewhat later. In America the northeastern states of the United States followed quickly.

After 1870 Japan was industrialized as the first non-Western country. The rest of Europe followed only around 1880.

The beginning of the end of this revolution was in 1845 when Friedrich Engels, son of a German textile baron, described the living conditions of the English working class in “The condition of the working class in England“.
2.3 THE SECOND INDUSTRIAL REVOLUTION

The second industrial revolution started around 1870 and ended around 1930. It was characterized by ongoing mechanization because of the introduction of the assembly line, the replacement of iron by steel and the development of the chemical industry. Furthermore coal and water were replaced by oil and electricity and the internal combustion engine was developed. Whereas the first industrial revolution was started through (chance) inventions by amateurs, companies invested a lot of money in professional research during the second revolution, looking for new products and production methods. In search of finances small companies merged into large scale enterprises which were headed by professional managers and shares were put on the market. These developments caused the transition from the traditional family business to Limited Liability companies and multinationals.

The United States (U.S.) and Germany led the way in the Second Industrial Revolution. In the U.S. there were early experiments with the assembly line system, especially in the automotive industry. In addition, the country was a leader in the production of steel and oil. In Germany the electricity industry and the chemical industry flourished. The firms AEG and Siemens were electricity giants. German chemical companies such as AGFA and BASF had a leading share in the production of synthetic dyes, photographic and plastic products (around 1900 they controlled some 90% of the worldwide market). In the wake of these two industrial powers (which soon surpassed Britain) France, Japan and Russia followed. After the Second Industrial Revolution more and more countries, on more continents, experienced a more or less modest industrial development. In some cases, the industrialization was taken in hand by the state, often with coarse coercion – such as the five-year plans in the Soviet Union.

After the roaring twenties the revolution ended with the stock exchange crash of 1929. The consequences were disastrous culminating in the Second World War.
2.4 THE THIRD INDUSTRIAL REVOLUTION

The third industrial revolution started around 1940 and is nearing its end. The United States and Japan played a leading role in the development of computers. During the Second World War great efforts were made to apply computer technology to military purposes. After the war the American space program increased the number of applications. Japan specialized in the use of computers for industrial purposes such as the robot.

From 1970 the third industrial revolution continued to Europe. The third industrial revolution was mainly a result of a massive development of microelectronics: electronic calculators, digital watches and counters, the compact disc, the barcode etc. The take off phase of the third industrial revolution started around 1980 with the advent of the microprocessor. The development of the microprocessor is also the basis of the evolution and breakthrough of computing. This had an impact in many areas: for calculation, word processing, drawing and graphic design, regulating and controlling machines, simulating processes, capturing and processing information, monetary transactions and telecommunications. The communication phase grows enormously at the beginning of the new millennium: the digital revolution. According to many analysts now a new era has emerged: that of the information or service economy. Here the acquisition and channeling of information has become more important than pure production. By now computer and communication technology take up an irreplaceable role in all parts of the world. More countries depend on the service sector and less on agriculture and industry.
2.5 EFFECTS OF THREE INDUSTRIAL REVOLUTIONS

The first (and second revolution) transformed an agricultural society into an industrial society where mechanization (finally) relieved man of physical labor. The craft industry could not compete with the factories that put products of the same or even better quality on the market at a lower price. The result was that many small businesses went bankrupt and the former workers went to work in the factories. The effects of industrialization were seen in the process of rapid urbanization of formerly relatively small villages and towns where the new plants came. These turned into dirty and unhealthy industrial cities. Still people from the country were forced to go and work there. Because of this a new social class emerged: the workers, or the industrial proletariat. They lived in overcrowded slums in poor housing with little sanitation. The average life expectancy was low, and infant mortality high. The elite accepted the filth of the factories as the inevitable price for their success. The chimneys were symbols of economic power, but also of social inequality. You see this social inequality appear after each revolution. The gap between the bottom and the top of society becomes very large. Eventually there are inevitable responses that decrease this gap. It could be argued that the Industrial revolutions have created the conditions for a society with little or no poverty.

