Deflationary Demographics

Posted on June 27, 2013 Posted in Deflation, Demographics, Indicators, Inflation, Macro39 Comments

If the combined demographics of the major nations are exerting an overall deflationary pull on the global economy, then we ought to see clues in the data. Broadly-speaking, USA demographics began a downtrend around 2000, Europe around 2005 and China around 2010. Therefore, the biggest pull has been in place since 2010 or so.

G7 and E7 countries combined industrial output has been weakening over this period. The question is whether this measure is going to continue downwards and break beneath zero or pull upwards again from here:

Source: Moneymovesmarkets

Retail sales in some of the key advanced economies have also shown a declining trend over this period, and are also at the point whereby they either pull up or drop into the negative:

Source: Capital Economics / IBtimes

The global PMI composite for services and manufacturing shows something similar: a weakening trend over the last several years and the same predicament going forward:

Source: Markit

Combined leading indicators for the OECD nations have also shown weakness the last couple of years but are trying to pull up again:

Furthermore, we have seen a renewed round of easing recently, with rate cuts across the globe in the last couple of months, as shown below, which should have a positive effect several months hence:

Source: Business Insider / Moneygame

Lastly a look at specific USA data on its own does appear to show trends being pulled down over time:

Source: Streettalklive

Source Dshort

Now let me outline two scenarios going forward. The first is that the world economy picks up in the second half of 2013. Positive effects from the round of further rate cuts, plus the drop in input prices through recent softer commodities push most of the above indicators upwards and away from danger. Demographics continue to exert their influence in keeping global growth weak and unimpressive, but growth is nonetheless maintained and improves, at least temporarily. Asset markets would be the primary beneficiary, with stocks most likely winners again, under low growth low rates. Commodities should also get a boost, in a mean reversion away from oversold and overbearish, and on improved global demand. If commodities then gained too much traction, the risk would be of oil and other key inputs tipping the world into recession given global growth is fragile due to demographics.

The second scenario is that the combined demographic trends of USA, China and Europe, that are now collectively at their most potent, drag those indicators above negative and the world economy tips into recession under deflationary momentum. So no spike in commodities, no excessive inflation or subsequent tightening, but rather like a global version of Japan in the 1990s, whereby no central bank action could prevent the demographic waves from cutting spending and investing. Such a deflationary shock is the scenario Russell Napier is predicting. QE has failed to produce either strong or self-sustaining growth, and growth in emerging market reserves has reversed, limiting their ability to deal with another deflationary shock. Inflation is the only real solution for the indebted developed country governments, to inflate the debt away, yet they cannot induce the necessary inflation, due to the combined demographic downtrends. If the world was to tip into a deflationary recession, then I expect a panic would ensue and stocks would sell off hard. The perception would be that despite the billions spent on propping up the economy, it had all failed and central banks were powerless. The massive debt that had been racked up in trying to stimulate and support was also now growing even bigger under deflation – a double failure. Of course, demographics would be the culprit, and eventually by around 2020 the trends would have improved in USA and China and others sufficiently to give the global economy traction again, but not before a massive sell-off in assets.

Stocks look to be rising again since the new lunar positive period, so I am hopeful my preferred scenario of a re-test of the highs will ensue. If this is a topping process in equities then we may then see the historically normal switch to outperformance in commodities. Certain indicators, such as Martin Pring’s, suggest commodities are about to gain traction again, and given they have been oversold and overbearish for some time now, a mean reversion would make sense. If commodities were to truly rally and then top out after stocks in the normal sequence, the whole momentum move for commodities would have to happen fairly quickly. This could happen through solar maximum inspired speculation, but until and unless commodities become the money target then this scenario remains theory for now.

If commodities do not take off, but rather leading indicators weaken and provide a negative divergence to the equities high retest, then the deflationary scenario could be unfolding. I would expect bonds and cash to be beneficiaries to some degree, whilst equities fall hard, and I believe gold would rally again, as the anti-demographic go-to. Once again I could see a solar maximum inspired speculative peak, this time in gold.

I have to end on the scenario not mentioned. Central banks continue to tease enough growth in the economy to keep stocks in favour. Not too much to inspire inflation and commodities momentum. Not too little to slip into deflation. Sustained weak growth in the economy and sustained easy money conditions, with the latter inspiring continued flows into equities, and perhaps a solar maximum inspired speculative peak happens in stocks. Under this scenario I would expect Japanese equities to outperform, under their belated demographic catch up, full-on central bank push, and as an energy importer benefiting from the subdued commodity prices. If this scenario were to be the theme of H2 2013 then I would expect renewed economic weakness in 2014 as the recent round of easing wears off again, and demographic forces continue to pull. Would we then slip into deflation at that point, or could yet another round of central bank interference once more have the required effects?

It comes down to whether central banks are really in control here. Are they successful in their ZIRP and QE efforts? The evidence suggests not, as they cannot induce inflation nor sustained growth. Japan’s central bank could do nothing to overcome their demographic downtrend in the 1990s. Central banks can only encourage or discourage through their tools, they cannot force. With US, Chinese and European demographics united down in this decade, I think that’s too potent a combination for central banks to overcome. It’s just whether they can keep it at bay for now. So let’s see how leading indicators develop, and whether commodities can attract a rally or not. Timing the solar peak remains troublesome as the experts cannot agree, but assuming it remains ahead, then I expect it still has a key role to play here. I expect a sunspot-associated speculative peak, and maintain the most likely asset to benefit is gold, as demographics are anti-equities, anti-t-bonds and deflationary. If it isn’t gold, then the combination of easy-bubble-making monetary conditions and solar inspired speculation should inspire a moon-shoot in another asset.

