Poland WIG, Geomagnetism and US Dollar Index

I modelled the Poland WIG in the same way as the Malaysian, Indian and Brazilian stock indices.

The lunar edge over the last 4 years for the Polish stock index looks like this, compared to the others:

28may20131A decent sensitivity.

The Polish WIG now features on the short and medium term model pages, and here it is on the latter timescale:

28may20132A pretty good tracking of the model.

The geomagnetic model has lately made a notable switch into a downtrend, shown against the SP500 on the shorter term timescale here:

28may20133There is now a notable divergence which could spell a trend change in stocks or a topping process beginning imminently. However, rising into the solar maximum has previously encouraged speculation and into the 2000 peak the market pulled away from the geomagnetic model, as the speculation overruled. So two competing things to consider, but in short the low-geomagnetism support for the market has been pulled away.

Lastly, I checked the US dollar index history to see if previous bull markets in the dollar corresponded to positive demographic trend periods. Here is the USD history since 1967:

28may20134

Source: Bespoke

The US enjoyed a positive demographic trend period from around 1980 to 2000, so both the main bull markets that can be seen fell within this. However, so did the USD bear market from around 1985 to 1995, so I don’t see a useable relationship.

I am away for a few days, back Monday. See you then.

 

 

Advertisements

Secular = Demographic

Secular bull or bear markets in both equities and real estate are in essence demographic bull or bear markets, with equities and real estate correlating fairly well with each other over time, and in turn with demographics. In other words, slow moving trends in demographics make for the longer term ‘secular’ bull or bear markets in stocks and housing, within which there are cyclical bulls and bears. To enable this relationship in any particular country, certain fundamental conditions are required: sufficient levels of sanitation and education, social discipline and peace, a sufficiently diversified economy and good infrastructure, i.e. what we would generally find in developed countries but may be lacking in positive-demographic but raw frontier nations.

The first chart shows US demographics, using middle-old, middle-young and net investor ratios, modelled against a composite of real stock prices and real house prices. The composite topped along with demographics circa 1965, then bottomed together around 1980, then topped again around 2000.

X1All three demographic measures swung fairly closely over that 50 year period, which perhaps explains why the composite tracked so well. We might note that the composite peak in 2000 was fairly extreme, suggesting an episode of excess greed that subsequently required wash-out, and also that the secondary peak circa 2005-7 was counter new demographic trends, and thus liable to the steep crash that then followed in the composite.

Looking forward, net investors stops falling as of around this year, the middle-young ratio bottoms circa 2015 and the middle-old ratio after 2020. This suggests there is scope for new ‘secular’ bull markets in stocks and housing, but it is unclear when they might kick off. Note though that the composite has again made a counter rally to the demographics from 2009 to 2013, which suggests another leg down in real terms would be appropriate before any new secular bull. Note also that we don’t see strong uptrends or all three measures united again, like from 1980-2000, which suggests future secular bulls in the USA may not be as powerful.

Next up is the same chart for Japan, but not stretching back as far in time. Again the equities and real estate composite peaked with the demographic measures in the late 80s, and again with a fairly excessive greed peak and subsequent harsh wash out.

X2

The composite has belatedly taken off again only in the last 6 months, with net investors and middle-young having turned positive again around 2002, continuing until around 2020. There has thus been a 10 year delay in Japanese stocks and housing in turning back up with demographics. However, this period coincides with the wash-out negative-demographic period in the USA, the largest economy in the world, which suggests Japanese risk asset markets were infected by situation in the USA.

The third chart shows the same modelling for the UK. The demographics for the UK topped out in the late 1960s and the stocks/housing composite made a top around then but went on to eek out a slight higher peak circa 1972. So again we saw belated adjustment as this was then rectified to a combined low in the late 1970s. Demographics and the composite then made a strong secular bull until the 2000s.

X3

The peak in the composite for the UK was around 2007, in line with the demographic peak. For the UK this peak was higher than in 2000 and justified by the demographics. The US peak circa 2005-7 was a lower peak than in 2000 and fittingly its demographics were already on the decline. The later demographic peak in the UK was reflected in other major nations and thus possibly ‘infected’ the USA in pulling the US composite up into a decent 2005-7 peak despite the falling demographics. Looking forward, the UK faces demographic downtrends until around 2020-2025 which suggests a secular bear could be in play until then. However, we need to look at the demographic positions of the other major economies of the world so see the overall picture as evidence of cross-infection and lags are at work. To that end, here are the three demographic measures as used above for China, Germany, France and India.

China made an excess-greed peak in equities and real estate circa 2007, tying in with the topping of demographic trends. It now faces difficulties until circa 2020.

X4

Germany faces similar headwinds until around 2020, or potentially even around 2035.