The third revolution transformed an industrial society into a service society. Where mechanization man relieved of physical labor, the computer relieved him of mental labor. This revolution made lower positions in industry more and more obsolete and caused the emergence of entirely new roles in the service sector.
3 INDUSTRIAL REVOLUTIONS AND STOCK MARKET INDICES

The Dow Jones Industrial Average was first published halfway through the second Industrial Revolution, in 1896. The Dow Jones Industrial Average Index is the oldest stock index in the United States. This was a straight average of the rates of twelve shares. A select group of journalists from The Wall Street Journal decide which companies are part of the most influential index in the world market. Unlike most other indices the Dow is a price-weighted index. This means that stocks with high absolute share price have a significant impact on the movement of the index.

Figure 2. Exchange rates of Dow Jones Industrial Average during the latest two industrial revolutions. During the last few years the rate increases have accelerated enormously.

The S & P Index is a market capitalization weighted index. The 500 largest U.S. companies as measured by their market capitalization are included in this index, which is compiled by the credit rating agency Standard & Poor’s.

Figure 3. Third industrial revolution and the S&P 500

S&P 500

 

3.1 WHAT DOES A STOCK EXCHANGE INDEX LIKE DOW JONES OR S&P 500 REALLY MEAN?

In many graphs the y-axis is a fixed unit, such as kg, meter, liter or euro. In the graphs showing the stock exchange values, this also seems to be the case because the unit shows a number of points. However, this is far from true! An index point is not a fixed unit in time and does not have any historical significance. Unfortunately many people attach a lot of value to these graphs which are, however, very deceptive.

An index is calculated on the basis of a set of shares. Every index has its own formula and the formula results in the number of points of the index. However, this set of shares changes regularly. For a new period the value is based on a different set of shares. It is very strange that these different sets of shares are represented as the same unit.

After a period of 25 years the value of the original set of apples is compared to the value of a set of pears. At the moment only 6 of the original 30 companies that made up the set of shares of the Dow Jones at the start of the take-off phase of the last revolution are still present.

Even more disturbing is the fact that with every change in the set of shares used to calculate the number of points, the formula also changes. This is done because the index which is the result of two different sets of shares at the moment the set is changed, must be the same for both sets at that point in time. The index graphs must be continuous lines. For example, the Dow Jones is calculated by adding the shares and dividing the result by a number. Because of changes in the set of shares and the splitting of shares the divider changes continuously. At the moment the divider is 0.132319125 but in 1985 this number was higher than 1. An index point in two periods of time is therefore calculated in different ways:

Dow1985 = (x1 + x2 + ……..+x30) / 1

Dow2012 = (x1 + x2 + …….. + x30) / 0,132319125

In the nineties of the last century many shares were split. To make sure the result of the calculation remained the same both the number of shares and the divider changed. An increase in share value of 1 dollar of the set of shares in 2012 results is 7.5 times more points than in 1985. The fact that in the 1990-ies many shares were split is probably the cause of the exponential growth of the Dow Jones index. At the moment the Dow is at 13207 points. If we used the 1985 formula it would be at 1760 points.

The most remarkable characteristic is of course the constantly changing set of shares in during the take-off and acceleration phase of a revolution. Generally speaking, the companies that are removed from the set are in a stabilization or degeneration phase. Companies in a take-off phase or acceleration phase are added to the set. This greatly increases the chance that the index will rise rather than go down. This is obvious, especially when this is done during the acceleration phase of a transition. From 1980 onward 7 ICT companies (3M, AT&T, Cisco, HP, IBM, Intel, Microsoft), the engines of the latest revolution were added to the Dow Jones and 5 financial institutions, which always play an important role in every revolution.

This is actually a kind of pyramid scheme. All goes well as long as companies are added that are in their take-off phase or acceleration phase. At the end of a transition, however, there will be fewer companies in those phases.

