Economic Growth, Demographics And Solar Variation

Economic growth occurs two ways: increasing population and increasing productivity per capita (which can be achieved through technological evolution and improvements in organistation/management/systems). Both increase overall GDP.

World population has grown exponentially over the last 2000 years:

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Source: Sub-dude

As has GDP per capita:

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Source: filipspagnoli

A principle of the globally adopted capitalist economic model is that compound growth enables long term poverty reduction: that people can pursue their own self-interests and help themselves to disproportionate shares of the pie as long as the whole pie grows so that more people find themselves better off than less. Hence countries typically target 2%-10% annual growth, which when compounded means exponential growth. To achieve exponential economic growth we need either exponential population growth or exponential per capita growth (ideally both). The latter reflects human progress and technological evolution whereas the former is more of a ponzi scheme, requiring ever increasing numbers of people to maintain an ‘illusion’ of increasing prosperity.

Something changed around the 1970s. The growth rate in world population went into decline:

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Source: TimesHigherEducation

World GDP growth and GDP per capita growth also trended to a peak.

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Source: DoctorCopper

The pick up in GDP and per capita GDP in the 2000s is now rolling over again, suggesting the secular trend remains down:

24ja5Source: TheNextRecession

24ja7Source: TheNextRecession

The peak in population, GDP and GDP per capita growth rates fits with the peak in solar variation: the grand solar maximum:

24ja6Source: WattsUpWithThat

The trend in long term solar variation suggests we are now headed for another minimum, like the Dalton or Maunder. These historic minima corresponded to lower GDP growth and lower population growth, cementing the relationships between the three.

Inflation also peaked around the 1970s:

24ja8Source: Yardeni

As did growth in energy supply.

24ja9Source: Financial Press

Declining rates of growth in population, GDP, GDP per capita, inflation and energy supply spell major trouble for a global system reliant on exponential economic growth as well as inflation and employment targetting. However, the true impact of this has been postponed in two ways.

Firstly, the ‘gap’ has been filled by increasing debt:

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Source: isj.org.uk

However, we have reached the point of debt monetisation in US, UK and Japan, i.e. the end game. The question is how long the end game can last.

Secondly, sub-demographic trends of the major economic nations have largely been supportive since the 1970s, peaking out in phases.

Here is US population growth per decade. Forward it by 40 years so that the births become the important ‘middle’ age bracket and we get the secular trends in real US stock prices: down into 1980, up into 2000, then down projected out to 2030.

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Source: Business Insider

Here is Japan’s 5-yearly population growth rate. Again, forward it 40 years and we have a big spike in the middle bracket to deliver a major peak in equities and real estate around 1990, a small relief uptrend in the current window 2010-2015 (as we have been seeing) and otherwise a fairly grim outlook.

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Source: Stat.go.jp

Collective dependency ratios, middle-to-old ratios and net investor ratios in the major nations were largely positive until recently, with China the last to break down: 

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In summary, we have postponed the impacts of the major growth rate peaks (GDP/GDP per capita/population) of the 1970s through debt until we have reached the point of monetisation, and the support from demographic sub-trends of the major nations has now expired. Solar maxima have historically given way to recession, and solar variation predicts a new grand minimum ahead which has historically correlated with low GDP and population growth. I am therefore led to the fairly bleak conclusion that this solar maximum speculative peak will turn out to be a major historic peak for the world.

Timing Major Market Peaks

Starting on the smallest timescale, and working up to the largest.

1. Timing within the month

Lunar phasing influences human sentiment. It produces fortnightly oscillation in the stock market: positivity/optimism around the new moon and negativity/pessimism around the full moon. The cumulative influence of this can be seen in stock market returns over the last 20 years:

LE1

In keeping with this, we find that major market peaks typically occur close to new moons, around maximum optimism/positivity:

NewMoonMajorPeaksThis adds to the case for a peak having occurred in equities on 31 Dec 2013 (Dow and Nikkei, plus SP500 double top with 15 Jan), associated with the Jan 1st new moon. If that proves to be false and equities break higher, then a future new moon (next one Jan 30th) may produce the timing of the major peak.

2. Timing within the year

Geomagnetism influences human sentiment, with higher geomagnetic disturbance associated with negativity/pessimism. The inverted seasonality of geomagnetism correlates closely with stock market seasonality, and typically we find that major market peaks occur close to the peak in both, around the turn of the year:

13jan50

13jan11Gold made its secular peak on 21 Jan 1980.

Again, this adds weight to equities having peaked 31 Dec 2013, but if that proves false, then we might expect a final peak still to be at hand, in January, before the seasonal model turns down.

3. Timing within the decade

Solar maxima occur roughly every 11 years and produce human excitement, which translates as protest, war, and speculative excesses in the markets. Major market peaks typically occur at the solar maximum, close to the smoothed peak and on a monthly spike in sunspots.

SolarMaximaParabolicPeaksWe can measure speculative excesses in terms of market valuations, sentiment readings, leverage and technical indicators and we see a cluster of these in US equities currently. Solar forecasts, solar pole flips and sunspot counts collectively suggest the smoothed maximum and monthly sunspot spike may be occurring Dec 2013 into Jan 2014, which in association with those speculative excess readings, again adds to weight to a possible peak in the Dow, SP500 and Nikkei.

4. Timing within the century

Demographics drive secular bull and bear markets, as swells in investor or disinvestor age groups produce periods of upward or downward demand for equities. Japan’s secular stocks bull ran through 4 solar cycles due to a long positive demographic trend from the late 1940s to around 1990. Japan’s middle-to-old, middle-to-young and net investor ratios all peaked in the late 1980s, and accordingly we saw Japanese equities terminate with a speculative excess at the 1989 solar maximum, and thereafter move into a secular bear in line with demographic downtrends.

US demographic measures for equities demand peaked around 1965. The real SP500 peaked November 1968, terminating with the solar maximum of November 1968. Thereafter US equities entered a secular bear market, whilst gold, as the anti-equities or anti-demographic asset, entered a secular bull market. Demographics and equities bottomed around 1980, whilst gold made its secular speculative peak, all timed with the Dec 1979 solar maximum.

X1

US demographic ratios were collectively positive from 1980 to 2000, enabling a secular bull market in equities lasting 2 solar cycles through the speculative finale of March 2000, which was again a solar maximum. Gold endured a secular bear market through those two decades, bottoming out as demographics turned down around 2000, and entering a secular bull market.

Looking forward we see a slight divergence in the 3 charted demographic measures: the middle-to-young ratio bottoms out around 2015 but the middle-to-old and net investor ratios not until around 2025 (shown boxed above). When we draw in collective downward demographic trends for Europe and China, the greater likelihood is of a secular bear in US equities (and a secular bull in gold) lasting through to around 2025, rather than ending now. Solar cycle 25 is predicted to peak around 2023-2025, which would provide the timing for a speculation secular peak in gold.

