Saturday, April 28, 2018

Interest Rates, Demographics and Stock Markets. Captain Kirk here we come!

Harry S Dent used demographics of the Baby boomers to predict stock market performance. He predicted based on the generational behavior patterns. He stated that a new generation goes to school and costs money; that generation gets older and starts a family and buys a home. Young kids grow up and costs lots of money and needs larger homes and parents take on lots of debt. The generation becomes ‘empty nesters’, saves and invests for retirement. The generation retires and sells assets to finance life of the golden years while creating stock market crashes. Harry would overlay his demographics on stock market performance charts and first was very bullish for up to the year 2000 and then predicted a great depression era around 2012. His general ideas came through, but he believed too much in the effect of demographics and in detail he was often out by miles.

Inflation in the 1980s could be explained by the growing debt society created to educate the kids of the baby boomers. It justified the sky-high inflation and with that high interest rates and even high oil prices. But the baby boomers should have stopped buying and borrowing between 2005 and today; it should be the Millenniums repeating the patterns of their parents. Yet debt levels have kept going up while inflation has fallen. We saw under Mulroney a close relation though between tax increases, inflation rates and interest rates. So maybe there is a relation.

But now, although debt levels have been higher than during most of history and after we experienced a falling inflation rate and corresponding interest rates for decades, this model seems to fade. First of all, our grand parents and parents had experienced the Great Depression and one or both World Wars. Did they truly follow the same generational patterns as we, baby boomers did?  Isaac Asimov in the Foundation Science Fiction series also felt that it is possible to predict the future based of human behavioral patterns although it required a lot more sophistication than Harry Dent's: a secret Second Foundation  of psycho-historians that guided mankind and when that failed an nearly god-like robot living in hiding for centuries in a cave on the moon. Coincidentally, the founder of the Second Foundation was Hari Seldon. Great story, but realistic?

Canada's Prime Interest Rate 1960 - Today
Here is Canada’s prime rate from 1950 to today. You may recognize the 1982 peak in North American inflation with peak interest rates followed by ever-falling rates thereafter until today. Pure demographics! Baby boomers in the 1980s were in prime child rearing years and in high indebtedness – so was the theory.  Then with becoming empty nesters and with becoming more mature in their careers they should have spend less; save more and thus interest rates fell. Duhh.. but why then has debt kept on going up? What about the role of energy prices that fired up inflation during the oil shocks of the 1970s. How is that related to those nasty kid bearing baby boomers? But the stock market has boomed after the 1982 interest rate peak. So now market valuations should be sky high as interest rates are lower than low.  Earnings have grown consistently but to be honest, P/E ratios have not increased as the theoretical relation between interest rates and stock market evaluation suggest. We are right now trading at earnings valuation levels not that different from historical averages. Oil prices were sky high, peaking at $147 dollars or so around 2011, and yet there was not a lot of inflation like in the 1970s.
Dow Jones 1960-Today. Notice nearly inverse of Interest rates from 1982 until today, yet...
As a kid, I was always told that the 1950s, while recovering from the second world war, was Europe’s and America’s golden age. I became a teenager with the Beatles and Rolling Stones. Elvis and Chuck Berry were already passé. Frank Sinatra and Tommy Dorsey were quaint and ancient. Look at stock market performance from the Great Depression until 1955. Now that was a bull market, although a bit interrupted during the 1939 to 1945 world war! Hmm, does the War on Terrorism from 2001 onwards (we are still in Afghanistan and Iraq) affect our stock market as well?  Sorry, you can’t find it back in the charts? But those modern wars although not as intense as the 2nd world war or the cold war, last now for over a decade! Yet, we barely notice it in our daily lives. 