Demographics, Disinflation and Deflation

Posted on June 23, 2013June 23, 2013 Posted in Bonds, Commodities, Demographics, Indicators, Inflation, Macro, Stocks53 Comments

I have enlightened myself again this weekend, and I feel just in time. More outlook changing research. These last 4 months or so have been a real leap forward in understanding, personally. So yes, some of my views have changed, parts of the site need updating, but let’s get to the important. Demographics not only dictate ‘secular’ bull and bear markets in stocks and real estate, but also play a major role in inflation, disinflation and deflation.

It is labour force growth or shrinkage playing a key role in price inflation. A swell of people aged 15-20 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. There are correlations with inflation in labour force growth (15-60), young labour force percentage (15-40) and dependency ratios (inverted – old and young versus the working population), all of which are approximations of the same idea. It’s another simple but powerful mechanism, in the same way swells in the ‘investment’ age group produces equity bull markets.

Countries with ageing populations have generally experienced low inflation in recent years, whereas younger countries have experienced higher inflation, due to the resultant spending boom:

Source: Andrew Cates

Japan’s proportion of 15-40 year olds has historically correlated with inflation levels:

Source: James Bullard

Japan’s working force growth projection suggests Japan will not successfully reinstate inflation this decade, but will at least manage to change the trend as of around this year:

Source: Andrew Cates

Here is the 15-40 year old ratio history versus inflation for the USA, also showing the correlation with inflation:

Source: James Bullard

And two projections forward:

Source: James Goulding

The charts suggest the USA should be tipping from disinflation into deflation. That is, if we assume the Fed is powerless to stop it.

Now look at dependency ratios for some of the main countries, we first see that collective trends historically matched broad global inflation history (nb: dependency ratios are not inverted in this chart):

Dependency ratios collectively fell (i.e workforce proportions grew) between 1965 and 1980, which was a period of rampant inflation. Since then we have seen overall disinflation, and this is confirmed below:

Looking forward, we see collective deflationary dependency ratio trends in the major nations, with the exception of India and Brazil (nb: dependency ratios are inverted in this chart):

The alternative 15-40 ratio measure paints a similar picture of price deflation ahead for five of the most important economies:

This explains why ZIRP and QE have failed to bring about inflation in Japan and now the USA. These countries want to inflate, but the demographic trends mean the public just won’t spend sufficiently in the economy for it to happen. For the majority of the major nations, this is a problem going forward, as the demographic trends persist and worsen. For the global economy, this is a problem, because the combined GDP of Brazil and India and other smaller positive-demographic countries is much smaller than the combined influence of the USA, China and Europe.

So what’s likely to happen? The central banks of these countries are largely pushing on a string. They can’t force spending and investment, they can just use ‘carrot and stick’ tools to encourage spending and investment and discourage saving and cash. The evidence suggests that disinflation should continue. The risk is that disinflation turns into deflation, as the demographic trends suggest. The global economy is at risk of falling into a new recession, or even depression. It explains why the recovery since 2009 has been spotty and weak. The central banks will likely have to persist with ZIRP and QE and perhaps also deploy other unorthodox tools, but which would likely have the same lack of potency. If deflation takes hold, then debts would grow, savers and currency holders would be beneficiaries, and investment would become unattractive because future prices would be lower. Risk asset markets would fall.

So why are equity markets so strong currently? We have disinflation and low growth, together with the ZIRP and QE easy money conditions. Whilst the former two conditions hold, then speculation is encouraged by the latter two. It would take a plunge into recession and deflation to generate the exodus out of stocks, and it is such a development that a couple of analysts that I respect are touting (e.g. Russel Napier, using the Q ratio, predicts the SP500 to bottom at 400 in 2014). With this new research, I now understand why.

But could this benign status quo continue, with low growth and pro-speculation conditions, with the central banks acting together to maintain such conditions? Well, I would repeat that all they can do is encourage and discourage through their limited toolkit. They can’t force. The demographic trends are now united negative in USA, China and Europe, which provides a powerful downward pressure. There are less new investors coming to market, and more leaving. So how can stocks keep rising? I suggest the answer lies in the current margin debt situation:

Source: NY Times

Stock market participants have increasingly borrowed and leveraged in the market. So it’s not more investors but the same investors buying more and more on credit, and as the graphic shows, when margin debt reached over 2.5% of GDP previously, the stock market fell into a cyclical bear subsequently.

Here is the correlation between the S&P composite p/e ratio and the middle-old demographic ratio for the USA, with projection:

It suggests a fair p/e of around 10 by next year. As of Friday’s close the p.e was 18.4. A shrinking of p/e can be achieved either by stocks holding up nominally but strong inflation eating away at the valuation, or it can be achieved by stocks tanking under no-inflation or deflationary conditions. By the demographic projections further up the page, the second option appears likely. This would also mean US stocks could be in for severe falls ahead.

Deutsche Bank produced the next chart which shows US market cap as a percentage of GDP versus middle-old demographics. SMC as %GDP is a valuation measure for the stock market and the second chart below shows where we currently stand, which is very much overvalued versus the demographic forecast in the first chart:

Source: Business Insider

Source: Vector Grader

Again this suggests the US stock market should be in for sharp falls, both real and nominally, because the demographics don’t support inflation. I therefore believe US stocks should be a good shorting opportunity ahead, together with Europe and China. However, I still think Japan is set to do well as a long equities bet. The pick up in labour force growth for Japan, shown higher up the page, from this year looks set to change the deflationary trend even though true inflation looks set to remain elusive. So that suggests at least stabilisation in the economy. However, equity prices could grow much stronger, in line with the M/Y ratio:

The next two years is a particularly good demographic period for Japan as middle-old and net investors measures also rise. Plus Japan is playing catch up to demographic trends that turned up as of around 2002. I maintain that Japanese stocks took off then but were pulled back by the global crisis of 2007/8. So, the question is whether they would again be dragged back by a new global recession and a stocks bear in most of the major nations. I don’t think they would be immune, but I would still expect them to outperform and eventually deliver their demographic fulfillment. Plus, there is a chance of a fast speculative boom. Current monetary conditions encourage bubbles, and the new Japanese government has upped the ante by saying it will buy equities as part of its reflationary policy. With speculative behaviour also at peaks around solar maxima, I think there is a chance Japanese equities could go crazy, and so I will maintain long Japanese equities and add on any further retreats.

