Something Even Bigger than the Election Cycle?

By Matt Blackman – Market Analyst for www.TradingEducation.com  

While the election cycle has exerted a significant force on stocks and markets, here we examine a long-term cycle that has the potential to wield an even more powerful and long-lasting impact.

There is little doubt that the election cycle exerts one of the biggest influences on the stock market, not only in the U.S. but around the world. And as we have seen, it has an even greater impact on commodity-based stock markets like the Toronto Stock Exchange (TSX) because of the inflationary effect pre-election pumping has had on commodities. However, there is some evidence that there is an even more powerful cycle affecting markets since the beginning of the twentieth century and possibly further back than that.

In his thought provoking and controversial book, The Great Bust Ahead, Dan Arnold lays out a theory that he believes clearly explains booms and busts over the last 100-plus years. In a nutshell Arnold says that markets have been driven by demographics – specifically by those in their maximum earning and spending years, the 45 – 54 year olds. When this group represents the largest segment of the population like it is now and like it was in the roaring twenties and mid-sixties in the U.S. and late eighties in Japan (before their crash of 1990), economies and markets boom. The more of these high-spending gray-wavers there are, the greater the boom.

Conversely, the fewer of them there following it, the more severe the downturn. Arnold believes the next peak will come no later than 2013 and possibly earlier after which a “rapid, relentless and catastrophic” fall will occur until about 2025 when this demographic again comes into play.

According to Arnold there are more than 100 million baby-boomers in America and they will start hitting retirement age in 2011 leading to what he believes will be “the greatest depression in U.S. and U.K. history – much worse than the Great Depression of the 1930s.” It seems too simple to be true. How can plain demographics explain complex economic relationships?

Arnold’s theory relies on one very powerful relationship. Consumer spending accounts for 70% of gross domestic product (GDP) in the U.S. which measures economic growth and so it follows that where the consumer goes the economy and markets are sure to follow. If the biggest spending demographic does begin to decline in 2011, there is no doubt that it will have a sizeable impact.

Figure 1 – Chart from The Great Bust Ahead showing inflation-adjusted Dow Industrial performance (blue line) versus demographic profile of the gray-wavers (red histogram). The cyan line shows projected Dow performance based on this demographic cycle and green arrow is where we are today. Chart www.thegreatbustahead.com

The good news is that between now and then Arnold says the Dow will at least double to 26,000 with a maximum based on the demographic data of 32,000 as this rally continues. One caveat is that in 2003 he predicted a Dow at 13,000 by the end of 2004 (see */Heading for a Meltdown /*link below) which was nearly 2.5 years early, highlighting the challenges of market forecasting.

However, combine this spending demographic with the fact that 2007 is a pre-election year and the prognosis for both the economy and markets is positive at least until the next Presidential election in November 2008. However, once the election economic euphoria has faded, it could be rough sledding as we head into 2009 and 2010 especially if something causes the all-important 45-54 year group to cut spending early.

Read Dan Arnold’s 2003 article entitled Heading for a Meltdown http://tinyurl.com/2be269   

Matt Blackman is a market analyst for www.TradingEducation.com, a free educational website, and is a technical trader, author, reviewer and keynote speaker whose work has appeared in a number of major financial publications, websites and newsletters. He is also the host of www.Electionomics.com a website devoted to investigating the impact of elections on stock markets around the world.  He is a member of the Market Technicians Association (MTA) and Technical Securities Analysts Association (TSAA).