There is a correlation between solar cycles and birth rate, with evidence of an 11 yearly peak in births. There is also evidence of a link between economic prosperity and birth rate, whereby births decline in recessions and bear markets and increase in the good times. Combining the two, we have the framework for alternating positive and negative demographic swells which peak or trough around solar maxima, and hence we have historically reliably seen demographic trends and associated speculative asset bulls/bears peak and terminate around sunspot peaks.

Therefore, the secular bear in US equities that began in 2000 is likely to continue through to around 2025, and the secular bull in gold that began in 2000 is likely to continue to and peak around 2025. In support of this we see current historic overvaluations in US equities that argue for further reset in stocks ahead, and a lack of speculative mania for gold at the current solar maximum.

17ja1 17ja2Both charts above model the historic trends in US demographics and the terminations at solar maxima, and the projections forward are the extensions of these phenomena. The ‘mean reversion’ common to to them both reflects the transience of demographics (a young dependents swell headwind will become a middle-age swell tailwind which will become an old-age swell headwind) and the double-excess produced by solar maxima (demographics stretch demand by population, solar maxima stretch demand per capita) before sunspots cycle down again. The biggest mania of all-time is clear to see on that second chart: the dot.com boom. Not only does mean reversion subsequent to that mania have some way to go (a wash out to -50%) but demographics support this occurring.

To summarise all the above, and make it useful looking forward, we can time major asset peaks by probability (there are no dead certs, and exceptions occur). Any major asset peak will probably occur close to a new moon, typically around the turn of the year, and normally at a solar maximum. Demographics guide at which solar maximum a secular asset peak will likely occur and whether a solar maximum should deliver a secular or cyclical speculative excess.

Forecasts for gold and equities

We are currently at the likely solar maximum for solar cycle 24, at the turn of 2013 into 2014. Demographics are supportive of a secular bear in equities (that began in 2000) continuing through to the next solar maximum circa 2025, and similarly a secular bull in gold (2000-2025). The speculative excess in equities that we are seeing in association with SC24 maximum should be a cyclical peak. The timing of that cyclical peak in stocks has good odds of being around the turn of the year (2013 into 2014) and close to a new moon. That makes a top close to Jan 1st 2014 a contender, and failing that one near Jan 30th 2014 (the next new moon). Again, these are just probabilities, but if we take a different angle and look at indicators such as II sentiment, put/call ratio, skew, deviation above MA, yield-tightening ROC and margin debt, then we have a case for equities to begin to fall ‘imminently’, regardless of solar maxima and lunar phasing. Combining both, the case becomes more compelling for a top here.

Gold’s secular bull began in 2000, and like all secular bulls, it has been in a strong dominant uptrend punctuated by occasional cyclical bears or corrections. Below we see the US equities secular bull progression 1980-2000 contrasted with gold’s secular bear in that period (cyclical bulls and bears within an overall downtrend).

17ja3Source: Stockcharts

Gold’s secular bull of 2000-2025 should be a strong dominant uptrend like stocks 1980-2000, or like an extended version of gold’s last secular bull of the 1970s.

17ja4The cyclical bear of Dec 1974 to Aug 1976 occurred as the Dow rallied from a Dec 1974 low to a Sept 21 1976 top, with gold’s secular bull momentum resuming as equities topped out. We could therefore expect something similar to be occurring now, and this is supported in the oversold, overbearish extremes reached in gold and miners and the technical basing that appears to be currently taking place.

A threat to bullish resumption in gold is the current excess leverage we see in evidence in margin debt, net investor credit and Rydex leverage. If sharp falls erupt in equities then a period of forced redemptions could mean blanket selling of assets, as occurred in Autumn 1929 and Summer-Autumn 2008. Gold /miners escaped neither, in short-lived but sharp pullbacks. In THIS post I compared the topping process analogies of 1929, 1987 and Nikkei 1989 to the Dow today, and based on that we might expect sharp falls to erupt as of mid-February. There is a history of steep falls occurring at the seasonal geomagnetism peaks of around March/April and October, and occurring on Mondays once investors have had a weekend to mull over doubts. So by probability we might this time look to the particular potential of Mondays in the period March-April 2014 for heavy falls to erupt. Potentially then, we could see gold and miners rally until then, but be dragged back during such heavy stocks selling, thereafter resuming the secular gold bull in earnest.

Equities should now enter a new cyclical bear market, and continue to alternate cyclical bulls and bears within a secular stocks bear through to around 2025. By demographics (and as is becoming evident in economic data) this should be under deflationary rather than inflationary conditions, and this makes an important difference to nominal prices. The path of US equities for the next 10 years should look similar to the 1990s to early 200s Nikkei or the real inflation-adjusted 1970s SP500, with lower highs and lower lows:

17ja5Source: SeekingAlpha

Using Russell Napier’s maths (taking valuations back to historic washout levels), then we have a target of around 3500 on the Dow by my target of around 2025. Again drawing on history, odds are we get there in a couple of cyclical bull-bear oscillations, and hence something like this:

17ja6It is an initially shocking chart, but it is in keeping with deflationary demographic projections and valuations washout. Plus, this has already happened before: to the Nikkei, under the same twin circumstances.

Expecting the Dow to be sub 4000 by 2025, and gold to be making a parabolic solar-max finale to a strong secular bull, the Dow-gold ratio should bottom beneath 0.5, potentially even beneath 0.1. But the one factor that I have not mentioned so far is central bank intervention.

It is certain that a tipping over into deflationary recession and equities bear will draw further response from central banks. If equities start to decline for the next couple of months but in a measured way and economic data disappoints (as predicted by certain leading indicators) then I would expect the Fed to stop tapering QE and wait-and-see, and otherwise little change. If equities then start to accelerate declines and economic troubles escalate and we enter a dangerous feedback looping, then we should expect the Fed, and other central banks, to up the ante and go more unorthodox. Quite what that will entail remains to be seen, but drawing on history, recent and past, this could mean imposing restrictions on shorting shares, preventing capital from leaving the country, ‘strong-arming’ into treasuries, and more direct, targeted inflationary tactics. There is of course the potential for increased nationalism and for hostilities between certain nations to increase (USA-China, China-Japan) as internal problems escalate.

I don’t want to speculate too far ahead, but I see major lasting opportunities at hand in short equities and long gold, tempered by realism over what central banks will do should my projections come to pass. Monetising debt whilst tipping over into deflation under unprecedented collective demographic downtrends which should mean a further decade of secular stocks bear and global economic weakness is a very bleak outlook. As a trader, I think the biggest gains are potentially to be made at the front-end of that, in case the rules get changed. Speculators making money out of an economic crisis are an easy target. It very much depends on how things come to pass, whether we are nursed through another ‘lost decade’ or whether things are about to become acute, under a global deflationary recession, a debt-monetisation end-game or a de-railing and bubble-bursting of China’s economy.