X5

France is in a united downtrend until circa 2035.

X6

India is in an ongoing uptrend in two measures, and the middle-old ratio is a little deceptive as India is starting from a very small older population which is growing. For that reason there is a downtrend in the ratio, but it is still fairly benign compared to the more developed countries above.

X7

The chart for Brazil looks very similar to India, ongoing positive, and if we round out the top 10 major economies of the world, Italy is similar to the other European countries with unfavourable demographic trends, whilst Russia has a positive period from now until circa 2025. The caveat for Russia would be that is may not score as highly on the criteria for the relationship to fulfill, for example the stock market quite closely tracks the prices of energy commodities due to the economy not being as diversified.

So with a view of the next 10 years, the largest economy in the world, the US, has fairly flat demographics and is unclear. The second economy, China, is at risk of a secular bear until circa 2020 but then improves. The third economy, Japan, is in a positive period until around 2020, and is in fact playing catch up to demographics. The fourth largest economy, Germany, is negative until around 2020 but has better potential after that. The UK, France and Italy are part of an unfavourably-demographed Europe, whilst Brazil and India are ripe for long bull markets.

In short, from now until around 2020 Japan, India and Brazil are in positions to rally but China and most of Europe are pulling down, with the USA unclear. From circa 2020 to 2025, Germany, USA and China are in better positions for secular bulls, whilst Japan’s window closes. On balance, that suggests a global secular bull with many participants has better odds in the second part of the decade, so the question is what is going to happen between now and then, i.e. select secular bulls in those countries with favourable demographics only, or ‘infection’ from the larger economies to the others.

Most of the major economies of the world, listed above, enjoyed positive demographic trends from circa 1980 until circa 2000 or 2005. That made it easy for the world to embrace a collective strong secular bull on the whole. Looking forward, there is a large pool of countries with strong demographics for the next 20 years, but they are largely ’emerging’ countries, including Brazil, India, Turkey and Malaysia. That suggests there will be a global shift in performance over time away from the old developed world to these countries and others. However, currently, USA, China, Japan and Germany make up almost half the global GDP, which means their fortunes affect the world. It will take a long time for the emerging countries to alter this in a significant way.

This is my suggestion. If US stocks and real estate (and in turn global stocks and real estate) can make another cyclical bear leg down to bring the composite down to the demographics, and put them at better relative cheapness to  other assets, by circa 2015, then there will be better odds of a global secular bull beginning 2015 and strengthening from around 2020-2025.

Now I need to bring in solar cycles at this point, because something is going on with them, which further shapes the picture.

Here is the UK real equities chart versus sunspot cycles. The three major peaks in equities coincided with every third solar peaks. Inbetween interim peaks were made, also at 3-cycle intervals. And commodities also made secular peaks every third solar cycle, which were the buy points for equities.

X8

We know the performance in equities largely correlates with demographic trends, and from research in my recent posts, we know that there is a solar cycle influence on demographics. However, is that ‘every third’ solar cycle rhythm just an accident, or is it a ‘natural’ sine wave? The long term real Nikkei chart reveals links with solar peaks but no such repeating rhythm. However, commodities have made a secular bull once again over the last decade, in alignment with the pattern.

We know that over time, real commodities have gone nowhere, and have been no long term investment. They just enjoy bursts of interest.

Real Commodities SolarWe know that they do not correlate with demographics, but rather tend to make secular peaks and troughs that are fairly opposite to equities. So do they just come into favour when stocks and real estate are out of favour? There must be more to it than that. Real negative interest rates unite the periods in which commodities soared, however, commodities are closely correlated with inflation, so their rises cause the negative real interest rates. In the 1970s interest rates were high, but real interest rates were still negative due to very high inflation.

The period into 1917 was similar to 1980: high yields rates and velocity, high commodities and inflation. 1947 similar to today: low yields rates and velocity, high commodities and inflation. Right now we have only mild inflation, but there have been bursts of problematic inflation, particularly in 2008 and 2011. This chart shows those sets of relationships in the US, and the UK experienced very similar.

X9

So the four commodities secular bull periods are only all united by two things: high commodities and high inflation (with the inflation being notably higher than rates, to create negative real rates). As commodities are the key driver of inflation, we are left with one uniting feature: escalating commodity prices. So what causes these periods of escalating commodity prices?

I believe it’s a multi-part answer. Supply lags is one known. It can take 10 years for a new mine or energy field to come into production. That can create a decade-long demand and supply inbalance, as periods of lower commodities demand can close down projects and therefore create problems of inelastic supply further along in time. Commodities come into favour when their relative pricing to other assets is historically low, and this occurs at the end of secular bull runs in stocks / housing (as evidenced in dow-gold or real estate-gold ratios). Demand for commodities can also increase as more countries develop and urbanise,which can occur from economic boom periods. In today’s environment of ultra low rates and yields – similar to 1947 – investors look beyond cash and bonds for returns, putting commodities in favour. Conversely in the 1970s and 1910s, investors looked to hard assets (commodities) as hedges against supply-side inflation. Common to all, stocks and housing were in down trends due to demographic trend changes so commodities then became the go-to investment.