Now one more demographic correlation, this time with government bonds. This work by Credit Suisse is the same simple idea: the ratio of those who are predisposed to buying government bonds to those who are really not determines the long term path of bond yields:

Source: Credit Suisse

For the US and Europe we see a change in demographic trend has taken place over the last 10 years which should see outflows from bonds going forward, and yields therefore rising. The US changed trends first, which suggests treasuries are belatedly falling to trend now, and that the flows out of treasuries are justified.

If a sharp cyclical bear does occur in equities, then we would have a similar deflationary shock to 2008. In that experience, most assets were sold off as people needed to raise cash to pay for losses elsewhere. Gold did not escape. It was government bonds that were the recipient of the money flows. Would they be this time?

Let’s turn to gold. Historically, gold has performed well when demographics have been in negative trends. I recently showed that the Dow-gold ratio had bottomed and topped very closely with demographic turns in both the USA and UK. Below, the same p/e demographic ratio as shown further up the page but with the gold price added also shows the inverse correlation:

Source: Glenn Morton

You may read that in the 1970s gold rose as an inflation hedge, in the 2000s gold rose under disinflationary conditions, and gold also performed as a deflation hedge in 1933. Gold is touted as a hedge against systemic risk and financial market instability, as hard currency or as a store of value under conditions of negative rates or currency dilution. What I would suggest is that gold is the go-to, the default investment, under certain demographic conditions, i.e. ‘negative’ demographic conditions. When demographic trends are counter equities and real estate and government bonds then gold becomes attractive by default. This ‘last resort’ status is reflected in gold’s real performance over time, namely it goes nowhere in the long term.

When equity p/es are declining under m/o demographics, and stock market interest is in decline due to m/y and net investor demographics, but labour force growth demographics are inflationary, then we have disinvestment in the stock market but price inflation in the economy. This was the 1970s, and reflects the broad collective downtrends in demographics amongst the major nations at the time. Gold and commodities outperformed.

When equity p/es are advancing under m/o demographics, and stock market interest is increasing due to m/y and net investor demographics, and yuppie/nerd demographics are pro bonds, and labour force growth demographics are price disinflationary, then we have investment in the stock market and bond market and price disinflation in the economy. This was 1980-2000 for most of the major nations, although Japan changed demographic trends circa 1990 and went its own way. Equities and bonds outperformed.

From 2000 to current, we saw some divergence in demographics. For the USA, equity p/es were declining under m/o demographics, stock market interest was in decline due to m/y and net investor demographics, and labour force growth demographics were disinflationary, so we had disinvestment in the stock market (secular bear market) and price disinflation in the economy. However, Europe largely retained positive demographic trends until mid-decade and China until around 2010. China’s conditions were price inflationary, and as the biggest consumer of commodities, commodities had a demand story. Some have suggested that gold performed well in the 2000s under disinflationary conditions, i.e. that it is a beneficiary under disinflation, which may be true. However, the picture is muddied because of the price inflationary China demographics which could equally have been the story for gold’s rising, partnering with commodities again.

Which brings us to now and the next few years ahead. We see more united demographic trends again. For the USA, China and Europe, equity p/es should be declining under m/o demographics, real estate interest should be declining under m/o and dependency ratio demographics, stock market interest should be in decline due to m/y and net investor demographics, yuppie/nerd demographics should be counter government bonds, and labour force growth demographics should be price deflationary. So we should see disinvestment in the stock market and bond market and price deflation in the economies of these countries. What would be the winner under such conditions? I believe it has to be gold, as the default, go-to asset again. I suggest this would be the difference to 2008, as government bonds have changed trends and with ZIRP still making cash unattractive, money has to flow somewhere. If the solar maximum is ahead this year and this deflationary shock happens 2013-2014 with gold the recipient, then we would once again produce a secular peak close to the solar maximum.

What about commodities? I am not sure if commodities as a whole would be winners in such a deflationary shock. I have my doubts, because the demand story should be on the wane, and they are a class for inflationary trends. I believe the question is whether they collectively would become a speculative target, rather than an economic demand target. If equities are close to topping then commodities could go outperform here in the historically-usual pattern of topping last as the economy rolls over. However it would be done so most likely on speculative interest, rather than tight inventories. Geopolitical or climate events could play a part, particularly as the solar maximum has historically inspired protest, revolution and temperature peaks. The solar maximum has also historically seen speculative climaxes, so the potential for commodities as a class to rise is possible, particularly if oil took off. However, I am now very much open to the alternative, which is that the price deflationary demographic trends, particularly in China, take down commodity prices from here, and precious metals perform alone. I am therfore going to refrain from adding any more to my long commodity positions for now, and watch developments.

In short, I think calls that gold’s bull market is over are premature, as it is the counter-demographic go-to asset. Equities are on borrowed time due to counter demographic performance and margin debt. Collective demographic trends in USA, China and Europe are not in favour of stocks or real estate, nor pro-government bonds. Price deflationary trends are in place, which means falls are likely to be hard in nominal terms for risk assets. Commodities may not escape this, unless they are initially speculated to a peak and then join the falls. We don’t really have a precedent for such a coming together of trends, but I believe gold should be the winner as bonds, equities and real estate are counter demographic and cash is unattractive under ZIRP. I want to short stock indices from USA, China or Europe, but want to play long Japan, as it is the demographic exception. Brazil and India are also positive-demographic, but are not likely to escape a sell-off. I want to add long there post-falls. I will remain short treasuries and long precious metals.

