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Strategies & Market Trends : Booms, Busts, and Recoveries -- Ignore unavailable to you. Want to Upgrade?

To: AC Flyer who wrote (27284)	1/10/2003 11:13:32 PM
From: TobagoJack	Respond to of 74559

Hi ACF Mike, <<... disclosure ... comfortable anonymity ... for you?>> for me? fun and mischief, which in turn is fun. As for the disclosure of allocation is concerned, makes the fear real, terror genuine, and decisions meaningful ... much like a money manager;0) Chugs, Jay

To: AC Flyer who wrote (27284)	1/11/2003 3:35:25 AM
From: TobagoJack	Read Replies (2) \| Respond to of 74559

ACF Mike, I think you will be right as well, though timing may be off by a bit ... dailyreckoning.com Why Demographics Tell Us The Market Will Fall John Mauldin There are certainly connections between age demographics of the population and the stock market. However, I do not buy into Harry Dent's theory espoused in his book The Roaring 2000's, which states that the stock market will go up until the Baby Boomers start to retire in 2007. He makes connections between charts and numbers that I do not feel are warranted. But he is certainly not wrong that there is a strong correlation between age and buying and saving (investing) preferences. Dent's mistake is in assuming that because Boomers will be saving until 2007, the stock market will be going up as well. There is a certain appealing logic to this, but unfortunately there is no statistical correlation. As Rob Arnott's study shows, the actual underlying correlation for much of the apparent connection between the boomer generation and the stock market can be found in the ratio of children, workers and retirees. Now we find a rigorous academic study which shows a further strong correlation between age demographics and the Price to Earnings ratio. This paper is by three rather well known economics professors writing for the Cowles Foundation at Yale. (John Geanakoplos from Yale; Michael Magill from University of Southern California; and Martine Quinzii from University of California, Davis.) The importance of this study is not that it gives us some new startling conclusion. It corresponds quite well with research and observations by Michael Alexander in his book Stock Cycles, among others. What this paper presents is a model of how and why the changes in the age demographics influence stock market prices. It takes us from the world of anecdotal or inferential evidence into more solid statistical basis for prediction. It moves us from the intuitively obvious (guessing) to a place where we can be more confident about our assumptions. When combined with the half-dozen other studies I have written about on this topic, it makes me much more comfortable that my opinion that we are in a long term secular bear market is accurate. (You can read about those studies in the draft chapter on secular bear markets in my upcoming book.) The Predictability of Randomness Quoting from their introduction (with my added emphasis): "The results that we obtain strongly support the view that changes in demographic structure induce significant changes in security prices – and in a way that is robust to variations in the underlying parameters. When we parametrize the model to U.S. data, we obtain variations in the price-earnings ratios which approximate those observed in the U.S. over the last 50 years, and in line with recent work of Campbell and Shiller (2001), the model supports the view that a substantial fall in the price-earnings ratio is likely in the next 20 years. For the 40 year cycle in population pyramids, gives rise to a 40 year cycle in equity prices-and the prices, although random, have a strong predictable component." Essentially, the authors create a fairly complex mathematical model of the economy. They note that based on earlier studies, there is a demonstrable difference between how young workers spend and invest and how older workers spend and invest. Further, there are differences in income. They take into account business cycle shocks, output fluctuations and how much risk tolerance or aversion each generation has. "Because the typical lifetime income of an individual is small in youth, high in middle age and small or nonexistent in retirement, agents [that's us - John] typically seek to borrow in youth, invest in equity and bonds in middle age, and live on this middle-age investment in their retirement." This is a well-known lifecycle of an investor, but it has an important role to play: "....this lifecycle portfolio behavior implies that the relative size of the middle and young cohorts, which can be summarized in the medium-young cohort ratio, plays an important role in determining the behavior of the equilibrium prices on the bond and equity markets. In simpler terms, they divide the various age groups and generations into "cohorts." They vary the birth rate of each cohort to show baby booms and baby busts. The ratio between young generations (or cohorts) and middle-aged generations is something they call a MY ratio. (Middle-Young) When you factor all the variables, apply different sets of economic assumptions, subject the model to "shocks" (such as the 1973 Oil Crisis) and so forth, the outcome is still the same: there is a strong correlation between the ratio of young and middle workers and the price to earnings ratio. Indeed, when you overlay their MY ratio with the P/E ratio on a chart, it appears that the MY ratio is now the "trend" to which the P/E ratio is invariably brought back. Thus their model predicts that the P/E ratio will drop from the current 30 or so to somewhere between 5 and 16 in the next 20 years. The wide range is because of different assumptions. If you make fairly optimistic assumptions, you get 16. If you are pessimistic, your assumptions might lead to the model showing 5. But a drop to 16 is a very dramatic one. This is different than simply saying, as Robert Shiller does, that P/E ratios always revert to the historical mean, which is about 15. This paper suggests there is a fundamental reason for that "reversion to the mean": the age ratio between generations. You can read the paper for yourself here. Sideways to Down for 20 Years? Now, let's look at some implications. First, remember that average actual corporate profits grow at roughly GDP plus inflation. That has been roughly 6%. That means profits double every 12 years. Let's take an optimistic view that the economy is going to really rebound this year and the P/E ratio of S&P core earnings next year will be 30, rather than the current 45 or so. That means that if the P/E ratio drops to 16, it will be 12 years before the market permanently rises from the levels at which we are today. You don't even want to do the numbers for what happens if the P/E ratio drops to 5. Will the market go up next year? The model is not that precise. As Alexander shows, the price movements from one year to the next is pretty random. All this paper tells us is that sometime over the next 15-20 years, there is going to be a fundamental shift to the downside in the average P/E ratio. This means that the market moves sideways for a very long time until the P/E ratios come into line, or that the market drops at some point. Other work I have written about suggests that markets will move down in concert with future recessions during secular bears. It is reasonable to assume that we will have several recessions over the next 15 years, so one could expect a long drawn-out secular bear. Not a pretty picture for index fund and buy and hold investors. But it is also a market with different types of opportunity for more nimble investors and those with a willingness to think outside of the buy and hold box.