Following a decade long commodities bull market we have reached the point today whereby commodities are relatively historically expensive to stocks and real estate, peaking in this regard so far in 2011, and whereby new supply has been catching up and coming on stream in the last few years. However, real interest rates and yields remain negative and so maintain commodities interest, whilst demographics for the major nations largely remain in downtrends which should keep equities and real estate under pressure to the benefit of commodities. It’s therefore a balanced picture, but recall that commodities have been a terrible long term investment, so if the balance tipped further towards stocks and real estate then we should expect an end to the commodities bull.

With all that in mind, this is my view on what is most likely to happen. Commodities ought to make one last bull rally, in keeping with solar cycle history: excitement and inflation into and around the peak. Both equities and commodities have a history of making major peaks near to the solar maximums, regardless of cyclical patterns. That should tip the world into a recession and equities into a bear, to take off again from yet lower relative value levels circa 2015 once demographics are bottoming out more in the US. For stocks and real estate to be already in secular bull trends at this point – say, from 2011 – is rather counter the collective demographics. This fundamental downward pressure on stocks and real estate (in certain key countries) ought to reassert itself shortly and money flows ought to move into commodities (for likely one last time) under conditions of negative real interest rates.

If there is another cyclical bear in the US, then as per the cyclical bears of 2001 and 2008, the other major country stock indices are likely to participate – i.e. all moving as one. However it ought to be shallower in those countries with more favourable demographics.

State Of The Markets

The Fed’s hint of possible scaling back of QE as early as next month provided the break in the US and Japanese stock market bull runs. I suggest that QE-cut is unlikely to happen next month but the markets were ripe for a catalyst to pullback and that provided the puncture in confidence. Below is the updated lunar geomagnetic model and Sp500 chart. We are in the lunar negative period and geomagnetic disturbances have pulled the overall model down, so the market was levitating against these two trends, and therefore vulnerable to a break.

23may20139

The full moon is tomorrow and the end of the lunar negative period is Tuesday, so there is potential for more downside in the next couple of trading days. However, it is too early to say whether this week’s snap will be swiftly recovered thereafter or whether we have made a more decisive trend change. My thoughts at this point are that the Fed did enough to put uncertainty back into the markets until the next FOMC decision of 19 June. So I could foresee a correction/consolidation until then. I believe they then won’t scale back QE as early as that (though it could come in the following months) and so the markets will rally up again. Combined, that could provide a possible topping process formation.

Linked to this are the fortunes of the US dollar, gold and commodities in general. By my work, money flows should shift into cyclicals and commodities as equities enter a consolidation or topping process. Gold has potentially double bottomed this week and continues to track the Nasdaq’s correction of 1998. However, it’s too early to be sure of a bottom. The US dollar meanwhile made an intraday reversal on the Fed’s comments, which could be telling as it was the reversal of a breakout above the 2012 high:

23may201310Source: Ino.com

If US equities lose their momentum then I would expect the USD also to do so, and this could inspire a move into commodities if the global economy and leading indicators remain supportive. Crude oil once again failed to break out of its large triangle, this time to the upside, and so is back in the range lacking direction.

Here are the latest economic surprise readings:

23may20131

23may20132

23may20133

23may20134

23may20135Source: Citigroup

Bar Japan, they are all around historically low levels from which reversions normally occur. I checked the history of Citi economic surprises as a market indicator and they weren’t very meaningful in the bull of 2003-2007. However, as this is a mean reverting indicator, we can broadly expect these indices to rise going forward and thus provide some sentiment support for pro-risk. Plus there is some evidence that cyclicals tend to perform well when they are rising.

Turning to leading indicators, the situation for now is fairly positive as shown by the World LEI and CB LEIs below:

23may20136Source: Recession Alert

23may20138

Source: Conference Board

ECRI leading indicators for the US continue to be positive:

23may20137Source: Dshort

China flash PMI was weak in the latest reading, Europe PMIs improved. My overall view is that there is fairly low risk for the global economy over the mid-year given that there were rate cuts and increased stimulus in Q1 in various countries, together with fairly benign commodity price action and inflation. I think it therefore possible that money continues to flow out of government bonds into pro-risk, but the reversal in bonds and yields is a fairly new development so it is too early to be sure it is enduring.