Figure 4. The two most recent revolutions and the Dow. The stock value increase has accelerated enourmously during the acceleration phase of a revolution.

3.2 STOCK MARKET BOOMS

The Dow was first published in 1896. The Dow was calculated by dividing the sum of the 12 component company stocks by 12:

Dow-index_1896 = (x1 + x2+ ……….+x12) /12

In 1916 the Dow was enlarged to 20 companies; 4 were removed and 12 added:

Dow-index_1916 = (x1 + x2+ ……….+x20) /20

The shares of a number of companies were split in 1927, and for those shares a weighting factor was introduced in the calculation. The formula is now as follows (x1 = American Can is multiplied by 6, x2 = General Electric by 4 etc. )

Dow-index_1927 = (6.x1 + 4.x2+ ……….+x20) /20

On 1 October 1928 the Dow was further enlarged to 30 stocks. Because everything had to be calculated by hand, the index calculation was simplified. The Dow Divisor was introduced. The index was calculated by dividing the sum of the share values by the Dow Divisor. In order to give the index an uninterrupted graph the Dow Divisor was given the value 16.67.

Dow-index_Oct_1928 = (x1 + x2+ ……….+x30) /Dow Divisor

Dow-index_Oct_1928 = (x1 + x2+ ……….+x30) /16.67

Since then the Dow Divisor has acquired a new value every time there has been a change in the component stocks, with a consequent change in the formula used to calculate the index. This is because at the moment of change the results of two formulas based on two different share baskets must give the same result. When stocks are split the Dow Divisor is changed for the same reason.

In autumn 1928 and spring 1929 there were 8 stock splits, causing the Dow Divisor to drop to 10.47.

Dow-index_Sep_1929 = (x1 + x2+ ……….+x30) /10.47

From that moment on a an increase (or decrease) of the set of shares results in almost three times as many (or fewer) index points as a year before. In the old formula the sum would have been divided by 30. The Dow’s highest point is on 3 September 1929 at 381 points.

So the extreme increase followed by an extreme decrease of the Dow in the period 1920 – 1932 was primarily caused by changes to the formula, the constant changes to the set of shares during the acceleration phase of the second industrial revolution and splitting of shares during this period. Because of these changes in the Dow investors were wrong footed. The companies whose shares constituted the Dow index at that time also continued into the stabilization and degeneration phase.

After the stock market crash of 1929, 18 companies were replaced in the Dow and the Dow Divisor got the value 15.1.

Table 1. Changes in the Dow, stock splits and the value of the Dow Divisor after the market crash of 1929

The table makes it clear that the Dow Jones formula has been changed many times and that the Dow Divisor in the period 1980-2000 (take off phase and acceleration phase of the third revolution ) and has actually become a Dow Multiplier, due to the large number of stock splits in that period. Where in the past the sum of the share values was divided by the number of shares, nowadays the sum of the share values multiplied by 7.5. Dividing by 0.132 is after all the same as multiplying by 7.5. (1 / 0,132 = 7,5). This partly explains the behavior of the Dow graph since 1980.
3.3 SHARE PRICE / INCOME RATIO DURING AN INDUSTRIAL REVOLUTION

During the pre-development phase and the take-off phase of a revolution many new companies spring into existence. During the acceleration phase of a revolution it will be clear that many of these companies also enter the acceleration phase of their existence (Figure 5).

Figure 5. Typical course of market development: Introduction, Growth, Flourishing and Decline.

The expected value of the shares of these companies which are in the acceleration phase of their existence increases enormously. This is the reason why shares in the acceleration phase of a revolution become very expensive.

The share price / income ratio of shares increased enormously between 1920 – 1930 (the acceleration phase of the second revolution) and between 1990 – 2000 (the acceleration phase of the third revolution). In acceleration phase of a revolution there will always be a stock market boom (Figure 6).