I stated at the top of the post that I believed this analysis to be just in time. By that I mean I suspect equities could fall hard at any time, and that’s the position I want to add to my portfolio: short stock indices. I can now see more of a case why US equities could be in an eiffel tower formation and about to collapse. So I am going to add short without delay. If China liquidity and emerging market issues don’t escalate this week and set off sharp declines, then I would ideally still like to see a more regular topping process with another attempt at highs before rolling over, over the next couple of months.

Macro And Markets

Posted on June 21, 2013June 21, 2013 Posted in Bonds, Commodities, Currencies, Demographics, Geomagnetism, Indicators, Inflation, Lunar Cycles, Macro, Real Estate, Solar Cycles, Stocks22 Comments

The Fed announced tapering of QE as of 2014, subject to developments of course. It will first need to taper out its QE to zero before rates can rise from ZIRP. Rates will then likely be raised slowly as in the 1950s due to high government debt. Together this means easy monetary conditions will persist until US demographics bottom out 2014-2019. I suggest that is broadly necessary to counter the demographic downtrend and could mean that we see continued low growth with more asset bubbles appearing and then popping.

What would change this course of action? If inflation became problematic and yields rose too far too fast. Currently inflation is benign as global growth remains fairly soft. History reveals that a low growth low inflation low rates environment is good for equities. It took the last 12 months for investors to really gain confidence in economic growth persisting (if soft) and with a gradual bottoming in government bond yields:

Source: Bloomberg

At those record low yields, investors were making a guaranteed real loss, yet money flows were still attracted into government bonds – with the assistance of QE in USA, UK and Japan – due to fear of greater losses in other asset classes. Recently that has changed, and it is because low economic growth has persisted long enough with some of the main worries (e.g. Euro debt, sovereign default) deflated. That does not preclude new crises emerging, but there has been a gradual process of repair since 2008, and I suspect we have seen the bottom in bond yields.

Because we are currently in demographic downtrends for the USA, China and Europe, I suggest it makes sense that only low growth is the current norm and that easy monetary conditions are likely to be maintained until a collective demographic improvement as of around 2020. Gains in real estate and equities should be capped by the demographic downtrends, but supported by the easy money conditions. Commodities have historically performed well during demographic downtrends, but could struggle to make large gains if soft growth holds down demand. Money should continue to flow out of government bonds, with any of those three classes the recipient, unless real yields rise too high for bonds to become attractive again. Yields cannot be allowed to rise too high because of high debt servicing and negative economic impacts. Combined, that makes for a fine balancing act between all four asset classes.

Japan is one economic giant that is in a demographic uptrend and I believe the recent surge in equities there is a belated catch up to that trend.

I believe Japan was ripe to bottom around 2002, along with demographics, but was then pulled back down again with the global crisis in 2007/8. The H1 2013 Nikkei rally was stopped at the long term declining resistance, but I think this time it will burst through it successfully, in due course:

The Japanese government has declared it will do whatever it takes to re-inflate the economy and assets including buying equities. The question is how long it will take to break through. If US equities are beginning a topping process then it would seem unlikely that Japanese equities break out at this point. If emerging markets are heading into a crisis, as Russel Napier believes, then a global sell-off would likely take place again.

There are 3 possibilities here for US equities. One is that they have run up in an eiffel tower parabolic formation and will collapse now down the other side. Two is that they have begun a topping process whereby we should see an overall sideways volatile range over several months whilst negative divergences appear. Three is that they are consolidating before further gains.

Because of the sharp run up and the demographic headwinds, I have my doubts about option three. However, cyclical stocks bulls usually end with commodities and inflation rising to become problematic and helping tip the economy into recession. Inflation rises, yields rise and the higher input costs and higher rates squeeze the economy. Bonds top first, then equities, then commodities. At this point we appear to have seen a top in bonds, but do not yet see commodities or inflation rising. Therefore we don’t see the usual historic pressures to pull down equities. Low growth, low inflation, low rates: good for equities.

For option 1, a harsh collapse, some analysts are referring to a 1987 overlay, predicting a crash. I can’t rule it out, I can just refer to that current environment again – it differs significantly from 1987 where yields and rates were much higher. We know that flash crashes can happen, where automated selling begets automated selling, but I suspect we’d need a swift change of status quo to bring it about. Something like the possible emerging markets crisis.

For option 2, a topping process, we would have time. There is no rush to short until we need more technical evidence of a topping range and negative divergences in breadth and leading indicators begin to appear.

In the short term, I believe we could be reaching a point this weekend whereby equities rally up again. Passing through the full moon together with a possible bottoming out in geomagnetic disturbance – the Singapore STI shown here mapping very closely to the model:

Plus, low Nymo and bullish percent / call put readings in US equities suggest a bounce imminently.

If equities do bounce then crude oil has a chance of holding its breakout, which it is currently backtesting. If crude cannot, and falls back into the triangle, then the textbook action to follow would be a breakdown out of the bottom of the triangle, which would likely spell prolonged doom for the commodities complex.

So will commodities come again? I believe they will. Nothing goes up or down in a straight line. Mean reversions eventually occur, if not something more juicy. What could give them momentum? A top in equities or concerns about the economy functioning without QE could spur money into precious metals as safety again, with a short squeeze possible on record short interest. Geopolitical developments can affect oil prices and in turn wider commodities and protests/wars are common at solar maxima. Global warming and global wierding remain risks to agricultural commodities, with May having come in at the 3rd hottest on record globally and Jan-May the 8th hottest on record. Global temperatures have historically peaked around solar maxima.