Sunspots, Geomagnetism, Global Temperature And Birth Rate

Both sunspot and geomagnetism cycles correlate with long term global temperature variation, with geomagnetism having the closest correlation co-efficient:

22may20137

Source: Landscheidt

Changes in global temperature have been demonstrated to influence fertility and birth rates. A composite of 19 countries below shows the inverse relationship between temperature and birth rate over the last century:

22may20134Source: ScienceDirect / Harry Fisch

Sunspot and geomagnetism cycles therefore affect demographics through global temperature variation.

There is also a global temperature oscillation related to solar cycling, shown below. Therefore we have two solar influences on climate: an 11 yearly oscillation and a long term trend following long term changes in solar activity.

22may201311

Source: C Camp

There is typically a spike in births around solar maxima – an 11-yearly peak – oscillating like the above:

22may20135Source: W Randall

Additionally, birth rates have been shown to vary with the economy, typically declining during recessions and rising during boom times.

22may20138

Source: Pew Social Trends

There is a pattern to recessions following solar peaks, and therefore births declining following solar peaks. The chart below shows all three for the US, with the solar peaks marked in black. There is generally a spike up in births at the solar peak followed by a pullback or flattening in births aligned with a recession.

22may201310

The major peaks in births occurred close to the solar maximums of 1917, 1958 and 1989.

Typically there is growthflation in the economy into a solar peak – which should encourage more births – and human excitement peaks with the sun. Perhaps human excitement at the solar peak also translates into more births, in terms of human behaviour effects, as snow shoe hare populations have been shown to peak around solar maximums. Then, following the solar peak recession and unemployment peaks typically occur, which would pull back the birth rate.

In asset markets we also see both an 11-yearly oscillation correlated to solar cycles and additionally a mapping of long term trend. This is a busy chart, but it attempts to show both the 11 year solar oscillation and the long term solar variance trend against risk assets, demographics and temperature – click to view larger:

Z20

So we have a six-way relationship between sunspots, geomagnetism, climate, demographics, the economy and the financial markets. The sun is the agent, and temperature and human behaviour (which translates into economic, risk asset and birth rate effects) are the subjects. There are two patterns: an 11-yearly oscillation and a long term trend variance. Within this multi-relationship there also appears to be a cause and effect chain from the sun to global temperature to birth rate (which becomes demographics) to long term risk asset performance in stocks and real estate.

If we are moving into a long solar quiet period then global cooling should become the theme and this should have implications for fertility, producing a trend of increasing global births. However, if man-made warming overrides the cycle of cooling then the opposite could occur. Whichever wins out should have implications for the world economy and financial markets later in the century.

Japan Financial Markets Economic Correlations

I wanted to test the correlations and interrelations on Japan. As it went through a different experience to the USA over the last half a century, did the same correlations in assets and the economy hold true? Data history is more limited than for the US, but sufficient to test. Correlation coefficients over +0.5 are considered strong positive correlations between two datasets, and some datasets have been scaled to share the same chart, where e.g. *3 or /10 is shown. Click on a chart to see it larger.

Firstly, I found the same five-way block correlation between interest rates, bond yields, money velocity, real commodities and inflation. Here are two pairings from that group:

Y1

Y2Note that the level of inflation was overall at a lower level than in the US over the last 3 decades but the relationship between real commodities and inflation is still clear.

As per for the US, I found this five-way block then produced the correlated-two of recession and unemployment. Below it can be seen how recession followed spikes in inflation, even if the spikes were low.

Y3

I also discovered the asset pairings are again found in Japan, with bond yields and commodities related, whilst real house prices and real equities go their own shared path. I show here real stocks and real house prices:

Y4

Uniting those two assets into a composite in the next chart, demographic trends again appear to have played a key role in their secular trending.

Y6That Japan did not participate in the secular stocks bull through to 2000 and the secular housing bull through to 2005 that the USA did, makes sense in light of the demographic trends in the period from 1990 to 2005. Additionally, the speculative peaks in Japanese stocks and housing circa 1989/1990 (around the human excitement solar maximum of 1989) were fairly extreme ‘greed’ overthrows, which then need time to washout on the other side.

However, demographic trends overall collectively turned up again from around 2005 and should continue positively until circa 2020. Japanese equities effectively made a triple nominal bottom in 2003, 2008/9 and 2011/12, whilst real estate has been basing since 2010, but a sustained rise in risk assets in Japan did not materialise until November 2012 onwards and I believe this sharp move is a belated catch up to the demographics. If 2013-to-date was added to the above chart we would see a significant pull-up in the stocks/housing composite.