Figure 6. Two industrial revolutions: share price /income ratio

Share price /income ratio during a stabilization phase of a industrial revolution will decrease; The companies whose shares constituted the Dow also continued into the stabilization and degeneration phase (Figure 6).
4 WILL HISTORY REPEAT ITSELF?

Calculating share indexes as described above and showing indexes in historical graphs is a useful way to show which phase the industrial revolution is in. Especially financial institutions play an important role during an industrial revolution. The graphs showing the wages paid in the financial sector therefore shows the same S curve as both revolutions.

Figure 7. Historical excess wage in the financial sector

The third industrial revolution is clearly in the saturation and degeneration phase. This phase can be recognized by the saturation of the market and the increasing competition. Only the strongest companies can withstand the competition or take over their competitors (like for example the take-overs by Oracle and Microsoft in the past few years). The information technology world has not seen any significant technical changes recently, despite what the American marketing machine wants us to believe.

Investors get euphoric when hearing about mergers and take overs. Actually, these mergers and take overs are indications of the converging processes at the end of a transition. When looked at objectively each merger or take over is a loss of economic activity. This becomes painfully clear when we have a look at the unemployment rates of some countries.

New industrial revolutions come about because of new ideas, inventions and discoveries, so new knowledge and insight. Here too we have reached a point of saturation. There will be fewer companies in the take-off or acceleration phase to replace the companies in the index shares sets that have reached the stabilization or degeneration phase.

Humanity is being confronted with the same problems as those at the end of the second industrial revolution such as decreasing stock exchange rates, highly increasing unemployment, towering debts of companies and governments and bad financial positions of banks.

Figure 8. Two most recent revolutions: US market debt

Transitions are initiated by inventions and discoveries, new knowledge of mankind. New knowledge influences the other four components in a society. At the moment there are few new inventions or discoveries. So the chance of a new industrial revolution is not very high.

History has shown that five pillars are indispensable for a stable society.

Figure 9. The five pillars for a stable society: Food, Security, Health, Prosperity, Knowledge.

At the end of every transition the pillar Prosperity is threatened. We have seen this effect after every industrial revolution. The pillar Prosperity of a society is about to fall again. History has shown that the fall of the pillar Prosperity always results in a revolution. Because of the high level of unemployment after the second industrial revolution many societies initiated a new transition, the creation of a war economy. This type of economy flourished especially in the period 1940 – 1945.

Now, societies will have to make a choice for a new transition to be started.

Without knowledge of the past there is no future.

All Stock Market Indices Are Fata Morganas

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All Stock Market Indices Are Fata Morganas

All Stock Market Indices Are Fata Morganas

Have you ever wondered what information a stock market index actually gives? An index point is not a fixed unit in time and does not have any historical significance.

Two measurements during a marathon

Imagine the following two measurements:

  • In the first measurement, the average time is measured which 30 runners need to run a marathon.
  • In the second measurement the same runners start a marathon. However, after 10 kilometres the 10 slowest runners are replaced by 10 fresh. After 20 kilometres again the 10 slowest runners are replaced by 10 fresh and after 30 kilometres this happens again. Again the average time is measured.

In which measurement will the average time over 30 runners be the smallest? And what will happen to the average time if the stopwatch is running more slowly during the second measurement? In the beginning of the second measurement, there are 60 seconds in a minute and at the end this increased to 380 seconds in a minute. Does it still make sense to compare the two measurements?

If your answer to this question is no, you will probably have no problem qualifying stock market indexes such as the AEX, DAX, S&P 500 and the Dow Jones Industrial Average as fata morganas.

All Stock Market Indices are Fata Morganas

The parallel with stock market indices is easy to draw. An index is calculated on the basis of a set of shares. Every index has its own formula and the formula results in the number of points of the index. However, this set of shares changes regularly. For a new period the value is based on a different set of shares. It is very strange that these different sets of shares are represented as the same unit. In less than ten years twelve of the thirty companies (i.e. 40%) in the Dow Jones were replaced. Over a period of sixteen years, twenty companies were replaced, a figure of 67%. This meant that over a very short period we were left comparing a basket of today’s apples with a basket of yesterday’s pears.

