Of Babies And Bull Markets

by: Seth Walters

The price behavior of markets is truly fascinating. At times, they seem to be almost simplistic in their predictability, and at other times they seem totally chaotic. And yet, despite the complex nature and differential feedback of the inputs that go into determining equity prices, stock market technicians have discovered price patterns that repeat themselves over and over again. And thus, despite the mathematical complexity of inputs to price action, some of which come from outside the system and should be completely unpredictable, at times the markets behave in a beautifully simplistic manner, bouncing off various trendlines almost like clockwork.

Today, I will present a new leading indicator of inflation-adjusted equity prices over time: The number of live births. Along with this indicator, I will present the output of a mathematical model I built to predict the future annual number of live births, which I think may give some indication as to the broad future movement of the equities markets up to the year 2100.

Click to enlarge

There are a number of interesting features of this data. The first, and most interesting to an investment audience, is that an increase in the annual number of live births seems to portend an increase in the inflation-adjusted value of equities several years down the road, just as a fall in the number of live births predicts a decrease. The shape of the birth rate plot is also eerily similar to the shape of the inflation adjusted Dow Jones (NYSEARCA:DIA) plot.

We can see for example that there was a spike in births stretching from 1903 to 1914, which was echoed in size and shape by the bull run of 1920 to 1929. Similarly, the sharp drop in births in 1914 mirrors the vicious bear of 1929-1932. The birth rate continued to decline after that, but reversed in 1933 and increased until about 1959. This was mirrored by a bull market in equities from 1947 to 1965. And finally, the great bull run from 1982 to 2000 was preceded by a bull market in babies which started in 1976.

I dug into the data that I had and built a model intended to predict birthrate. Without getting into the details of the model, I can tell you that for every point that is predicted by the model, it uses only birth and fertility rate data that is 16 years old or older at the time. So for example, the model's prediction for 2012 uses only data from 1996 and earlier. The fertility rate in the United States is amazingly mathematically beautiful, and can be described pretty accurately by a declining secular trend combined with a cosine function or two. Thus, there is a general decrease, but there is also regular mathematical oscillatory behavior in this datum.

Unfortunately, while my model does a spectacular job of predicting the number of births from 1940 to 1990, it has become a bit less accurate since, although you can still see the correspondence. Whether this is due to birth control, abortions, immigration, or some other factor I do not know.

The take home message in this data is that twice before, when the number of births declined, so did the inflation-adjusted Dow, a few years later. Our most recent peak in births was in 2006, and given the typical lag time of this leading indicator, we can expect the inflation-adjusted Dow to start experiencing secular forces that promote a decline in prices right about now. This trend may be shallow or it may be deep. There is a bit more to the Dow than just the number of births, but we can observe that, twice before, the Dow has descended from its peaks back to an inflation adjusted baseline, which today is around 3,000. Since that is an annual average, that might mean that the Dow would have to touch 2,000 at some point to actually achieve such a target. I think it is possible that this time is different and we will buck the historical trend - that changing technology has made a real difference this time, or that the decrease in births is shallow enough not to plunge the Dow back to that low baseline. But I don't think it's entirely unreasonable to expect the pattern to repeat itself, especially given the intractability of long-term, structurally damaging unemployment trends, and the specter of unprecedented debt loads and worldwide sovereign defaults. If the decrease in live births turns itself around in 2013 and this indicator starts to rise again, this might predict an eventual bottom to a slide in stocks... around 2019 or 2020. This would mean that the secular bear market that started in the year 2000 would last for about 20 years, which is within the bounds of prior experience. This is one possibility.

I think there are three important numbers that it will be prudent to pay attention to going forward. The first is the annual average price of the Dow, the second is the number of live births (this information is published monthly but isn't typically looked at as economic data although as I have shown it really is), and the last is the CPI inflation number. I previously published the chart below, but I will reproduce it here, as I believe it shows a very important level in the Dow to watch over the long term.

Click to enlarge

The bottom line here is that if we see the Dow have an annual average close (adjusted for inflation in 2012 dollars) below about 10,000 any time soon, it suggests that the long term resistance that became support in 2008 will have been broken, and stocks are headed for their biggest downturn perhaps in all of history. If the Dow is able to bounce off this level or never reaches it, then investors have less to worry about. However, considering that the support was provided by things like TARP and QE, and massive government interventions of a government and even a world of sovereigns that are running out of fiat credibility, I am not so sure that this support will be able to remain intact during the next downturn. These are the sort of trends that persist over decades, and thus, for the investor, what happens in 2013 and 2014 may serve as valuable technical signals to guide what they do or do not do with their investment capital well into the next decade.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.