Drawing in bond yields and real commodities to make a 4-way risk asset composite, and as per the USA comparing against the quadruple-agent composite of sunspots, geomagnetism, demographics and real interest rates, there is again a notable mapping between the two (again, 2013 should provide a belated pull-up to the model: a divergence being rectified):

Y7Generating the forecast into the future, but with the caveat of using assumptions and historic rhymes, we get this:

Y8The prediction will be refined over time to validate or invalidate those underlying assumptions and patterns, but the overall uptrend is due to the demographic trends that stand to boost risk assets until circa 2020 and then the next solar maximum should continue the upwards pull until circa 2025, implying there is a good chance of an overall secular bull in stocks and real estate in Japan for the years ahead.

I therefore suggest that the government’s recent doubling down on stimulus is in fact not required, and so it has the potential to supercharge proceedings. So far the yen has dropped sharply, bonds yields have taken off and inflation expectations have risen significantly:

Y9Source: BusinessInsider

As Japan is a net commodity importer, the sharp drop in the Yen pushes up import prices for energy and other resources, so they already have commodity price inflation despite commodities recently underperforming. If commodities now rise, as per my forecasts, then there is a danger that Japan suffers major commodity-based inflation, which should be correlated with money velocity soaring, and an inflationary feedback spiral develops. The government should then accordingly raise rates, but cannot raise them too fast or too far because of the record debt servicing. That, collectively, is why there is a hyperinflation risk. If problematic inflation does erupt then eventually the risk is of a stock market crash. However, until then (and maybe it does not come to pass), stocks are likely to do well based on demographics and a belated catch up, and they should also perform well under ‘some’ inflation. So the question is whether stocks will pullback sufficiently to offer an opportunity to get in or add more. I am long the Nikkei, but do not feel comfortable adding more on the long side at this point when stocks have risen almost 100% in 6 months. Conversely, despite the trade doing very well at the moment, I do not wish to take profits as I believe the major rally to be justified, and expect more gains ahead. So I stay put for now and we’ll see how things develop.

Timing The Top In Equities

1. By the Bradley Siderograph that would be 22 June:

20Jun20131Source: Amanita

2. By Eurodollar COT it would be now:

20may20131Source: Nowandfutures

3. By the historic seasonality of geomagnetism it would be June or July:

20may201324. By actual geomagnetism we have the potential for a top here, due to the SP500 pulling away from the model, which has lost its uptrend looking out to mid-June:

20may201335. By Pug’s EW a top should be now (and this is echoed in Alphahorn’s EW projections):

20may20134

Source: PUGSMA

6. Using MRCI’s historic matching tool, 1987 is the closest mirror, which kept rising until October at which point it made one the biggest crashes of all time:

20may20135Source: MRCI

7. To add to that, the lunar/solar eclipse configuration of 1987 which occurred prior to that crash matches this year but instead falls now in May-June, and this is the basis of Puetz’s crash windows:

20may20136Source: Kim Rice

8. Gann Global draw out the closest historic rhymes as the 1950s and 1920s. The former suggests a retreat is overdue, the latter that the market can keep going until August:

20may20137Source: Gann Global

9. The Presidential cycle echoes the projection for an August top:

20may20138Source: Seasonalcharts

10. By my work, the closest historical mirror is 1946-7. Stocks topped in Q2 1946, with money switching from that point to commodities. With a normal lag in feeding through, inflation took off as of July 1946 and was elevated for 2 years from then, through the solar peak of May 1947.

20may201310Source: Matthew Claassen

Note treasury yields reversed course along with stocks topping, and commodities took over. Note also though the backdrop to this was the lifting of price controls and the Fed reducing its control over the treasury market.

OK, it’s up to you to decide which of the above are valid, if any, as forecasts for a market top. I am not convinced by some, but it does no harm to round up and compare. But I’ll summarise like this. There are generally two types of tops, parabolic peaks that collapse down the other side, or topping processes that are rounded lasting several months. The move in (US) stocks is starting to be parabolic. If this continues and steepens – and some of the models have room for further gains into June, July or August, to allow this – then we might rather expect an ugly subsequent collapse once ‘everyone is in’. If on the other hand we see a pullback shortly and this turns into a topping process, then we can look for a range to be carved out near the peaks whilst internals, and leading indicators, deteriorate. Perhaps most usefully, all the models, bar none, suggest a top should occur between now and August.

Milton Friedman wrote a paper on investor reactions to the 1940s and 1950s government policies – which were similar to today (ultra low rates, interfering in the bond market) – and concluded that the rise in equities into 1946 was not considered durable by investors because of the government artificial supports. That would suggest the current rally in stocks may be on borrowed time, as there has been as yet no reversal in policy, and in fact recent global actions have been to double QE in Japan and drop interest rates yet further in various countries.