Even more disturbing is the fact that with every change in the set of shares used to calculate the number of points, the formula also changes. This is done because the index, which is the result of two different sets of shares at the moment the set is changed, must be the same for both sets at that point in time. The index graphs must be continuous lines. For example, the Dow Jones is calculated by adding the shares and dividing the result by a number. Because of changes in the set of shares and the splitting of shares the divider changes continuously. At the moment the divider is 0.15571590501117 but in 1985 this number was higher than 1. An index point in two periods of time is therefore calculated in different ways:

••••••••••••••••••••••••••••
Dow 1985 = (x1 + x2 +..+x30) / 1
Dow 2014 = (x1 + x2 +.. + x30) / 0.15571590501117
••••••••••••••••••••••••••••

In the 1990s many shares were split. To make sure the result of the calculation remained the same both the number of shares and the divider changed. An increase in share value of 1 dollar of the set of shares in 2014 results is 6.4 times more points than in 1985. The fact that in the 1990s many shares were split is probably the cause of the exponential growth of the Dow Jones index. At the moment the Dow is at 16,437 points. If we used the 1985 formula it would be at 2,559 points.

The most remarkable characteristic is of course the constantly changing set of shares. Generally speaking, the poorly performing companies are removed from the set and companies in the growth phase, which perform well, are added. This greatly increases the chance that the index will rise rather than go down, you don’t need a probability calculation

Should the European Union reindex the stock markets?

It makes no sense to compare the number of points with the number of points of a stock market index from 30 years ago. The time is ripe for the European Union, after the introduction of the euro, to reindex European stockmarkets to 100 points. A fata morgana is an optical phenomenon, and so is the graph of a stock market index.

Written by Wim Grommen

Stock Market Crash, A Historical Pattern? by Wim Grommen

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Stock Market Crash, A Historical Pattern?

Stock Market Crash, A Historical Pattern?

by Wim Grommen

Every production phase or civilization or other human invention goes through a so called transformation process. Transitions are social transformation processes that cover at least one generation. In this article I will use one such transition to demonstrate the position of our present civilization and its possible effect on stock exchange rates.

When we consider the characteristics of the phases of a social transformation, we may find ourselves at the end of what might be called the third industrial revolution. Transitions are social transformation processes that cover at least one generation (= 25 years). A transition has the following characteristics:

  • It involves a structural change of civilization or a complex subsystem of our civilization.
  • It shows technological, economical, ecological, socio cultural and institutional changes at different levels that influence and enhance each other.
  • It is the result of slow changes (changes in supplies) and fast dynamics (flows).

Examples of historical transitions are the demographical transition and the transition from coal to natural gas which caused transition in the use of energy. A transition process is not fixed from the start because, during the transition, processes will adapt to the new situation. A transition is not dogmatic.

Four Transition Phases

In general, transitions can be seen to go through the S-curve, and we can distinguish four phases (see fig. 1):

  1. A pre-development phase of a dynamic balance, in which the present status does not visibly change
  2. A take-off phase, in which the process of change starts because of changes in the system
  3. An acceleration phase, in which visible structural changes take place through an accumulation of socio-cultural, economical, ecological and institutional changes influencing each other; in this phase we see collective learning processes, diffusion and processes of embedding
  4. A stabilization phase, in which the speed of sociological change slows down and a new dynamic balance is achieved through learning

A product life cycle also goes through an S-curve. In that case there is a fifth phase:

  1. The degeneration phase, in which cost rises because of over capacity and the producer will finally withdraw from the market.

 

Three Drastic Transitions

When we go back into the past, three transitions took place with far-reaching effects.