In the near term, I continue to look for clues in the markets for the equities/gold, bull/bear switch. I am long gold, short equities, and looking to add to both on further confirmations of reversals in fortunes.

The Bull Case And The Big Picture

Let’s distinguish between prospects for a stock market correction and prospects for a bear market, and start with the former.

There are multiple signals for an imminent stock market correction, such as sentiment and euphoria readings, put/call ratio, skew, distance from 200MA, divergence in stocks above MA. I’ve covered these, and more, in detail in recent posts. The history of each individual flag gives us a guide as to the timing and nature of a correction, but it’s just a guide. The risk, and the bull case, is that things go crazier yet: steeper parabolic under the excitement influence of the solar maximum. We see no decisive break in the markets yet and certain measures of breadth and sector participation are still supportive. Barring an external shock it can take time for perceptions to shift. If we try to anticipate buyer exhaustion, then current leverage, sentiment and investor credit are suggestive of ‘all in’, but we could still eek a little more out of each and propel higher yet.

My ‘balanced’ view. Multiple flags, with different angles on the market and with broadly reliable histories, are pointing to an imminent correction. Some of these indicators are at all-time record extremes, and the aggregation of both the warnings and the levels is a trader’s opportunity. Mean reversion always occurs, so a correction will come, but that could be ‘eventually’. If I were to play the long side, I would look for bullish momentum to resume, and play with stops for short term profits, knowing that under such one-way sentiment, high leverage, and technical levitation, the market is particularly vulnerable to a sudden fall or a lasting decline. If we take a purely statistical approach to the markets (you can find that in THIS post), and remove any big picture bias, then the risk-reward is on the short side, until we have seen a correction that relieves the current extremes. The data gives high confidence that short positions here will produce positive returns, if any drawdown en-route can be tolerated. If there is little leeway for drawdown long or short, then the prudent approach would be to sit aside whilst both prospects of steepening parabolic and steep drop or crash are in currently in play.

Now to the bigger picture, and the potential for a bear market.

Looking statistically again, valuations such as market cap to GDP and CAPE, corporate profit margins to GDP, levels of margin debt and investor credit, and bull market trend/gain history: they are all at top percentile readings that have historically ushered in bear markets. The bull case relies on ‘this time is different’, namely: valuations need adjusting as bond yields and cash are suppressed, margin debt can go some way higher yet due to low rate of borrowing or there will be an orderly transfer from leveraged buyers to new buyers, and the Fed is underpinning the stock market and trumping normal factors. It has always been dangerous to side with ‘new norms’ because mean reversion, until now, has always occurred.

The current extremes seen in sentiment and euphoria typically occur towards bull market peaks, but can on occasion be generated in young bull momentum. The case for a young bull is that certain stock indices, e.g. SP500, decisively broke above 2007 highs in a mirror of historic secular bear termination breakouts, and the economy is now finally picking up. Regarding the former, the break-out case doesn’t apply to other major global indices such as FTSE, Euro Stocks, Nikkei and Hang Seng, and regarding the latter, the pick up in the economy is tentative and may prove to be fleeting. Much of the data coming out currently is backward looking to October/November. Broad and narrow money measures suggest the pick up may be tipping over again. But, for now, data is generally positive and we could argue for the possiblity of positive feedback looping. Nonetheless, it is still a stretch to make a case for young equities bull momentum when valuations, leverage and bull market history collectively indicate we are at historic secular/cyclical topping levels. It would be unprecedented to see either a rapid catch up in the underlying (GDP, earnings, revenues) or significant collective further extension of valuations, leverage, and bull market trend/gain. Rather, the evidence suggests current euphoria and sentiment extremes are more typically those of a bull market ripe for termination.

So let’s now look at the macro picture and assess what kind of bear market we could be in for, because there are again two options.

The first option would be a bear market that is a pause in a new secular stocks bull, sufficient to remove the froth that has built up in sentiment, valuations and leverage. On the SP500, this could be a retrace to the 2000/2007 resistance breakout, which from current levels would be 20% down. A successful backtest and a new cyclical bull thereafter. The option second would be a deeper, longer bear market, which would be classed as continuation of a secular bear market from 2000. A case for the first option could be built on exponential technological evolution and collective central bank support (commitment to enduring low rates and stimulus as appropriate). A case for the second option could be built on demographics and debt. We then need to look for evidence as to in which camp the balance of power lies.

The economic recovery since the 2008 crisis has been historically weak in various areas, such as consumption, income, retail sales, job growth, productivity and private investment, and thus we still have ZIRP and QE 5 years on. I believe there are two reasons for this: demographics and debt. I have covered demographics in detail on this site – please do a site search if you are a new reader – and I can summarise that we see collective trends that suggest growth and consumption will remain weak for some years ahead. The bull case relies on growth and earnings picking up this year onwards to historically normal levels but this will be very difficult to achieve against the demographic backdrop. Over the longer term, a combination of pro-active immigration policies, greater global economic influence in positive-demographic countries such as India and Brazil, technological and societal shifts could potentially help alleviate the pressures, but we are looking at sustaining a secular bull market right now.

Turning to the debt issue, much of the world is suffering from all-time record debt: household, corporate and public. The problem with high and growing debt is that more and more has to be spent on servicing the debt, crowding out investment, and restricting other spending.  High debt has historically correlated with low growth and low productivity. Money invested in government bonds is not invested in productive capital. Below we see the growth in US debt:

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Next we see US public debt as a percentage of GDP. To add to the wars labelled, the Vietnam war of the 60s-70s was also highly costly.
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It is the combined costs of the wars that have led to the current predicament. War provides no economic benefit. There is a short term boost as certain industries boom and jobs are created, but ultimately it is highly costly, paid for in part by increasing taxation and by cutting other government spending, but mainly by increasing government borrowing. The build up of the debt led to the cutting of the gold standard, and since then debt has been on a one-way path. Compound debt can run away, unless revenues (GDP) can grow at a faster rate, or inflation is sufficiently high to shrink the debt, or, as a last resort, monetisation is undertaken (money printing to buy the debt). As growth has shrunk under the debt-overhang and both inflation and growth have been crimped by demographics, even more borrowing has been taken on to try to offset these factors, exacerbating the problem. Hence we are at that last resort of monetisation and no way back.

Here is the combined debt picture for US, UK, Eurozone and Japan:
10ja3China’s debt is ballooning too. All these countries are in demographic downtrends, and all are compromised by ballooning debt. This sets the scene for a particularly nasty global negative feedback looping (US demographics topped out around 2000, Europe around 2005 and China around 2010, therefore the collective pressure is now at its greatest). It is asking a lot of technology to deliver a range of paradigm shifts in the near future to somehow turn this around, particularly when corporate investment has been neglected. Meanwhile, conditions of zero rates and QE have failed to convince consumers and corporates to spend, borrow and invest, other than in asset bubbles. Thus it seems likely that debt and demographics will and are overwhelming policy and technological evolution, and the secular bear market will ultimately continue. However, I would of course accept that this position is to some degree theoretical whilst equities remain in a bull market and whilst economic reports are largely respectable.