 

 

 

 

 

 

 

 

 

What Really Moves The Markets

The evidence has led me to a ‘dumb’ model of the markets, whereby humans are more subjects and less intelligent creatures of free will. It’s up to you to decide whether I have simply found what suits me and filtered out the rest, i.e. dumb seeks dumb. If we remove all the noise by looking long term, I suggest sunspots and geomagnetism are two big (but very subtle) drivers of human behaviour towards risk assets, with demographics (which are influenced by solar cycles) simply providing bulges in demand to produce long term bull markets in stocks and housing.

I suggest the solar phenomena are influencing human behaviour in the economy and financial markets alike, and that is why we find treasury yields, interest rates, money velocity, inflation and commodities largely correlated together. Optimism, excitement and positive sentiment driving all up, or pessimism, fear and negative sentiment driving all down. Just waves of sentiment supplied by nature. Plus, when increasing numbers join the investor age bracket of the population versus old and young over a period then enduring bull markets in stocks and housing can occur simply due to the growing demand the demographic trend provides. No complex interaction of fundamentals, just more people investing for retirement.

So I figured the next step was to produce a composite model of sunspots, geomagnetism and demographics for the USA over the last century to see to what degree this correlates with the long term US risk asset composite that I charted earlier in the week: namely real stocks and commodities, real house prices and treasury yields. To do make the triple ‘agent’, I used annual mean sunspots, annual average geomagnetism (inverted, because low geomagnetism is pro-risk, high geomagnetism anti-risk) and for the demographics the middle-young ratio up to 1950, then a composite of middle-young, middle-old and percentage of net investors from 1950 to current. To make the quadruple ‘subject’ I used real SP500 annual values, the Schiller real house price index, the commodities index and 10 year treasury yields.

This chart shows how geomagnetism relates to sunspot cycles over the long term:

17may20131Source: NASA

Peaks in geomagnetism occur typically 1-3 years after sunspot peaks, averaging 2 years later. This fits with recessions and unemployment peaks usually occurring within a couple of years after the solar peak, as peak geomagnetism escalates pessimism and fear. The strength in a geomagnetic peak is also a reasonable predictor of the strength of the next solar cycle.

Once I had worked back half a century, compiling the data, this is what popped out (click to view charts larger):

Z16

The model didn’t work out so well in the periods around 2006, 1974 and 1951. I then discovered what united the three: real interest rates were negative:

Z15

Inbetween, the model worked very well. When real interest rates were negative, risk assets (particularly commodities) got an uplift, regardless of sunspots, geomagnetism and demographics. This is because this type of inverted evironment discourages cash and savings, and encourages borrowing and speculation. People are not being compensated by leaving their money at the bank to offset the gradual erosion of purchasing power, so they seek hard assets and risk investments instead.

So I added negative real interest rates to the model (netting them from the composite where they occurred in the last century) and completed the history, and this is the result:

Z17

Overall a very close match with the moves into and out of stocks, commodities, housing and t-yields over 100 years.

Therefore, I am suggesting there are 4 main agents in moving financial risk asset markets: sunspots, geomagnetism, demographics and negative real interest rates. On a yearly basis, they collectively mapped the bull and bear waves up and down, with little missing.

I then attempted to project the model into the future for the next 20 years.

Demographic projections to this end are fairly reliable as those entering the key age groups over the next 20 years are largely already alive so we have a good idea of numbers moving through. I therefore used all three measures again – middle / old, middle / young and net investors – and combined into a composite.

For sunspots, there is a historic rhyme with a past period of solar cycles as shown:

17may20132Source: WattsUpWithThat

So I projected sunspots forward based on solar cycles 5 and 6. Then, using the link between a geomagnetic peak with the next solar peak, as referenced further up the page, and its typically peaking 2 years after a solar peak as well as general relations with the sunspot cycling, I constructed a geomagnetism model for the next 20 years.

Lastly, for negative real interest rates, I used the late 1940s and 1950s as a guide due to its historical mirror, with high government debt meaning rates had to be kept low, whilst modelling inflation based on its correlation with solar maxima.

The result:

Z18

Clearly, there are assumptions and a reasonable tolerance allowance in my 20-year forecasts for the three datasets that make up the model other than demographics. One assumption is that the solar maximum is ahead this year. If that proves correct then there is a fairly potent combination of a sunspot peak with negative real interest rates, which contribute to the 2014 spike, before dwindling sunspots and peak geomagnetism arrive along with fading demographics. From 2022 to 2027 a bull market in stocks and housing should be enabled by an upturn in demographics and the next solar maximum. Overall, however, the future model is downward sloping, as demographics are poor relative to a golden period like 1980-2000, and the sun potentially enters a new ‘minima’ period as shown in the SC5 and SC6 historic rhyme above.  This is also despite the built-in expectation that real interest rates may oscillate in the negative for some time yet, as the Fed only slowly and gingerly moves up rates, balancing servicing high debt with keeping inflation in check.