1. The First Industrial Revolution

The first industrial revolution lasted from around 1780 to 1850. It was characterized by a transition from small-scale handwork to mechanized production in factories. The great catalyst in the process was the steam engine, which also caused a revolution in transport as it was used in railways and shipping. The first industrial revolution was centered around the cotton industry. Because steam engines were made of iron and ran on coal, both coal mining and the iron industry also came into bloom.

This revolution ended in 1845 when Friedrich Engels, son of a German textile baron, described the living conditions of the English working class in The condition of the working class in England. The result of this revolution was an immense gap between rich and poor.

2. The Second Industrial Revolution

The second industrial revolution started around 1870 and ended around 1930. It was characterized by ongoing mechanization because of the introduction of the assembly line, the replacement of iron by steel and the development of the chemical industry. Furthermore coal and water were replaced by oil and electricity and the internal combustion engine was developed. Whereas the first industrial revolution was started through (chance) inventions by amateurs, companies invested a lot of money in professional research during the second revolution, looking for new products and production methods. In search of finances, small companies merged into large scale enterprises, which were headed by professional managers, and shares were put on the market. These developments caused the transition from the traditional family business to Limited Liability companies and multinationals.

After the roaring twenties, the revolution ended with the stock exchange crash of 1929. The consequences were disastrous culminating, in the Second World War.

3. The Third Industrial Revolution

The third industrial revolution started around 1940 and is nearing its end. The United States and Japan played a leading role in the development of computers. During the Second World War great efforts were made to apply computer technology to military purposes. After the war, the American space program increased the number of applications. Japan specialized in the use of computers for industrial purposes such as the robot. At present, computer and communication technology take up an irreplaceable role in all parts of the world.

The acceleration phase of the third industrial revolution started around 1980 with the introduction of the micro-processor. The third industrial revolution has clearly reached the saturation and degeneration phase.

Stock index graphs are fata morganas.

What does a stock exchange index like DJIA, S&P 500 or AEX really mean?

The Dow Jones Industrial Average (DJIA) index is the oldest shares index in the United States. A select group of journalists of The Wall Street Journal decide which companies are included in the most influential stock exchange index in the world.

Unlike most other indices, the Dow is a price average index. This means that shares with a high price have a great influence on the movements of the index.

The S&P index is a market value index. This index, compiled by credit evaluator Standard & Poor’s, includes the 500 largest US companies, based on their market capitalization

The Amsterdam Exchange Index (AEX) is the most important stock exchange index in the Netherlands. It shows the development of share prices of the top 25 funds of the Amsterdam Stock Exchange, based on trading. The AEX is the average price of the shares of those funds.




In many graphs the y-axis is a fixed unit, such as kg, meter, liter or euro. In the graphs showing the stock exchange values, this also seems to be the case because the unit shows a number of points. However, this is far from true! An index point is not a fixed unit in time and does not have any historical significance.

An index is calculated on the basis of a set of shares. Every index has its own formula, and the formula gives the number of points of the index. Unfortunately many people attach a lot of value to these graphs, which are, however, very deceptive.

  • An index is calculated on the basis of a set of shares. Every index has its own formula and the formula results in the number of points of the index. However, this set of shares changes regularly. It is therefore very strange that different sets of shares are represented by the same unit.After a period of 25 years the value of the original set of apples is compared to the value of a set of pears. At the moment only 6 of the original 30 companies that made up the set of shares of the Dow Jones at the start of the acceleration of the last revolution (in 1979) are still present.Even more disturbing is the fact that with every change in the set of shares used to calculate the number of points, the formula also changes. This is done because the index which is the result of two different sets of shares at the moment the set is changed, must be the same for both sets at that point in time. The index graphs must be continuous lines. For example, the Dow Jones is calculated by adding the shares and dividing the result by a number. Because of changes in the set of shares and the splitting of shares the divider changes continuously. At the moment the divider is 0.15571590501117 but in 1985 this number was higher than 1. An index point in two periods of time is therefore calculated in different ways:

    Dow 1985 = (x1 + x2 + ……..+x30) / 1
    Dow 2014 = (x1 + x2 + …….. + x30) / 0.15571590501117

    In the nineties of the last century, many shares were split. To make sure the result of the calculation remained the same both the number of shares and the divider changed (which I think is wrong). An increase in share value of 1 dollar of the set of shares in 2014 results is 6.4 times more points than in 1985. The fact that in the 1990’s many shares were split is probably the cause of the exponential growth of the Dow Jones index. At the time I’m writing this, the Dow is at 16,437 points. If we used the 1985 formula it would be at 2,559 points.