The proof, of course, will come piece by piece in the economic data. Should equities hold up a while longer and central banks / governments get their balancing acts right, particularly China, then maybe a period of positive feedback looping can develop and extend. If a stocks bear erupts, as indicators alone suggest, then realistically this would sink the fragile economy as that wealth evaporates. A deflationary shock is also a possibility, as such events have occurred in the past when countries flirted with very low inflation.

Understand that I have not changed stance from my previous posts, but rather I’ve tried to keep it balanced in this post and see the bull case, as it’s important to challenge yourself. So yes, equities could potentially move higher in the near term. The onus is on the bears to take this down and until they do in a meaningful way then we are in a strong bull market. However, the weight of evidence for either an imminent correction or bear market is compelling. And yes, at the global macro level, things are currently reasonably benign and economic data generally not too troublesome, so my expectations regarding demographics and debt could potentially be proven to be less potent than I predict. However, again, it’s about the weighing up the evidence and I believe I side with the probability. I’m short, either for a correction or a bear, and will increase shorts on market clues.

Demographics: Bear Market, Global Recession And Deflation

Historically, demographic trends have correlated with secular bulls and bears in financial assets, economic growth/recession and inflation/deflation. Demographic forecasts are reliable because future trends were set in place with past swells and shrinkages in birth numbers. They would change if a country was subject to large scale death (war, pandemic, or similar) or the government henceforth adopted radical immigration policies. Demographics are particularly potent in countries that are relatively closed to migration, so understand that China has the smallest percentage of immigrants of any country (0.1% of the population), and Japan just 1.9% (compared to USA, UK and Germany all over 10%). My focus is on USA, China, Japan, Germany and UK, as collectively they make up 50% of world GDP. Know that whilst the European Union abolished barriers to movement within it, the demographics across all the member nations are uniformly poor.

1. DEFLATION

Young labour force percentage of population (aged 15-40) and dependency ratios (inverted – old and young versus the working population) have both historically correlated with inflation/deflation. A swell of people entering the workforce works up price inflation through spending, whereas more people entering old age relative to the work force is disinflationary through saving and disinvestment (read more HERE).

Deflation2

Deflation1In the first chart above, we see the UK alone is currently in a small window of young labour force growth, whilst in the second chart China is just peaking out in dependency ratio (inverted). This is reflected in reality, with the UK currently registering the highest producer price inflation and China the highest consumer price inflation of the five. At this point in time, we generally see trends of disinflation. Demographics predict this will turn into outright deflation, and that deflation should be the norm for the next couple of decades (barring countries with inflationary demographics becoming much more dominant globally, such as India and Brazil).

7ja1 7ja3 7ja4

2. GLOBAL RECESSION

Due to globalisation and an increasingly open world economy, recessions around 2009, 2001, 1998, 1991 and 1982 have all been global in nature. Due to the US contributing 22% of world GDP, particular attention needs to be paid to indicators of future US growth, with China second.

Dependency ratios (inverted – old and young versus the working population) have historically correlated with economic growth / recession. That chart is presented in section 1. above. The picture for the next 2 decades is bleak.

Stepping aside from demographics for a moment, levels of debt have also been shown to assist or impede growth historically. Where public debt to GDP has exceeded 90%, economic growth has struggled. For 2014, Japan will be around 230%, UK and USA around 115% and Germany 85%.  China has the lowest ratio of public debt of the five, but its broader debt has been ballooning since 2008. Including corporate and household debt, China’s total debt to GDP has reached 218% of GDP (from around 130% in 2008).

DemographicsDowGoldRatioGlobalGDP

3. EQUITIES BEAR, REAL ESTATE BEAR

Demographic trends in middle-to-young ratio (aged 35-49 / 20-34), middle-to-old ratio (35-49 / 60-69), percentage net investors (35-49 / all) and dependency ratios (charted in 1. above) have all been shown to have a correlation with stock market and real estate market performance historically, on a longer term secular level. There are young borrowers/spenders, middle-aged investors (partially investing for retirement) and old-ages disinvestors. If the middle group is growing relative to the others, then we have a growing demand for the stock market. Similarly, the old and the young don’t typically buy houses, so a swelling middle-aged group relative to the others is an environment for a housing boom, and vice versa (read more HERE).

BM1

BM2

BM3Using the weighted average composite as our overall guide looking out to mid-century, M/Y is flat whilst M/O and NI are down, suggesting long term ‘buy and hold’ may be a strategy doomed to the past, to be replaced by ‘short and hold’. Add in Dependency Ratios from 1. above and the picture worsens further. Within those overall trends there are positive windows for individual countries, for instance the USA sees M/Y, M/O and NI measures rising together between around 2025 and 2030, and the composites also suggest that period could be the backdrop to a cyclical bull. However, when the composite trends above from 1980-2000 are compared to what lies ahead of us now, the contrast is stark and suggests enduring downwards pressure on equities and real estate, in long secular bear markets.

The longer term fortunes of bonds have also historically correlated with demographic trends.

23jun16This CS graphic suggests yields will remain fairly low and contained, as demand for bonds will be maintained. However, through to 2020, the bias in yields, aside Japan, is overall upwards, suggesting net selling on balance. It is my view that gold, as the historic anti-demographic, is due to be the lead asset in the period ahead, as the collective trends above suggest deflation, recession, and net selling of equities, real estate and bonds.

SUMMARY

A) Historic correlations in demographic trends and secular asset cycles, growth/recession and inflation/deflation. B) Unprecedented collective demographic downforces now in place, with evidence of impact in economic data. C) Downtrends in play for much of the first half of this century, suggesting tough times for the global economy and no safety in equities or real estate.

Europe has structural problems, a cautious central bank, and a relatively strong currency, mirroring 1990s Japan and making it the candidate for the first into deflation. China is closed to migration and thus trapped in a sharp demographic reversal, largely the result of its 1 child policy. Previous breakneck growth was built on exports, the market for which collapsed in recent years, leaving it with declining GDP and excess capacity. Stimulus response in 2008 was to invest in even more infrastructure, increasing the excess capacity issue. Non-public debt is ballooning whilst the authorities attempt to tighten, resulting in two cash crunches already this year, as well as high profile company bankruptcies. That makes China the candidate for delivering a 2008-style global crisis.

Solar Maximum Delivers Speculative Parabolics

Historically, solar maxima have correlated with earthquakes and peaks in temperature oscillation. They have also correlated with protest/war/revolution, inflation oscillation peaks and speculative parabolic peaks (often secular bull peaks). With both magnetic poles now having flipped for SC24 maximum, I’ve annotated the following chart from Solen:

6ja1The Japanese and Indonesian earthquakes were both amongst the highest Richter magnitude quakes ever recorded. The Italian earthquake was one of the most devastating ever in property damage.