As time progresses, the assumptions in the projections can be confirmed or denied and the forecasts within it refined. As this is a long term model, forward validation is going to take some time. Nonetheless, the backwards validation that came out of the data confirmed the validity of what I believed mainly moves the markets over time, with negative real interest rates added to the three that I set out to test. I am well aware that this is not the mainstream view and would be a hard sell to investors: that the four agents of risk asset markets over the long term are sunspots, geomagnetism, demographics and negative real interest rates. However, drawing those together into a composite appears to account for all the major bulls and bears that we have seen in equities, bonds, real estate and commodities over the last century.

I am still formulating my thoughts on the findings of this last week, but here’s one to end the post: maybe the Fed isn’t as foolish as many make out. The reason the Fed intervenes at all in periods of ‘bust’ or cleansing is to prevent a depression, which would be much harsher on the population and likely bring about social conflict. By pushing down interest rates into the real negative, it can induce risk-asset rallies, which make the people feel better if their investments are rising, and housing rising. The problem is this action typically produces commodity inflation, which is bad for the people. Now there is a large block correlation between official interest rates, t-yields, money velocity, real commodities and inflation, and then recession and unemployment. The first five typically rise together and then produce the latter two. By acting on t-yields through QE, rather than just acting on official rates, might the Fed be able to keep the 5-correlated from rising, and thus also prevent the recession and unemployment that follows too? It would seem worth a try. If that worked, they would perhaps be able to maintain an environment of negative real rates with the beneficiaries stocks and housing, whilst preventing the undesirable trio of commodities inflation, recession and unemployment from rising until they end QE. Right now, that overall scenario seems to be what’s in play in the markets, doesn’t it? However! I am doubtful this actually works. Commodities staged a big rally in 2011 despite QE2. I believe they will do so again and normal correlations will apply.

Update: 

One additional chart to ponder – is global temperature correlated too? It’s tempting to shift this along and see how it matches up, but I’d need a good reason to apply a lag. Any ideas folks?:

Z19

State Of The Markets

The latest picture for 4-way pro-risk:

16may20131

Source: Bloomberg

If a trend change occurred in late April then commodities and Euro-USD have yet to meaningfully participate. Stocks and bond yields however, have been strong.

The sharp rise in treasury bond yields continues to be reflected in German bunds and UK gilts, and the rush for the exits in bonds has been at its greatest in Japan:

16may20132

Source: Bloomberg

Here is the Japanese Nikkei monthly – an amazing six months:

16may20137If equity markets are on track, per my forecasts, for a top around June, then the Nikkei has a potential resistance there from which it could pull back.

Gold so far is progressing like the Nasdaq correction which I drew attention to HERE. I am looking for a higher low than in mid-April, or a lower low on positive divergence.

Crude oil is still in is large triangle, failing again at resistance:

16may20136As we are in the lunar negative period, we may need to wait until late May if it is going to eventually manage to break out upwards.

This chart suggests that an upturn in G10 economic surprises is required to shift outperformance away from defensives to cyclicals, which would include energy:

16may20133As economic surprises is a mean reverting indicator, the G10 indicator may have reached low enough to warrant a reversal.

Leading indicators also look supportive for this to occur as they remain overall positive. The latest Conference Board data revealed +0.4 for the UK, +1.2 for Korea and +2.1 for Japan. The latest OECD leading indicator picture is very healthy:

16may20134Source: OECD

My overall projections remain the same. A mid-year topping process for equities and rotation into commodities. Leading indicators are showing sufficient health for this to occur, and narrow money predicts emerging market outperformance going forward, which would tie in with increased strength in commodities. I am looking to see a gold bottoming formation, and an eventual break upwards in oil, as supporting developments. The sharp rise in bond yields bodes well for my overall scenario as that was a missing piece of the puzzle, and should be accompanied by a rise in money velocity. Geomagnetism has flattened out, but by seasonality there should be improvement into June/July before a trend change donwards into the Fall. Daily sunspots currently remain close to the record so far for this solar cycle – strength that looks more promising for a solar cycle maximum ahead in the Fall.

 

 

 

 

 

USA Financial Markets Economic Correlations

Correlations between real stocks, real commodities, real house prices and treasury yields, together with inflation, interest rates, recessions, unemployment, demographics and sunspots. A more detailed, step by step study of the correlations, using correlation coefficients, whereby +1 means a perfect lockstep relationship between two things and -1 means a perfect inverse relationship, whilst zero would mean no relationship. A reading over +0.5 is considered a strong positive correlation. Note some of the data has been scaled to share the same chart (indicated by, for example, /10 or *3). Also note for US inflation I have used an average of Shadowstats and official CPI since the 1980s, and official CPI before that. You can click on any of the charts to view larger.