The latest on solar peak prediction is that NASA believe a summer peak in 2013 is likely, NOAA a Nov/Dec 2013 peak, and SIDC running with two options as shown:

Source: SIDC

Averaging, we could look to a late 2013 smoothed maximum. Historically, secular asset peaks have been made close to solar maxima, along with inflation peaks. We should allow around 12 months for commodities to rise up and make a ‘secular’ peak and an associated inflationary peak if it is to happen along with this solar maximum, so it should be the theme from here into 2014 if it is to occur. With bonds having likely topped and equities having rallied hard, we are also ripe for outperformance to emerge in commodities. However, economic data out of China, increasing inventories, depressed sentiment in the class, and strength in the USD are some reasons why this is not occurring. Until this collective picture changes in some way, I have to remain open to the possibility that commodities will underperform through the solar maximum, and this could mean a different asset class is bid up to a speculative peak if the solar maximum is still ahead.

From my recent Dow-gold ratio analysis, I suggested two likely bottoms in the ratio: 2014 or 2025 (approx). Either a swift run up to a speculative peak in gold into next year, or a mid-point currently on the way to a bigger gold peak a decade away at the next solar max. From the same analysis, demographics in the main nations no longer offer clear support for either equities or gold going forward, which I suggest means we are likely to see less wild swings between the two, and alternating shorter bulls. So I remain happy to average down in gold and other commodities, particularly with my new cash injection, and await either a mean reversion rally or a possible momentum move into commodities once a trigger emerges. I also would add to long Japan equities on any further drops. I am tempted by the weakness in positive-demographic Brazil and India to build more of a long positive there, but each are currently experiencing their own economic or social problems which could yet worsen so I am going to hold off. I would look to add short equities if a topping process becomes clearer with negative divergences. I remain short treasuries.

I believe the greatest risk currently to my portfolio is some kind of sharp global sell-off, a collapse in US equities infecting all pro-risk. However, I really can’t call a winner from the three options I outlined above for US equities at the moment, so await further flags and developments. If pushed, I still place greatest likelihood by a historically normal unfolding of events, namely that bonds have topped and we will see equities top as commodities outperform, with commodities topping last, helping tip the world into recession and end the equities bull; that the solar maximum will inspire speculative peak and that peak will be in commodities (or precious metals at least) due to the collective demographic downtrends aside Japan. However, I am nowadays ultimately of the view that there is complex interaction between demographics, solar cycles, fundamentals, government intervention and more, that make it a difficult calculation. I believe anomalies can occur if several of these factors conspire together to produce one, which is why there is no holy grail. However, I expect clearer ‘probabilities’ to emerge from here, one step and development at a time.

Secular = Demographic

Posted on May 27, 2013May 27, 2013 Posted in Commodities, Demographics, Indicators, Inflation, Macro, Solar Cycles, Stocks22 Comments

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.

All 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.

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.

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.

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

France is in a united downtrend until circa 2035.

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.

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.

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.

We 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.

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.

Japan Financial Markets Economic Correlations

Posted on May 20, 2013 Posted in Commodities, Demographics, Indicators, Inflation, Macro, Solar Cycles, Stocks9 Comments

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:

Note 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.

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:

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.

That 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):

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

The 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:

Source: 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.

What Really Moves The Markets

Posted on May 17, 2013May 17, 2013 Posted in Bonds, Commodities, Demographics, Geomagnetism, Indicators, Inflation, Macro, Real Estate, Solar Cycles, Stocks28 Comments

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:

Source: 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):

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:

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:

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:

Source: 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:

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?:

USA Financial Markets Economic Correlations

Posted on May 14, 2013May 14, 2013 Posted in Bonds, Commodities, Demographics, Indicators, Inflation, Macro, Real Estate, Solar Cycles, Stocks20 Comments

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:

Combining 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:

Real 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.

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

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:

This is because recessions occur following inflation spikes:

So 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:

Sunspot 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:

The 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:

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

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:

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.

Sunspots, Equities, Treasuries, Commodities, Inflation, Money Velocity, Interest Rates And Demographics

Posted on May 10, 2013May 10, 2013 Posted in Bonds, Commodities, Demographics, Indicators, Inflation, Solar Cycles, Stocks42 Comments

Time to draw them all together and see the full correlations. This is US-based analysis due to data availability.

The first chart (click to view larger) reveals historic spikes in US interest rates, 10 year treasury yields, MZM money velocity and US inflation (averaging official CPI and Shadowstats data) all within a 2 year period around the solar maximum (note the 1968 solar max was November and the 1979 solar maximum December, hence the 2 year boxes following; also note some of the measures have been scaled to share the same chart).

Stepping back further in time, the 1947 solar maximum was accompanied by a 1947 inflationary peak, followed by spikes in corporate bond yields by 1948 and treasury bond yields by 1950.

If the next solar maximum is ahead in Autumn 2013, then by history we should see spikes in rates, yields, velocity and inflation within around 2 years of each other and of the solar maximum. Is it different this time because the government has acted to surpress both interest rates and bond yields? With velocity correlating closely with bond yields, is an inflationary peak not going to happen this time? I believe it will happen, as the same surpression occurred in the 1940s and yet the spikes took place.

The second chart (click to view larger) adds in real commodities using the CRB index adjusted for inflation (and again scaled). Interestingly, real commodities behave very similarly to rates, yields, inflation and velocity – all moving together into peaks (orange boxes) and troughs (red boxes), over periods lasting around 3 years.

There is a general pattern of collective peaks around each sunspot peak, and additional collective peaks before solar mimima. I don’t yet understand why we see rallies leading into solar mimina, however they have historically set up the panics and crashes that occur at the solar minimum. Nonetheless, yields, commodities, velocity and inflation all acting together is suggestive of waves of ‘human exctitement’ that brings about speculating, buying and circulating money in the economy, or the opposite.