2013 was the 4th hottest globally on record. Historically we have seen global temperature oscillate into a peak around the solar maximum.

The Arab Spring was a world-transforming series of major protests and revolutions. The Turkey, Thailand and Ukraine protests were amongst the largest ever in terms of participants.

We saw a series of commodity price parabolics peaking out towards the early part of the maximum, and we currently see a series of stock index parabolics (plus margin debt parabolic), which, with history as our guide, should peak out as the solar maximum starts to wane this year. However, we don’t know at what point that waning begins. By NOAA and NASA predictions it should be now, but by SIDC’s foreast it could be as of mid-2014. With 225 sunspots currently, it still appears to be in an uptrend:

A2Either way, the annotated top chart is unlikely complete. We could yet see further earthquakes, or greater temperature extremes in 2014, or more geo-political unrest, or more speculative mania. But without any more such developments, solar cycle 24 has re-affirmed those correlations.

Historically, the solar max then gives way to economic recession. Global recessions (if based on where real global GDP has been less than 3%) occurred in 2001-2 (SC23 max 2000), 1990-3 (SC22 max 1989) and 1980-3 (SC21 max 1979). Several factors may contribute to why this is. Geomagnetism, which is negative for sentiment, peaks after the solar max. Inflation, yields, rates and speculation all typically peak into the solar max, which collectively can tip an economy into recession. The chart below shows those correlations.

10may20131This time, we have not seen any interest rate rises, but we have seen a rate of change in bond yields in the last couple of years which is comparable to that marking previous tops. Inflation peaked out early in the SC24 max and is currently depressed, in keeping with collective demographic trends (money velocity has also diverged in line with demographics). There remains the possibility that commodities make a late-cyclicals charge and deliver a temporary inflation shock, but I’m not so sure.

Prior to all my demographics research earlier this year, I expected commodities to be the speculative target of this solar maximum, and to make their secular peak here, with gold the leading asset. However, by demographics gold has some years further to run, and is more likely to make its secular peak at the next solar maximum, or even beyond.

DemographicsDowGoldRatioGlobalGDP

That commodities have made secular peaks each 3rd solar maximum to date appears a pattern, but I believe is instead is demographic, but this will only be validated in the months and years ahead.

Let me explain. Japan enjoyed a long secular bull market from the late 1940s to the late 1980s, as shown in the first chart below, through 4 solar cycles. The second chart shows that this was because of a long demographic golden period, where productive-aged population ballooned, old-aged dependents stayed low, and child dependents were in decline.

26dece126dece2

The Nikkei peaked in 1989, in a parabolic, along with solar cycle 22. So it peaked at a solar maximum, but it took 4 solar cycles to exhaust the demographics.

The US demographic boom of 1980-2000 ran through 2 solar cycles. Stocks peaked in 2000, in a parabolic, at the same time as solar cycle 23.

The negative demographic period of the 1970s was a trend lasting just one solar cycle, and gold and commodities peaked out, in a parabolic, along with solar cycle peak 21.

In short, there is a history of demographics dictating secular market trends (so using secular market duration ‘averages’ is misleading), and of secular bulls peaking out at solar maxima (which average 11 years apart). We have negative collective demographic trends in the major nations lasting to circa 2025, before a flattening, which I therefore expect could deliver another full solar cycle of secular gold bull, to potentially peak out at the next solar max (which would be circa 2025). You may note though from the demographic composite that demographic trends look fairly woeful even out to 2050. It poses an interesting question as to whether this will be a different period for relative asset performance.

If commodities do not make a late surge in this solar cycle 24 maximum, then I believe we will tip into deflationary recession, as destined anyway by demographics, with the speculative manias and yields tightening assisting in this. That would then largely complete the correlations of a solar maximum.

If you are new to the site, reasoning and evidence for all these solar-related phenomena can be found by using the search facility.

2014 For Equities

Dow is up more than 5% five consecutive years now. A sixth such year has not happened before in history. A 5-year bull trend only occurred once before, in the 1990s, and was followed by 3 down years. Russell 2k rallies of similar size and duration to 2013’s (excluding accelerations from major bear lows) are shown below. In each case all the gains were given back the following year.

22dece1

Source: Fat-Pitch

2014 is the second year in the Presidential cycle, and is the weakest historically by returns, averaging flat. The logic for this is that is it a time for governments to deploy tougher, unpopular policies. The Investors Intelligence bull-bear ratio currently exceeding 40% also forecasts a flat return for the SP500 by the end of 2014, by averaging history, whilst the II bear percentage alone, around 15% the last 4 weeks, has historically produced returns of -5% to -20% over the next 6 months.

The Citigroup Panic/Euphoria Model, having crossed the Euphoria threshold, predicts an 83% chance of losses in 2014. Goldman’s analysis of performance following a year of 25% gains or more point to a median drawdown of 11% in the next 12 months.

Next is a chart highlighting a couple of previous occurrences similar to 2012 and 2013 where stock index rises were dominated by multiple expansion, not earnings growth.

22dece3Source: Fat-Pitch

In both instances the following two years saw better earnings growth. But notably the next two years were 1987, stock market crash, and 1999, at the end of which the Dow peaked, suggesting a common theme of pre-correction exuberance.

Both the following charts reveal that 10 year stock market returns are closely correlated to deviations from norms 10 years earlier. The first correlates average investor allocations and the second market cap to GDP. I have added the blue horiztonal line averages, revealing both are overvalued currently, but one more extreme than the other.

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Source: Philosophical Economics22dece5Source: Hussman

The logic behind both is that mean reversion always occurs. The bigger the deviation build the bigger the subsequent normalisation, as ‘this time is different’ each time is disproven. For US markets currently, we see the second highest market cap to GDP valuation outside of 2000, the 4th highest Q ratio valuation and 4th highest CAPE valuation in history. In all the other such historic outliers, a bear market followed to correct the extreme, there was no orderly consolidation of prices whilst the underlying fundamentals accelerated to catch up. ‘This time is different’ thinking argues that because the Fed has suppressed cash and bond yields, equities have to be revalued higher, so this valuation outlier doesn’t count, and there will be an orderly normalisation of valuation as earnings and GDP will accelerate and yields rise slowly, without any crash in equities.

Interesting to discover that the rally in the 1990s was also at the time considered to be Fed-induced and prolonged. Also interesting to find out that the rally in 1980s, where price also accelerated beyond earnings, was achieved in the opposite environment to today where bond yields were record high and twice as high as equity yields at the time. So for no risk, investors could choose bonds at twice the yield, but still went big into equities as they were at historically cheap valuations and were bought up to mean reversion. Today, investors can choose equities at higher yield than bonds, but equities are conversely at historically expensive valuations. No ‘revaluation’ was required in the 80s, so maybe none is required today and equities will be sold down to mean reversion.