Let’s start with a couple of the highest correlations:

Z1

Z2Combining the two, 10 year treasury yields, official US interest rates and MZM money velocity all move in almost perfect lockstep. They are currently all together at record lows. If one begins to rally, we should expect all to rally – with implications for the Fed.

Now let’s look at another closely correlated pair:

Z3Real commodity prices and inflation show a strong correlation. There is a feedback looping between the two as rising commodity prices cause price inflation but price inflation spurs money into commodities (hard assets) as an inflation hedge. There was a lot of debate around the 2008 and 2011 commodity spikes as to whether speculators were to blame. The trading of commodity futures has been around for 150 years in the US, and price spikes are more speculator-heavy because of the feedback looping. Regardless of which kicks off the process, the two occur together.

The next chart shows the relationship between US official interest rates and inflation. Most of the time there is a strong correlation, and as the Fed is the sole agent in rate-setting, we can say that the Fed move rates up and down either in response to or in anticipation of inflation, but largely in line with. However the late 1940s and the current period don’t match up as well as the rest.

Z4

The picture becomes clearer when we look at real interest rates (net of inflation), and extend further back in time:

Z5

We see three clear periods of negative real interest rates – which notably coincided with secular commodities bull markets. Inflation was higher during these periods. If you subscribe to the Shadowstats calculation of inflation (that official inflation stats have been significantly doctored over the last 3 decades) then the purple and red lines would be somewhat higher and lower respectively than shown at the current time. If you take the official CPI data as true, then annual inflation would be currently running around 1.5% which would still maintain the real rates line in the negative. I suggest true inflation is likely somewhere between the two, and thus as shown. As things stand currently, therefore, the environment for the secular commodities bull is still in tact.

Here is another correlation with inflation. US unemployment brought forward two years has a correlation over +0.5 with US inflation:

Z8

This is because recessions occur following inflation spikes:

Z7So we see inflation spikes bringing about recessions which bring about peaks in unemployment around 2 years after the inflation spike (due to unemployment being a lagging economic indicator).

Now let’s draw together unemployment (brought forward 2 years) and inflation, and bring solar sunspot cycles into the picture:

Z9Sunspot solar peaks correlate with inflation peaks, and unemployment brought forward 2 years. This is not a lockstep relationship – it is a correlation specifically related to the solar maxima – and the reasoning for that is the ‘excitement’ that Aleksandr Tchijevsky discovered around solar peaks in human history which is backed up by more recent research revealing bilogical changes in humans at sunspot peaks. If this ‘excitement’ translates into buying and speculation at solar peaks then we can justify spikes in inflation (with subsequent recessions and unemployment spikes).

If it is true that humans are biologically disposed to buying and speculation at solar maxima then a composite of risk assets, namely real stocks, commodities, real estate and treasury yields, should spike up at each solar maximum. Here it is:

Z10The composite uses Schiller real house price data and real SP500 index annual values. Each solar peak is accompanied by a spike in what can be termed risk appetite. There are other spikes inbetween the maxima, but what is key here is whether solar maxima reliably bring about spikes in risk assets, given that we are likely in the year of a solar maximum in 2013.

Within the risk asset composite, there are broadly speaking two pairs:

Z12

10 year treasury yields have a distinct relationship with real commodities, whilst real equities and real house prices correlate very positively together:

Z11

Yet commodities and stocks display an inverse relationship over time of around -0.5, with the result that the two above pairs are often going separate ways. Indeed, thus far in 2013 we have seen US equities and real estate rallying whilst commodities and treasury yields have been languishing. Is it time for a reversal?

If we bring in demographics at this point, and combine stocks and real estate into a composite, this is what we see:

Z13

All three demographic measures – middle to old ratio, middle to young ratio and percentage net investors – are all pointing down for the next couple of years. The stocks and real estate composite has historic correlations with the three measures ranging from +0.54 to +0.7, so all strong positive. It would therefore seem more likely that there is another leg down for real equities and real housing into circa 2015, rather than secular bull upwards action from here. Another leg down in real terms would also help satisfy secular p/e, Q ratio and regression to trend measures for equities, which all call for further washout.

Drawing all the above together, along with my previous analysis, I suggest it remains the most likely scenario that we see an inflationary peak to coincide with the solar maximum (allowing for a reasonable time window), within which commodities and treasury yields rise and stocks and real estate decline in real terms, but due to significant inflation hold up in nominal terms. A recession and peak in unemployment should then follow the inflationary peak. As of around mid-decade demographics improve sufficiently to remove the headwinds for equities and housing, which could enable a new stocks bull, with real interest rates turning positive again.

Once again, your observations and suggestions are welcome, as I believe there is more to be teased out.