  • The most remarkable characteristic is of course the constantly changing set of shares. Generally speaking, the companies that are removed from the set are in a stabilization or degeneration phase. Companies in a take off phase or acceleration phase are added to the set. This greatly increases the chance that the index will rise rather than go down. This is obvious, especially when this is done during the acceleration phase of a transition.This is actually a kind of pyramid scheme. All goes well as long as companies are added that are in their take off phase or acceleration phase. At the end of a transition there will be fewer companies in those phases.

Will the share indexes go down any further?

Calculating share indexes as described above and showing indexes in historical graphs is a useful way to show which the industrial revolution is in.

The third industrial revolution is clearly in the saturation and degeneration phase. This phase can be recognized by the saturation of the market and the increasing competition. Only the strongest companies can withstand the competition or take over their competitors (like for example the take-overs by Oracle and Microsoft in the past few years). The information technology world has not seen any significant technical changes recently, despite what the American marketing machine wants us to believe.

During the pre development phase and the take off phase of a transition, many new companies spring into existence. This is a diverging process. Especially financial institutions play an important role here. These phases require a lot of money. The graphs showing the wages paid in the financial sector therefore shows the same S-curve as both revolutions.

Investors get euphoric when hearing about mergers and take overs. Actually, these mergers and take overs are indications of the converging processes at the end of a transition. When looked at objectively, each merger or take over is a loss of economic activity. This becomes painfully clear when we have a look at the unemployment rates of some countries.

New industrial revolutions come about because of new ideas, inventions and discoveries, also new knowledge and insight. Here too we have reached a point of saturation. There will be fewer companies in the take-off or acceleration phase to replace the companies in the index shares sets that have reached the stabilization or degeneration phase.

In the graph below we see the share price/income ratio over the past two industrial revolutions. At the end of the 2nd industrial revolution in 1932 this index reached 5. At the moment we are at 15. The index prices can still go down by a factor 3.

Will history repeat itself?

Humanity is being confronted with the same problems as those at the end of the second industrial revolution, such as decreasing stock exchange rates, highly increasing unemployment, towering debts of companies and governments and bad financial positions of banks.

Transitions are initiated by inventions and discoveries, the knowledge of mankind. New knowledge influences the other four components in a society. At the moment there are few new inventions or discoveries. So the chance of a new industrial revolution is not very high.

History has shown that five pillars are indispensable for a stable society.

At the end of every transition, the pillar Prosperity is threatened. We have seen this effect after every industrial revolution.

The society’s Prosperity pillar is about to fall again. History shows us that the fall of the pillar Prosperity has always resulted in a revolution. Because of the high level of unemployment after the second industrial revolution, many societies initiated a new transition, the creation of a war economy. This type of economy flourished, especially in the period 1940 – 1945.

Now, societies will have to make a choice for a new transition to be started. Without knowledge of the past, there is no future.
Wim Grommen

 


Mr. Grommen was a teacher in mathematics and physics for eight years at secondary schools. The last twenty years he trained programmers in Oracle-software. The last 16 years he studied transitions, social transformation processes, the S-curve and transitions in relation to market indices. Articles about these topics have been published in various magazines / sites in The Netherlands and Belgium.

You can contact Mr. Grommen at @DOWDIVISOR30

Futures and Options welcomes guest contributions. The views presented here do not necessarily represent those of Futures and Options.

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