Spikes in margin debt and net investor credit balances to extremes have never previously been resolved in an orderly manner, always leading to bear markets or sharp corrections (as in 2011).

20dece4Source: STA Wealth

If ‘this time is different’ we would need to see an orderly reduction in leverage whilst lots of new buyers come to market. But recall through demographics, net investor populations are shrinking across USA, Europe and China, and this is reflected in declining trading volumes.

11dece3We therefore have a gradually thinning investor population, which adds weight to the likelihood of the current leverage excess spike being resolved in the usual historic manner, namely a deep correction or bear market.

However, in the near term, we could yet see more equities allocation and potentially even more leverage. How much higher could equities run before a bear market or a proper correction erupts? I say proper correction, because none of the pullbacks in 2013 have displayed the usual correction characteristics in terms of depth, duration, and flush-out or spike in breadth and vix. They have been shallow pullbacks, with keen buy-up. To this prolonged lack of correction we can add the deviation in distance above the 200MA of the major indices, the excessive bullish sentiment and the current divergences in breadth, and history is fairly compelling in suggesting high risk of a sharp correction. But again, the question is when, and from how much higher?

The 2007 top in US equities was marked by a steeper ascent in the last 12 months of the bull, but this is beaten in steepness by 2013’s rally. In fact, stocks have moved into a parabolic pattern:

20dece12Source: Sy Harding

Parabolic rises are typically resolved in a crash of similar steepness and depth. Comparisons to 1929 are valid if we consider the parabolic ascent, exuberance extremes in valuations, leverage and debt extremes, and a ‘this time is different’ mantra. Where 1929 differs is that it was the culmination of an economic boom with a demographic dividend. The current episode is neither.

History suggests a combination of internals degradation, buyer exhaustion and one or more ‘triggers’ are the likely terminators of a parabolic bull. We see breath divergence, but this should yet degrade further. In a normal topping process, there would be thinnest participation at the final push, but if this is a parabolic top, then we should see increasing divergence as we move higher. There is evidence of buyer exhaustion in sentiment and leverage extremes. We lack the trigger or triggers for the shift in perception. One potential trigger is the earnings season in January, as negative guidance is at a record extreme. A second is that the boost in GDP due to inventory build is likely to be reversed ahead as inventories give-then-take. A third potential trigger is if we see evidence that the current pick up in growth turns out to be a peak in growth rather than a new dawn.

22dece6Source: Moneymovesmarkets

The above chart is derived from OECD’s leading indicators and predicts a peak in industrial output between Dec and Feb.

The case that we are in a new secular bull market for equities relies on growth picking up in a meaningful way from here. For forward earnings calculations to be valid, GDP next year would have to average over 3% for the year and earnings growth come in around 10%. If global growth were to pick up, then we would likely see relative outperformance in emerging market equities and in commodities relative to developed market equities, as both are at relative cheapness to the latter and both are beneficiaries of a growth theme.

However, the history of demographics suggest a sustaining economic revival is unlikely to occur in the foreseeable future. Collective demographic trends in USA, Europe, other developed countries (aside Japan) and China are now both recessionary and deflationary, and we can see that in evidence below:

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Source: dattaman

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Source: Yardeni

The only G7 country in a positive inflationary trend is the only G7 country in a curent demographic tailwind window: Japan.

The demographic trends are pretty fixed on a medium term view, and historic evidence suggests that government / central bank intervention cannot force people to borrow or spend. Hence we see continued weakness in bank lending in Europe and the US, and real final sales of domestic product at previous recessionary levels.

5 years after the financial crisis, ZIRP is still in place across most of the developed world, and large QE programmes are still required in USA, UK and Japan. The global economy is fragile, and this puts it risk of rising bond yields and/or commodity price increases snuffing out any pick up in growth, as the former two tend to accompany the latter. The US cannot afford bond yields to rise much further because it would have a detrimental effect on interest sensitive sectors such as housing and autos (and also because of the servicing costs of its ballooning debt), whilst rising commodity prices, particularly energies, are input cost drags on all sectors.

To sum up, from a pure statistical perspective, removing any notion of the bigger picture, the probability for 2014 is at best a flat year for equities with a significant drawdown on the way, and at worst a significant down year. Stats are just a guide, but we see united predictions across a range of measures, drawn together at the top of the page.

However, when we look at similar episodes of stock market rises without earnings growth, similar outliers in stock market valuations to now (market cap to GDP, Q ratio, CAPE), similar historic spikes and extremes in margin debt, and similar extremes in bullish sentiment or euphoria as are currently in place, the same mirrors from history keep cropping up: 1929, 1987, 2000, 2007. Together, these signals point to something more historic and devastating at hand, and the ‘fundamentals’ for that occurring are provided by demographics. Yet the bullish momentum of the market and ‘this time is different’ thinking (Fed trumps all, equities need revaluing due to suppressed bonds and cash yields) are making for widespread complacency about (and dismissal of) the parallels.

Whilst we should not overly rely on any one indicator or discipline, it’s the collective case that gives me such conviction on the short side (disclosure: short stock indices). Now do me a favour and give me a convincing case below for why equities will rise in 2014.

Tower Of Sand

The last two years gains in the SP500 have been mainly through multiple expansion, i.e. just price not earnings:

18dece1Source: Guggenheim Partners

This year, so far, earnings growth has accounted for just 17% of the gains. Digging into that earnings growth, revenues have been weak:

18dece2Source: Yardeni

So companies have boosted earnings-per-share through buybacks, at a rate on par with 2007.

18dece3Source: CNBC

Historically, companies have funded buybacks through borrowing:

18dece4Source: FT

This time is no different.

18dece5Source: NakedCapitalism

October produced a record in corporate debt issuance, and investors have piled in to this market to drive spreads to record lows this year. They have even snapped up the riskier Covenant-Lite corporate debt which offers little protection if the company gets into trouble – to another record level:

18dece6Source: SoberLook

In short, investors have gone all-in on the corporate sector, both in equities and debt. The corporates have used the debt to buy back shares, thus artificially boosting earnings-per-share whilst revenues languish. Even with that, earnings growth has only accounted for 17% of share price rises this year. The rest has been speculation built on the ‘new norm’ of Fed accommodative policy trumps all. Record low debt spreads and historic extreme equity valuations result, and now present high risk to those invested.

Earnings guidance for Q4 (reporting season kicks off in early January) is the most negative on record:

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Source: Thomson Reuters

The main reason for this is because companies have expected revenues to improve, so cut their guidance for earlier quarters but kept their year end targets in tact. Revenues have failed to materialise and therefore there is a big gap between year end forecasts and actuals, producing that big red bar for Q4 earnings.

Here we can see the persistent theme over the last two years of companies having to lower their quarterly guidance in line with economic reality:

18dece7Source: Bespoke

Of course, in response to lowering guidance analysts then reduce estimates, and with the bar set very low, companies can then peversely exceed estimates and produce a satisfying earnings beat rate, which helps shore up investor confidence. The truth of the meagre earnings and dire revenues becomes distorted.

