Longer Term Cycles and Demographics Revisited

Today's post will be a big picture type post and discuss some major cyclical tendencies and how that relates to the market and economy.

The first thing I wanted to touch on are the longer term reliable cycles that show up in the markets. I don't use typical "cycle" type analysis in my trading, partly because I have never seen anything that I really think is objective and increases the bottom line. But I love to learn and read new ideas, so anybody that feels they have good sources for shorter term cycles, please drop me a comment with a link or book name etc.

Here are some of the most reliable cycles affecting the market on longer term (investing) horizons:

1) The Annual Cycle - stocks consistently show weakness and actually negative returns on average in September and October. This is one that I don't know much about the "why" it happens, though I have read some places that some laws regarding taxes on equities, etc may be the driving force behind this annual period of stock weakness. In the same way that the Christmas/New Year season (January effect, Santa Claus rally, etc) is stronger than average, the Sept-Oct period is consistently weaker.

2) The Decennial/Decade Cycle - Since there are less decades than years, this cycle has less data to draw from but still shows consistent tendencies. The basic pattern is that the middle years of a decade are the strongest for stocks, with the x5 year having a very strong tendency to be positive. The majority of bull market tops come in the x6 and x7 years. The other major tendencies are for weakness in the early years of the decade - x0 x1 and x2. Also, the x2 year tends to be the most common year for major bear cycles to bottom. Your guess is as good as mine as to why these tendencies exist.

3) The 4 Year/Presidential Cycle - This cycle has been remarkable for basically the last century. There is a very strong tendency for major corrections to occur and bottom about every 4 years. When relating this to a 4 year Presidential term, those corrections occur notably during the 2nd year of the term. Then the 3rd and 4th year of the term tend to be much stronger.

Just as recent history examples, in 1998 the Long Term Capital Management fund blow up happened with the sharpest correction in several years for stocks. This also occurred in the fall of the year. Then in Oct 2002 the tech bear bottom (also the fall). Then in May-July 2006 the most fear provoking correction of the 2003-early 2007 period occurred prior to the topping process in the second half of 2007. So, 2010 is the next "due" date for this cycle and will be Obama's second year. Some chalk this cycle up to the tendency for new administrations to quickly enact major policy changes early in their term. In typical govt. fashion, this amounts to major expenditures. And certainly in the last decade or so, the govt. spending/debt has been ballooning. Anyway, most people chalk this tendency up to some market reaction to new administration policies.

4) The Spending Wave/Lifetime Cycle - I became familiar with this cycle via Harry Dent's work. You can check out hsdent.com or his books for more info. Anyway, their main research is in the field of demographics and its relation to the markets. This is all very factual data that can be attained from government censuses and surveys and other data. Basically people move through predictable stages of life with predictable peaks and valleys in debt, earnings, spending, etc. Also, census data can tell you how many people are hitting these stages during giving periods of time.

So everyone knows about the baby boomers which is the largest segment of the population in our country. Well, they have been in their peak years of production and spending this decade, and based on averages would be projected to peak in consumer spending this year. (The data seems to indicate that it was probably last year or late 2007). These long trends of increasing earning and spending are now turning down as there is not an equally large population segment behind the baby boomers to continue their trend. So many of them will be retiring and will be gradually decreasing spending, decreasing net earnings, and eventually become an increasing social cost via Social Security, etc.

In our particular point in time, this baby boom also resulted in a major housing boom as they hit their peak home buying years in the middle of this decade (around 42 yoa). Unfortunately, sound lending was thrown out the window during this time, and it has led to a corresponding debt bubble (both in housing and also in consumer credit) of historic proportions. Anyway, there is every reason to believe that downturn of baby boomer spending and, in fact, major pressure to pay down debt, will drastically reduce consumer spending and corporate earnings for years to come. Since the money being paid down is to banks, and is fiat money/credit, the only question is how big the default will be and how many lenders will go down because of it. But that money/credit is definitely not going to be there for other major economic sectors.

While it is a process of years and decades for this lifetime spending cycle to ebb and flow, the market is able to react very quickly to data and realization of future trends. Because of that, the market always tends to lead the actual data and fundamentals significantly because it is able to rapidly bring asset values in line with perceived value. So for the stock market, you should expect the prices to be bottoming during and before the worst economic numbers are actually showing up, and then be advancing off those panic low valuations in the face of horrible economic data. That is in part what we are seeing now, but that is also why it is important to understand both fundamentals and the human psychological component of markets. For whatever reason, the mass psychology does not move between extreme perspectives in smooth trends. There are clear oscillations up and down in the midst of larger social mood trends. That idea is a fundamental tenet of Elliott wave theory and why it can be useful in analyzing auction markets and even other social trends.


Now there are several other cycles that we could look at like shorter term business cycles (Armstrong Cycle), long term economic cycles (Kondratieff Waves), etc, etc. But I think that once we get into those there starts to be significant overlap as to the causes of the cycles - like they are all models/representations of the same concept, even if they have different time frames they look at. My personal opinion is that largely these long term economic cycles are in fact monetary cycles. As long as we have the same basic monetary system and somewhat capitalistic, free enterprise economies, there will be cycles of indebtedness and business expansion as confidence and population growth/demand occur. And that will be followed by default of some debt and the eventual waning of demand due to population variances and willingness and desire to lend and borrow.

So looking at the cycles above, I believe demographics show that we are entering a period of multi year decreased consumer spending and lower corporate earnings. So there is little or no chance of true economic growth for a little while. Also, we are entering the early years of the coming decade when most often stock have been weak. Into next year, we will be hitting what has typically been the worst time for the 4 year cycle for stock prices. We are now entering a seasonally weak period for stocks, which should give a little added weight toward defensiveness toward stocks and possibly violent resumption of a longer term downtrend in stocks and the economy.