Sunday, November 24, 2013

11/24/2013 They can stop blowing bubbles if they want

Sector Model
Large Portfolio
(Since 5/31/2011)
Sector Model
Large Portfolio
No rotation this week, which gives us time to step back and ponder a few questions.
Let’s say there are six people living in your house.  What will give your household the most money?
First choice, you get a better accountant to pay lower taxes.
Second choice, you send out resumes and get a better job.
Third choice, three other members of your family all get jobs.
I think that we miss the obvious when we talk about politics and economics.  You could try to pay less taxes or get a better job, but the most effective way of improving your family finances is if more of you are working.
In that family of six, though, some folks are too young to get a job, and some folks are retired.  You have young kids and your retired parents are living with you.  The amount of money your family has, then, depends on how old everyone is.  The more people there are between 25 and 70, the more money your household can earn.
In 1914-1918, the world was devastated by a horrific war that took the lives of countless young men.  To compound the problem, the Spanish flu killed off even more young working aged adults.  By 1929 the economy collapsed into a Great Depression that lasted until the end of the second world war.  Then, in 1945, the great generation did the greatest thing of all: they made babies – lots and lots and lots of babies.
In the 1970s those babies were trying to get jobs, so two things happened at the same time: the unemployment rate went up, and the employment rate went up.  To repeat, BOTH “unemployment” AND “employment” went up.
“Unemployment” is the rate of people who are looking for work.
“Employment” is the rate of people who are working.
People were entering the workforce even faster than jobs were being created.
Today we have the opposite thing happening.  Now “unemployment” and “employment” are BOTH declining at the same time.  When both employment and unemployment were rising in the 1970s, we had to fight inflation.  Now that both employment and unemployment are falling, we are fighting deflation.
But we need to fine tune this model with a question.  Who is most likely to create a job: a 25 year old, a 45 year old, or a 65 year old?
The 25 year old can take risk, but has no resources.
The 65 year old has resources, but can’t take risk.
The 45 year old has resources and can take risk.
Most jobs are created by people between the ages of 35 and 55.
The S&P tends to track the birth rate plus 46 years, adjusted by…
Ned Davis adjusts against inflation, but there has been no inflation during QE.  I’ve toyed with M2 money supply, but that’s not an exact match either.  The truth is that no one knows exactly, which is the cause of the confusion about the direction the market will take in the next few years.
In previous posts I’ve estimated the future trajectory, but all anyone can do is estimate during this period of QE.
What CAN be estimated, though, is the NATURE of the market.
As I’ve noted here:
and here:
we are scheduled for a cyclical bull market to begin in 2013 and last into 2018.  In secular terms, this is a secular bear rally, with the final bottom to come in a collapse during 2018-2023.  By 2024, the secular bear is over and we enter a new secular bull.
The arguments you see in the news today are that we are either in a new secular bull market or we are beginning a bubble.
BOTH are wrong.  The 2009-2013 market was a QE bubble.  We are ENDING that bubble, not BEGINNING one.
Here is the breakdown:
1982-1999 secular bull market
2000-2023 secular bear market
2024-forward secular bull market
We know this from the birth rate plus 46 years.  The “secular market” is simply a reflection of what percentage of the population is between 25 and 70.  That’s it, PERIOD.  Everything else is noise.
But in the breakdown of the current secular bear we have the following:
2000-2007 secular growth halted
2008-2013 secular decline (i.e. cyclical bear)
2014-2017 secular rally (i.e. cyclical bull)
2018-2023 secular decline (i.e. cyclical bear).
In case you missed it, from 2009 we’ve had a roaring bull market and a mountain of quantitative easing.  Bernanke has been printing money like a mad man, and the market has been rising.  THAT was the bubble.  It isn’t STARTING now; they are trying to TAPER it now.
The bubble was the positive correlation of the Fed balance sheet and S&P returns:
But that correlation has recently broken down, even as the S&P continued to advance.  That breakdown in correlation marked the first bottom of the secular bear, and the beginning of a cyclical rally within that bear:
If they continue QE without tapering, of course, we’ll see further distortion.  So, my point isn’t that they WILL taper QE now, but merely that they CAN taper now without the market collapsing:

To summarize, we are not ENDING a bull and BEGINNING a bubble.
Instead, we can END the bubble because we are BEGINNING a self-sustaining bull.
In the next correction you’ll see all the news stories shout about a bear market.  They’ll be wrong.  The next correction will just be a correction.  There should be no bear market before 2018.
I could be wrong, of course.  A sharp rise in taxes or a sharp rise in interest rates could reverse the effects of QE instead of merely taper.  If that happens, we could return to “normal” levels, which are drastically lower than now.  On that chart above, 2013 would have seen S&P levels below 500, instead of the current level of 1800.  But that would be a change in the Fed balance sheet.  At current levels, a mere tapering would not halt the bull market.
Confused yet?
That’s what happens when the Fed does something it’s never done before.
In simplest terms:
The market will go up if they continue QE.
The market will go up if they taper QE.
The market will ONLY go down if they REVERSE QE.
…that is… until 2018.
Enjoy the ride.

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