Dow Jones 1928-1960 with 1928 crash. Check stock market performance from 1939 to 1945. Strange he? No crash!
In 1972, we went off the gold standard and since then we should have had rampant inflation according to the gold bugs. But if so, why does the 1928 – 1955 stock market boom look so much like the 1982-2001 bull market? Economists tell us that our real income hasn’t increased since the 1970s, but I can tell you that our standard of living compared to the 1950s, 1960s, 1970s and 1980s has gone up tremendously. World poverty has come down quite a bit as well. Compared to then we live the luxury of science fiction. By comparing from 1982 $900 gold peak to the 2011 $1900 peak, inflation was barely 72/29= 2.4% annually. Eh…????  I thought economists told us historically inflation was 4% and in 1982 it was over 10% So how does that jive? Is gold not an inflation hedge after all?
Flat markets between the rise of the Beatles (1964) and Paul Volcker (1982).
Here is the stock market from 1960 to 1987. Look up to 1982 there was no performance. They called the 1970s a lost stock market decade. However to me it looks like that it was nearly 15 years of lost stock market performance. From 1965 to 1980 or so was a time of little technological advance. No rail ways or electricity or cars or TVs were coming into our households as nearly daily innovations.  Between 1928 and 1960 we had all manner of technological breakthroughs, including invention of television, transistors and nuclear energy.  The 1970s were years of low growth with oil price shocks considered the big culprit. But looking back, those years were miserable with lots of unemployment lasting in Europe well into the 1980s and with little technological progress. Then, in the early 1980s, the color computer was introduced at an affordable price (around $700) to us young baby boomer consumers. People like me went nuts. Your own programmable computer in your house! I know that geology when I grew up was kind of a static science where it took forever to create any kind of map that was drafted by hand and reproduced using ammonia saturated vellum. Printing machines were kept on a separate office floor to keep the stench away. Then came the dot-matrix printers and desk top computers. And our productivity shot through the roof.

2001 to 2008 was up and down, a period of seeming technology consolidation and stagnation like the 70s. But if you looked from 2001 to 2007 the markets clearly were going up. Those years were a resource boom in Canada like the 1970s and there was still considerable technology break through which may have accelerated today. Really, our standard of living has leaped forward. Just look at my vacuum-cleaning-robot, at my deLonghi coffee machine, at my computing power gone Wi-Fi throughout the house and my garage door opened from my smartphone, and my self-learning thermostat – not to talk about advances in my car. Shale-oil anyone? 
Yes, the doom & gloomers tell me the fiat currencies are about to collapse because of massive debt problems. The average worker has apparently had no real wage increases since the 1970s removal of the gold standard. Then why are we doing so well?  It must be the fault of all those rich people raking in all the money?  According to me it is the ever money hungry governments that takes more and more of our money. But even that hasn’t stopped us to live in ever larger and fancier houses. Just saying.  Oh, by the way, personally I never had it so good. 
So that is my conclusion. Stock market performance is not guided that much by interest rates. It are not just energy prices, nor is it the current stage of generational development that sets stock market performance. All those things appear to be somewhat cyclical and may cause stock market volatility or certain forms of trading patterns. But the real cause of our prosperity is technological advancement. We can be more productive and are becoming increasingly better at using the resources around us. Periods of fear for running out of oil and gas like in the 1970s, periods of fear for polluting our environment or changing our climate, or fearing terrorism or major wars, those seem often to push us from complacency and help us invent new technologies and increased productivity.  Just like in our personal life, for us to make progress we, as a society, need challenges - things that keep us from sitting on our laurels and to make us innovate. From that point of view, our knowledge and innovations seem to be on a parabolic upward trend. And if that is real, we will see unparalleled prosperity in the future despite claims of our economists and financial gurus to the contrary. So, immortality here we come. Aliens out there hold on to your seat because we will travel space not too long from now. And Elon Musk, you old fraud; yes we may be colonizing Mars sooner than we think. Oh… and Wall street, you are the real fraud scaring us with all your doomsday predictions while charging fees in the trillions. You apparently have no clue where stock prices are going with your every changing investment theses. Kind of like climate change, I guess (couldn’t let that one pass).  Finally: Captain James T. Kirk we are on the way!

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