When the market is especially perplexing, a look at basic trends often helps to sort out your thoughts. Investors today wonder if there is going to be a business slowdown, whether interest rates will continue to rise, and where the stock market is headed.

A scan of the three primary trends may clarify things, and perhaps raise questions to ponder:

> The stock market is still within a supercycle rise since the mid-1970s.

> Corporate earnings, which are cyclical, have reached a new high in Canada.

> Interest rates have dropped since their secular peak in 1981.

The three charts with this column picture the long-term situation for each better than many words could describe. Each creates a problem for believers in the “random walk,” the idea that security prices are unconnected and move independently.

The price index and bond yield charts show long trends still in place. They are vulnerable to change, though, simply because the trends are so old. Corporate profits are cyclical, which the S&P/TSX composite index earnings chart makes plain. The question is not whether the current rising earnings trend will change, it is when.

> Stock Prices. The rise of the S&P/TSX composite index since 1975, paralleling the rise of American stock prices, is an historical phenomenon. Think of it: in all the 300 or so years in which company shares have been traded in Europe and North America, there has never been such an extended advance, nor one so large.

Within this long move, stock prices have bobbled and at times moved sideways. At the beginning of the run, the Canadian market closed each year higher for six consecutive years. As the supercycle aged, runs of consecutive years of gain became shorter. There was a four-year run, then a three-year run.

Now, as the end of 2006 draws closer, it is still an open question whether the past three years of gain will become a four-year run.

Propelling the latest upsurge in this long price cycle has been energy. The S&P/TSX energy index has gained for seven consecutive years, the longest continuous rise since oil and gas stocks were first tracked in Canada in the late 1930s.

Of the other two major sections of the market, the financials sector has gained in 13 of the past 18 years. Materials have gained for five consecutive years, with a possible sixth year, pending the results in 2006.

The bull run has been pushed along by other long consecutive gains. For instance, up to last year, consumer staples had a 10-year run of annual price gains.

Can the market do anything better than this? What suggests adversity may confront stock prices? One thing: earnings.

> Corporate Earnings. Are Canadian corporate profits violently cyclical? You bet. And the cycles have been becoming more extreme. The chart shows how cyclical business has been through the phenomenal stock price rise since 1975. Each earnings peak has been followed by a swift drop.

The current cycle of rising earnings is the longest since 1975 — 54 months and counting. It started in spring 2002 with a deficit in TSX composite index earnings. Adjusted to the index, earnings then were minus $277. In September this year, earnings on the composite index reached $739. That is about 36% higher than a year ago — not the greatest rate of gain, but historically high.

Forecasts and estimates of future earnings are no help. As has been observed, “Earnings don’t lead stock prices, but stock prices lead earnings.”

The questions now are: how much longer will earnings rise? And when will stock prices start to anticipate the downturn? Is the next earnings drop going to be so serious it will jeopardize that comfortable 30-year uptrend in stock prices?

> Interest Rates. It is no accident the huge stock market rise of the past 30 years was accompanied most of the way by cheapening money. Interest rates have dropped since 1981 in a typical “bond bull market.” Such bond bull markets recur two or three times in a century.

The clearest indicator of interest rate trends is the longest-term bond of the highest quality — in this country, Government of Canada issues.

Short-term interest rates dance up and down from year to year, but the long bond defines the underlying direction.

The chart indicates the drop in interest rates continues. The yearend yield on Canada bonds over 10 years maturity has been lower in eight of the past 10 years. Rates can go lower within this trend. Long bond yields would have to rise to 6% or so to indicate the long drop in interest rates has ended. Through the turmoil of the past two years, while short-term interest rates jumped, long bond yields have shown no serious inclination to do this.

@page_break@Given that a significant business slowdown will occur in Canada, is serious consumer price inflation certain? If that is not certain, then long-term bond yields can continue to drop. IE