The third chart adds the real inflation-adjusted S&P500 and US demographics trends (middle to old and middle to young ratios combined) into the picture. Here we again see evidence of ‘human excitement’ correlating with sunspot peaks as some combination of real stocks, real commodities and inflation spike up around the solar maximum.

Demographic trends appear to be important for real stocks to peak, whilst commodities appear to behave opposite to demographics.

In summary, there appears to be a 4-way correlation between equities, sunspots, demographics and inflation, whilst there appears to be a 5-way correlation between rates, yields, velocity, inflation and real commodities. My solar-theory take on it is that the same phenomenon of human excitement (driven up and down by the solar cycle) translates into trends in buying, asset speculation and circulating money, hence the united correlations, whilst demographics (which also have a solar input: solar maximum peaks (and occasionally troughs) in births) additionally feed into equities due to investment/disinvestment in equities, relating to retirement.

I’d be interested in your thoughts on any of the correlations in the charts. I suspect there is more to be teased out.

Solar Cycles, Demographics and Equities

Posted on April 23, 2013April 23, 2013 Posted in Commodities, Indicators, Inflation, Macro, Real Estate, Solar Cycles, Stocks77 Comments

A long post coming up, but I found this to be outlook-changing research.

Firstly, the Japanese stock index long term chart, with solar cycle maximums marked as black lines (C for commodity secular peaks):

Underlying source: Wikipedia

A fairly simple 100 year history: a long secular bear followed by a long secular bull followed by a long secular bear that potentially just ended at the turn of 2012 into 2013. The secular turns fell very close to solar maxima.

Secondly, the US Dow stock index long term, with solar maximums again marked in black.

Underlying source: Stockcharts

Alternating secular bulls and bears. I argue the mid 20s to mid 30s episode was outsized greed and fear events that cancelled each other out on the way to the true secular peak in 1937. The secular turns fell very close to solar maxima.

Thirdly, the commodities index long term, with solar maxima marked. Again, alternating secular bulls and bears, and again secular turns falling very close to solar maxima.

Source: Nowandfutures

Fourthly, 10 year treasury yields long term chart, with every third solar maximum marked.

Underlying source: Multpl

A longer term cycling of secular bulls and bears, but again the secular turns falling close to solar maxima.

Here is real estate, but only half as much history available as a global index (hat tip Rob):

Underlying Source: P Loungani

There is a tentative cycle here, with the peaks alternating on solar maxima and solar minima. Furthermore, there is the main (circadecadal) solar cycle averaging 10.66 years, and a lesser (circahemidecadal) solar cycle averaging 5.75 years. They fit rather well with the two cycle parts noted above. But a little more history going forward is required to judge this model’s validity.

Moving on, the next chart is US unemployment versus solar cycling.

Source: Gorbanev / Ktwop

Rises in unemployment just after the solar peaks. The chart fits well with my own chart, showing recessions occurring after each solar peak (which correlates with geomagnetism peaks lagging sunspot peaks).

And also this chart, which shows inflation spikes occurring at each solar peak.

Below we see money velocity rising into solar maxima and peaking before or at the subsequent recessions:

And the next chart shows the treasury spread (10 year treasury yields minus 3 month treasury yields) widens to a peak leading into a recession:

Source: New York Fed

Let me draw all that together. At each solar maximum, we see a particular risk asset or assets making a secular peak, whether this be equities, commodities, real estate or bond yields. I argue this is sunspot-driven biological human excitement that translates as a speculative mania in the popular asset class of the time. We also see inflation and money velocity spikes at each solar maximum, which I argue is also behavioural effects in the economy of the same excitement phenomenon. After each solar maximum we see peaks in the yield spread and unemployment and recessions. Market history dictates that bull market cycles end with inflation rising, yields rising and overtightening, so this fits with the picture being revealed. Excessive and unsustainable speculation and buying in the markets leads to excessive inflation and tightening and tips the world into recession – economists would relate to that phenomenon as a regular cycle of greed and fear, boom and bust. But add in solar theory, and sunspot maxima biologically help inspire the greed/boom part, whilst geomagnetism maxima (lagging sunspot peaks) depress sentiment to assist in delivering the fear/bust part.

So by this modelling, we should be seeing a secular peak in commodities and a secular bottom in treasury yields around the current solar maximum, which should fall either Feb 2012 (past) or ahead in Fall 2013. Both commodities and treasuries have fulfilled secular bulls through to 2012/13, regardless of what happens next. The difficult part is in timing the turns when you are close in on the action, as we are as traders here in 2013. What is clear is that money velocity has not yet picked up and inflation has not peaked (making its high thus far in 2008). US jobs and yields spreads do not indicate a recession, and geomagnetism is currently benign. Jobs are in fact predicted to grow ino the Fall:

Source: PFS Group

Historically, recessions have begun an average 14 months after solar peaks, so we might expect to see leading indicators for jobs falling by now if the solar peak passed in feb 2012.

Collectively, these suggest the solar peak is more likely ahead in Fall 2013 than behind us in February 2012. I previously showed that world bond yield and money velocity charts could be bottoming out based on technical action thus far in 2012-2013, and in which case an escalation from here through the solar peak (assuming Fall 2013) would fit well with history. That would also suggest an inflation peak, and a secular commodities peak, lies ahead.

We can now cross-reference this solar picture with demographic models.

The next chart is a 100 year chart of the US Dow p/e ratio together with the trend in US demographics as measured by the middle-aged to young-aged ratio:

Source: CXOAdvisory

This chart is the same demographics trend shown against the inflation-adjusted Dow.

Source: CMG Wealth

Both the p/e and ‘real’ Dow do the same job of removing inflation from the picture. There is a clear correlation between equities and demographics.