The bidding up of equity prices without associated earnings growth has produced historic extreme valuations, averaged below:

13dece5

Source: Dshort

I suggest there are 3 secular cycles in the above chart. The 1920s saw an economic boom period with a positive demographic dividend, and by the end of the decade the thinking was that this boom was here to stay, a new norm, which gave rise to the speculative bubble and then collapse in 1929. It was not a new norm after all, and it took around 18 years to wash out excesses, to take valuations to a low enough level from which a new secular bull could erupt.

The 1950s and 60s was another (post war) economic boom period with a positive demographic dividend, and again new norm thinking took valuations to greed levels. The wash out was also around 18 years until valuations were at similar secular bull starting levels (note the demographic dividend was absent in the washout period).

The 1980s and 1990s then provided a third economic boom period with a demographic dividend in the major nations, excepting Japan in the second decade. This concluded with another ‘new norm’ bubble, and dot.com thinking took valuations to an all time exuberance record, and since then I believe we are in a gradual process of washout which should last another few years yet. US demographics peaked around 2000, Europe around 2005 and China around 2010, and we won’t see a collective demographic dividend return until 2020 or beyond. I believe this is why we face a weak economy and a gradual slide into deflation, and central bank intervention can do little to change this. Rather, central bank actions only encourage people into riskier assets by suppressing cash and bond returns, and make the cost of borrowing to do this ultra low. Hence we see another big disconnect now between the stock market and the economy.

Look again at the high outliers in the valuations average chart above: all were the peaks of economic and demographic booms (even 2007 where developing countries contributed a much bigger share to global GDP as China rose towards its demographic and economic peak). In contrast, the current exuberance is set against a weak economy and unprecedented collective demographic headwinds, which I believe makes it the most dangerous outlier yet. The ‘new norm’ this time is the Fed accommodative policy trumps all. It is a bubble.

There are multiple signs that we are reaching the top of this equities bull market (see my recent post Equities Bear Market Coming), and I believe we will see a bear market that will finally produce the washout to low extreme valuations. The negative demogaphic window is set to make this bear a deflationary shock, which means nominal values will have little protection. In other words, stock market falls will be harsh. On these grounds, Russell Napier quotes 400 on the SP500 as a possible bottom. This is maths plus history, not the peddling of fear.

The result would be something like this: a large megaphone with a lower nominal low than 2009:

26nove17Based on margin debt, euphoria, and valuation, the bear market looks set to erupt imminently. That means the Fed would be effectively out of ammo. It has had not the usual opportunity to end stimulus and raise rates to more regular levels, from which it can then ease in the face of a downturn. This should add to the ferocity of the downdraft.

By leading indicators the current window of positive economic data should turn out to be a peak, rather than the global economy finally seeing a new dawn. With commodities finely poised, I do not know whether they will rally as equities top out (in late cyclical style, similar to 2007-8) or break down as demand-supply slack outweighs. If the former, then we would see a temporary inflation until rising commodities help tip the fragile world economy into a deflationary recession. If the latter, then further commodity falls should do the job of completing the slide into outright deflation. Because of the credit excesses again (margin debt, corporate debt), a bear market would likely be unforgiving similar to 2008, i.e. forced liquidation of assets, with few asset classes spared. This time, however, treasury bonds would not seem so safe. Gold has a limited performance history under deflation, but I believe it has potential to be the go-to asset here.

The pretender to the throne, Bitcoin, which temporarily became as valuable as an oz of gold, looks to have burst, whilst gold’s washout looks very similar to 1976:

18dece8Source: Citi

The weak hands have been purged and equities show signs of topping. The next few years are an ideal anti-demographic window for gold to shine, and deliver the dow-gold ratio extreme which we have so far not seen. The question is whether it an escape a downward spiral of forced liquidations.

Nasdaq And Lessons From Japan

If the smoothed solar maximum for solar cycle 24 is occurring around now, and equities are the speculative target of solar inspired human excitement, and the Nasdaq remains the leading stock index, then we have evidence of such a speculative mania in the Nasdaq composite with a parabolic gaining traction, as referred to in the last post. Below is the longer term Nasdaq composite showing the last two solar peaks closely correlated in timing with Nasdaq peaks:

27nove1Underlying Source: Stockcharts 

Nasa predict the solar pole flip will be complete by Nov/Dec 2013, which typically signifies the solar max is complete, whilst SIDC have a sunspot projection showing a max around April 2013. Drawing those together with the possibility of a correlated Nasdaq peak, we have a window for the Nasdaq to peak out, in parabolic fashion, between now and June 2014.

If we look at the biggest four Nasdaq composite companies by market capitalisation, Amazon has at this point gone to crazy valuations under a steep parabolic, whilst Apple, Google and Microsoft are more contained. Google is the most expensive of the three at 23.9 forward p/e, whilst Apple and Microsoft are at 12.2 and 14.1 respectively. IF the Nasdaq is heading for a parabolic speculative peak (solar maxima in the past have typically correlated with parabolics in assets) then I suggest we probably would need at least another of these leaders to go to dizzy valuations like Amazon.

Now to lessons from Japan, and specifically, can the US and Europe avoid deflation or is it unavoidable?

By my research, Japan’s ‘lost decade’ was due to demographics, and with US (since circa 2000), Europe (since circa 2005) and China (since circa 2010) demographics now united in an unprecedented downtrend, I believe deflation is inevitable. BUT, Japan did make some ‘mistakes’, in belatedly adopting QE, and only keeping loose monetary policy once the economy entered periods of deflation, withdrawing once back into inflation. I say ‘mistakes’, because that is up for debate. Austrians and Monetarists argue that stimulus actually has a negative effect, for example government intervention quashes private economic activity and savers and retirees see their income quashed under ZIRP so actually cut consumption. Regardless, Japan’s massive QE and government spending programmes even failed to inflate their economy against a positive global backdrop of strong growth in the 1990s. Today, 10 out of the biggest 13 economies of the world are in demographic downtrends, making for that aforementioned unprecedented collective negative backdrop.

Analysts point to several other contributory factors for Japan’s failure.

One is the starting point of a bubble in stocks and housing prices, i.e. excesses that needed washing out. We can identify something similar leading us into the current situation for US and Europe, with a stocks bubble in 2000 and a housing bubble around 2006.

Two is associated with one, as the bursting of the bubbles encouraged households and businesses thereafter to pay down debt and not borrow, and to do so despite interest rates being brought down to negligible levels. Today we see the same occurring:

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27nove4Three, low productivity, low capital expenditure and excessive capacity. Again, repeated today:

27nove5 27nove6 27nove7In fact, there is a theme in that US data of some key economic indicators being lower currently than at historic recession start points, and you can find the same phenomenon in data ranging from real US GDP growth to real US retail sales growth to National Activity (Chicago Fed). On which note, an inverted yield curve has historically been a reliable leading indicator of recessions in the US and the health of the curve suggests no recession on the horizon. However, the suppression of yields by the Gov/Fed essentially makes this indicator redundant, as Japan three times entered recession with a normal yield curve under the same suppression intervention.

