The Fed follows their research team. We've used key pieces of Fed research in the past to predict soon-to-follow Fed comments. This recent piece, "Understanding the New Normal: The Role of Demographics" is the Fed's answer to their productivity conundrum. Until this report the Fed did not have a clear answer as to why rates and GDP were low. Now they do. They could have seen this one coming. We've written that demographics should lead to a low by the end of 2017. The Fed may be less sanguine which is probably why they want to hold off raising interest rates.
Here are the Fed's recent findings dated October 3rd:
(This is a long quote but a must read)
"Since the Great Recession, the U.S. economy has experienced low real GDP growth and low real interest rates, including for long maturities. We show that these developments were largely predictable by calibrating an overlapping-generation model with a rich demographic structure... The model accounts for a 1¼-percentage-point decline in both real GDP growth and the equilibrium real interest rate since 1980... The model also implies that these declines were especially pronounced over the past decade or so because of demographic factors most-directly associated with the post-war baby boom... Our results further suggest that real GDP growth and real interest rates will remain low in coming decades, consistent with the U.S. economy having reached a "new normal."
Our official reaction: "ouch."
The baby boom is one of the most predictable cycles you can imagine. Births are known. The Fed has finally figured out with many fancy formulas that this may be the cause of stagnant growth.
What's worse is they expect this to be the "new normal" for the "coming decades."
With this new Fed research out we can now understand why Fed officials are lining up dovish. The Fed has said they are data dependent. The numbers Friday were inline with recent trends.
We think this longer term thinking however may move the Fed from "data dependency" to "dovish regardless." We don't expect them to officially come out and say that.
Births Bottom End Of 2017
Because the Fed is now depressing us we wanted to turn back to our own work which is longer-term less depressing.
Here's the birth chart with our own additions as we'll explain.
The above chart is US births. The years we wrote near the graph are our peaks and troughs of births plus 50 years ("births+50").
In fact the Great Recession the Fed refers to above was precisely a peak in births+50. As you will see below, many market shifts corresponded to shifts in births+50.
Births+50 means that fifty year olds are critical to our economy. They are peak earners and spenders. As they increase spending and investment goes up. As they decrease spending and investment goes down. We don't think it's that complicated. We don't have the fancy formulas the Fed uses to prove this out. Nor do we think it's necessary.
Now that baby boomers are getting older this births+50 is trending down. That is causing disinvestment, saving and a lack of spending. That lack of spending is slowing the GDP. That lack of investment is driving less growth and so lower interest rates.
Short Term Low End Of 2017 Long Term Low 2022
The chart above shows that we don't get a pickup in the births+50 until 2018 and 2023. 2023 will be the start of a longer term uptrend. We have time to get ready for that one.
While the Fed calls for the "new normal" to be decades, we think it can last another six years with a short term pitstop a little more than a year away. Not so bad.
Stock Performance In Birth Peaks And Troughs
Here's the Dow Jones chart (NYSEARCA:DIA) showing the births+50 peaks and troughs.
Below the chart line are troughs in the births+50 and above the chart line are peaks in births+50.
You can see that the rising and falling of births+50 does seem to have some impact on the stock market. It's not the only driver to stocks but it is an important factor. The Fed is finally officially discovering that births have an important impact on the economy. People matter.
Here's the Dow's performance in those times.
In the times where births+50 went from peak to trough (down) the Dow averaged 2.4%.
In the times when the births+50 went from trough to peak (up) the Dow averaged 16%.
Currently we are in a down birth trend peak to trough. We are up 9.9% per year in that time so far. That would suggest that this period is outperforming prior down peak to trough periods. That would imply downside into the end of 2017 on a longer term basis. (Obviously many factors affect the stock market but this one factor implies longer term downside and the Fed may agree with that.)
The Fed is coming to the realization that demographics could be the main driver to the economic cycle. People drive the economy. That shouldn't be an epiphany. One day it all may be driven by drones but until then the birth+50 cycle should give us an important hint into what to expect on longer term moves. For now it looks like births+50 hit a down-cycle. For now the market is up but based on historical correlations, the market could have risk into the end of 2017.
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