Chart 14 shows the SP500 netted of inflation versus the same demographic trend, and I have added in the solar maxima (black lines) again.

Underlying source: Chris Puplava

Now things get interesting, because there appears to be a three-way relationship between solar maxima, demographics and equities, with peaks and troughs in all three lining up. In my Trading The Sun PDF I noted there was some research identifying solar cycling as influential in population and demographics in other species, as well as research attempting to correlate solar cycles with longevity and mortality in humans. But I have now additionally found a research paper by Walter Randall (1991) that identifies an 11-year cycle in human births, and here is the chart showing that dominant cycle in the US:

Source: W Randall

Randall also found variation in human conceptions relate to sunshine levels and geomagnetism.

I have added the solar maxima to the US births per year chart below. We see births have typically spiked up a little at the solar peaks.

Underlying Source: CalculatedRisk

And here are UK births, with solar maxima overlaid:

Some clear peaks and troughs aligning with solar maxima.

So, we have solar-inspired waves in demographics which provides a reasoning for a correlation between the two.

We can also explain the demographics correlation to the stock market. 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.

So there we have our three way correlation between sunspots, demographics and equities (and housing too). Because of the solar cycle related births swells, we will find certain demographic groups peaking in numbers and relative numbers around solar peaks. That provides peak demand or supply (e.g. a peak in retirees disinvesting), and together with the sun-driven biological changes in human excitement at the peaks, we have a recipe for asset invesment and speculation peaks at solar maxima.

In the US demographic chart above we can see that the steepness of the secular bull from 1980 to 2000 appears related to the steep demographic uptrend of that period. Now here is the same demographic model for Japan:

Underlying source: Chris Puplava

Again, peaks and troughs in stocks, solar and demographics line up. The steep secular bull up until 1989 again appears related to the steep demographic uptrend of that period. The reversal in demographic trend as of 1989 appears to explain why Japanese equities topped out at that solar maximum and did not keep going until the 2000 solar maximum, whereas US demographics did.

Looking forward, we can see that the US demographic model reveals a new uptrend from this solar maximum (circa 2013) to the next (estimated mid 2020s), which is supportive of a secular bull, albeit a relatively shallow one in real terms. Meanwhile, the Japanese model is already in an uptrend and is good until around 2020. Japanese stocks are currently in a sharp upswing, belatedly catching up the demographics and suggestive of a new secular bull.

We have looked at middle-young demographics, so let’s now draw in middle-old demographics. The chart below shows the picture for the US:

Source: BusinessSpectator

The US faces a demographic headwind looking out to 2020 in this regard, unlike its middle-young asset. Using the m/o ratio only we see a prediction for the p/e ratio to drop to just 2-3 by 2020. This should be offset to some degree by the improvement in the m/y ratio. Nonetheless, there is something notable here, which is that p/e ratios for country stock indices appear to largely reflect demographics. In other words, a country stock index with a cheap p/e is only a good buy if the demographic trend forecast reveals an uptrend ahead. Some of the most ‘expensive’ stock indices around the world right now by p/e valuation are Indonesia, Mexico and Philippines, all of which have very favourable demographic trends looking forward compard to most of the world. Rather than shying away from these indices because they appear overvalued compared to historical averages, it might instead pay to invest there, as they should get more ‘expensive’ going forward. This also explains why the Nikkei around 1982 maintained a p/e of around 20 whilst other stock indices were making single digit secular bottoms, because it was in the midst of a positive demographic trend looking out to 1989. Note this relationship is longer term and does not preclude shorter term p/e oscillations. P/e valuations will overshoot and undershoot the demographic trend but mean revert to it over time.

The next chart shows the middle/old trend for Japan, which is a tailwind out to 2020, like the middle/young for this country.

Source: Zerohedge

Two more demographic measures for the US. The first chart points to a bottoming out by around 2020, followed by an upswing into 2036, which is supportive for a secular bull market.

Source: HS Dent

And this chart shows an enduring trend in nominal labour force expansion in the US into mid-century, standing out from the other developed countries shown.

Source: SeekingAlpha

So combining all four demographic measures for the US, we have strong odds of a secular bull from around 2020 to 2030. Prior to 2020 it may struggle to gain traction, and need a deeper washout in p/e. Let’s not forget that we are dealing with ‘real’ Dow/SP500 and p/es, so inflation matters. A sharp rise in inflation could drive down p/es whilst the index goes sideways. A lack of inflation could mean the index falls nominally before embarking on a momentum secular bull run from 2020-2030. Either way, because this demographic uptrend from 2020-2030 is ahead, we might not expect a major washout in p/e in the US. The SP500 and Dow are amongst the more expensive indices by p/e around the world but this could reflect the positive demographics ahead.

Let’s now look at dependency ratios (proportion of retired and young to the working population) demographics globally. Trends in the developed world contrast starkly with trends in emerging countries, as shown here:

Chart 23 reveals the bad situation kicking in as of now in developed countries:

Whilst the next chart shows a particularly positive outlook for Philippines, Malaysia and India:

And the next chart provides another comparison:

Brazil looks good. The USA improves looking out to mid-century. And the worst: Japan. So let’s return to Japan, which we can also model using the dependency ratio as below:

Japan is understood to have battled with asset deflation for 2 decades. However, we see that demographics were responsible for a p/e or real downtrend in Japanese equities from 1989 to around 2000. Then the m/o and m/y demographic trends picked up again, and we can see in the chart below that the Nikkei effectively tracked sideways since then.