Four, persistent fear. The financial crisis lingered in the mind, causing consumers to continue to distrust banks and feel pessimistic about the economic future, which translated into holding back on investment and spending. Below we similarly see how US consumer confidence has never really recovered since the 2008 financial crisis (whilst Eurozone consumer confidence also languishes negative, with the latest reading -15.4):

27nove8

Source: Dshort

And I shared charts in previous posts showing how private investment has dried up whilst the government has backfilled.

In short, there are broad similarities between 1990s Japan and the US and Eurozone today. But what actually tipped Japan into deflation? It didn’t happen straight away, it occurred once Japan attempted fiscal consolidation, trying to contain its ballooning public debt and high government spending. Which is where the US is today: back at the debt ceiling / fiscal cliff, aware it needs to reduce the massive QE debt ballooning. But it is in a QE trap, which Richard Koo explains like this:

The QE “trap” happens when the central bank has purchased long-term government bonds as part of quantitative easing.

  • Initially, long-term interest rates fall much more than they would in a country without such a policy, which means the subsequent economic recovery comes sooner.
  • But as the economy picks up, long-term rates rise sharply as local bond market participants fear the central bank will have to mop up all the excess reserves by unloading its holdings of long-term bonds.
  • Demand then falls in interest-rate-sensitive sectors such as automobiles and housing, causing the economy to slow and forcing the central bank to relax its policy stance.
  • The economy heads towards recovery again, but as market participants refocus on the possibility of the central bank absorbing excess reserves, long-term rates surge in a repetitive cycle I have dubbed the QE “trap.”

This year we have seen a sharp recovery in bond yields, in line with the second point, and if he is correct then we should now be seeing a reversal in automobile and housing sales, which the data from the last 3 months in the US does show:

27nove9 27nove12 27nove11

Source: Calculated Risk

Meanwhile, the Eurozone is perhaps going to pay the price for its cautious central bank policy response since 2008 (compared to US and UK) by entering deflation first. Money supply has not grown in that period and narrow money as a leading indicator suggests the tentative recovery in Europe may be about to fizzle out again.

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Source: MoneyMovesMarkets27nove15

 

Source: Yardeni

Chinese monetary trends also show a slowdown into 2014, whilst producer prices have been in deflation over the last twelve months. Add China to the European Union and the USA, and that’s more than half the world’s economy in a collective demographic downtrend, before including other similarly demographically challenged major countries such as Canada and Russia. I just don’t see how this won’t escalate into a global deflationary recessionary feedback looping. If Japan couldn’t achieve it when collective major economy demographics aside itself were positive in the 1990s, and we see similar developments in data above as occurred in Japan, then it would seem the world economy is destined to slip into a deflationary recession. A QE taper and fiscal consolidation as part of debt ceiling renegociation as we turn into 2014 could provide the extra momentum on that path in the US, whilst for Europe any additional interventionary measures may well be too late at this point (and are of questionable effectiveness anyway).

 

 

New secular stocks bull market?

Did a new secular stocks bull market effectively begin in 2009 or 2011, with the recent breakouts above secular bear resistance making for a golden buy opportunity?

26nove16Source: Marketoracle

Or is a secular stocks bear still in progress and we are on the cusp of a major shorting opportunity, together with a GOLD buy opportunity?

26nove17Source: Marketoracle

26nove2Source: Approximity

The case for the stocks secular bull market would be that valuations washed out sufficiently from the peaks in 2000 to the lows in 2009, that central bank stimulus is doing enough to offset collective demographic down forces, and that exponential technological evolution will drive increasing profitability and economic growth from here. Here are a couple of charts I produced last year, pre demographic research, showing the secular bear p/e valuations progress, with the lower chart showing how I expected breakout in 2013 followed by retest of the breakout level in 2014, before secular bull momentum took hold.

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That projection was based on historic patterns, and still seems reasonable to me, if this is a new secular stocks bull. 2013 has indeed seen the ‘pentagon’ breakout in the major global stock indices, and a successful retest of the nose of the pentagon in 2014 would reset some of the froth we have built up this year as well as giving technical validation to the new bull.

However, since my demographic research, and broader thoughts progress, I have been more convinced of secular bear continuation, and the megaphone projection above. The case for secular bear continuation includes unprecedented collective demographic downtrends and overvaluation of equities by other measures. Here are Doug Short’s 4 valuation measures all showing historic overvaluation extremes, excepting the 2000 outlier:

26nove18Source: Dshort

There is a case for a breakdown to -50% if historic patterns are to be maintained, before a secular bull could be considered. The doubt is if 2000 was not an outlier but the new norm, namely a racheting up of higher and lower valuations, perhaps as a result of technological evolution also ratcheting up. Alternatively, valuations may change in context – namely that in this current era, ZIRP and QE have killed the attractiveness of cash and bonds, and we are therefore in an era where stocks are relatively more appealing:

26nove1And commodities? Deflationary demographics may have terminated the secular commodities bull before expectations, i.e. without a collective final mania. Or commodities may yet perform as late cyclicals, making a final ascent into 2014 that tips the fragile global economy into recession. The commodities indices are still in large triangles, since 2011, and whilst they remain so, the latter remains possible.

If, however, deflationary demographics are working their way through the commodities complex, then, by my research, there still remains a place for precious metals to shine, as the anti-demographic asset. The third chart down above in this post shows the progress of the dow-gold ratio, and also suggests the two secular possibilities. One, that the rising long term channel shows a repricing in the ratio in favour of equities (due to tech evolution) which means higher bottoms for the ratio and higher tops, i.e. the 2008-2011 lows were sufficient. Or two, that the fiat capital era has produced ever increasing extreme swings, which suggests the ultimate low in the dow-gold ratio is still ahead and will be the lowest yet.

Of course this will all become clear with the fullness of time. If demographics overcome central bank actions and tip the world into deflation, recession or both, then I expect stocks to lose and gold to win. If central bank actions together with tech evolution are overcoming demographics, then we should see a gradual strengthening in economic growth and profitability which should mean stocks (continue to) win and gold loses. Somewhere inbetween would be the scenarios in which rising yields or an inflationary shock (speculative run in commodities) or both tip the world into recession, which could reset stocks to some degree but keep both secular options open.

Back to the near term, we continue to see signs of froth in equities as well as signs of a melt-up in progress. That makes it difficult as it suggests it not prudent to go long here, but the short opportunity that it is setting up could be yet, 5%, 10% higher or even higher. Depends how crazy things might get, and if this the solar maximum then that potential is there.

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