We might therefore take a fresh look at it and consider the Nikkei was in a downtrend for a decade (or one solar cycle) and then turned sideways as the demographic trends in m/o and m/y changed upwards. The massive spurt since October 2012 therefore looks reasonable, as a belated catch up to trend. However, not all is well for Japan. The dependency demographic trend is the worst around the world in that it is likely to become devastating by mid-century. It also has the largest debt-to-GDP ratio in the world, over 230%. Interest rates are effectively zero, and cannot be allowed to rise much because of the servicing of the debt. There is little hope of major GDP growth in the years ahead because of the dependency trends and the debt. Despite this, Japan is going hell for leather in a bid to restart the economy and ignite inflation, now doubling money supply from 29pc of GDP to 56pc of GDP by 2014. The first result of this ultra-aggressive policy has been a swift 20% drop in the yen. As Japan is an energy importer, this has immediately produced a big uplift in energy price inflation. If I am correct in predicting a pick up in money velocity here, and also correct in a commodities/inflation peak ahead relating to the solar maximum, then I suggest there is the potential for Japanese inflation to quickly become problematic. As the government cannot combat with rate rises because of the debt servicing, the risk then would be hyperinflation. I know hyperinflation is overhyped, but I just wonder whether it is worth an outside bet here.

Hyperinflation has historically been initiated by either rapid increases in either money supply or money velocity, then the other one has joined in to complete the feedback looping. Japan is obviously at full acceleration on the former. Under hyperinflation, stock markets have historically gone wild in nominal terms, but the cost of living has gone even wilder. In Zimbabwe, the stock market went up 47,000% in a year, but the cost of living rose even faster. So a Japan hyperinflation trade could be achieved either by a spreadbet on the nominal index or a long Japan fund whilst short the yen. This is how I see it: Japanese stocks should rise on the belated catch up to m/o and m/y demographic trends, regardless of the Japanese government’s policy actions, but those actions have the potential to produce wild inflation which would then take Japanese stocks in nominal terms much higher.

Back to demographics. The headwinds facing many developed countries in dependency trends are problematic. Here is real estate modelled against dependency for six developed nations:

Source: Business Insider

If we refer back to the global house index chart further up the page, that cyclical model projected no real take-off in global house prices until 2019. These dependency charts suggest headwinds that further cement the likelihood that housing won’t offer a great return for the next few years in the developed world, applying equally to most other European countries, New Zealand and Canada. China and Korea also faces the same dependency trend issues starting around now.

The countries with the best demographic trends looking forward include India, Brazil, Mexico, Indonesia and Philippines. South Asia, ASEAN and South America look particularly fruitful regions going forward, and Sub-Saharan Africa too. If this is a global transition into a K-Spring, then investments in equities and real estate (K-Spring’s champions) might do best in these countries and areas. The USA should perform well too, from 2020 to 2030, but the period before 2020 is less certain.

Brazil and Mexico have good prospects until around 2025 but India and Philippines extend until 2040. Contrast this with China, which is just hitting trend reversal point into a negative trend, and we can see the likelihood of China stepping back from being the world’s leading growth engine, and in doing so maybe provide a backdrop to a secular commodities bear (as it is the world’s largest commodity consumer).

Source: DarwinsMoney

Dependency ratio trends and projections for select nations:

Source: John Eyers

Maybe the investment star of the next two decades will be India, which could feasibly rise for multiple solar cycles in a powerful secular bull that resembles the Nikkei into 1989 or the Nasdaq into 2000. With its 1.2 billion inhabitants it has the potential to mobilise something significant. But India, just like Brazil or Philippines or Mexico or Indonesia is an emerging country, with emerging risks. Let’s say the demographic outlook provides potential for great returns in these countries, but the structure to achieve it is less reliable than in the developed nations. The developed nations conversely have the track record but now the demographic headwinds.

To draw back together demographic trends, solar cycling and equities, we might expect that the positive demographic trends that have been in place in some of these emerging countries to have provided a secular bull over the last solar cycle, much like the Nikkei powered its way through 4 solar cycles in a secular bull set against a positive demographic backdrop. This is indeed what we see:

Source: Yahoo Finance

Over the last solar cycle, from 2000 until now, all the four country indices shown have made secular bull markets, not secular bears, in line with the demographic trends. They are all also amongst the most ‘expensive’ countries in the current p/e spectrum in the world, again in line with the demographic trend. I suggest that the ‘expensiveness’ of a country’s p/e rather has to be measured in terms of its relativity to its demographic trends. I also suggest that due to the demographic trends in all four remaining positive for another solar cycle, they should go on to continue their secular bull over the next solar cycle. I suggest that may be at a steeper rate, because it will be against the backdrop of a global K-spring, an up-cycle. As a reference point, see how the Nikkei secular bull (first chart in the article) that lasted for 4 solar cycles was at its steepest in the solar cycles of 1947-1958 and 1980-1989, both of which were global upcycles, a K-spring and a K-Autumn.

To conclude, these are the opportunities that I see (for myself of course… I am not an advisor).

1. Long Japan, due to m/y and m/o demographic uptrends until 2020, and an outside bet for hyperinflation. Averaging into any falls. We can see Japan’s little window of positivity here, in the upturn in the green line between 2005 and 2020:

2. Long USA, but more compelling as of 2020. At risk of a p/e washout before then. These two charts show head and tail winds respectively for the US market from now until 2020:

Source: Informed Broker

3. Long a basket of emerging markets with the best demographic outlooks: choosing from India, Philippines, Indonesia, Brazil, Mexico and potentially sub-Saharan Africa. Averaging into any falls.

Here is the very long term look at dependency ratios to end:

Source: Appliedmythology

If these projections hold true, then the four lowest listed regions should offer the best opportunities over the next solar cycle. The following solar cycle the USA stands to fare well (where the blue line flattens). And later his century Russia and Eastern Europe may get their shot at being investment gold.

Additional chart: prospects for specific sub-Saharan African countries: positive demographic trends for the next solar cycle for Algeria, Ghana, Nigeria, Cameroon, Ivory Coast and South Africa:

S O L A R C Y C L E S

Category: Inflation