Demographics and the stock market.

In 1987 I had the incredible luck of hearing from my manager that I passed the securities examination. He told me the results on Monday the 19^th day of October. For you younger readers (I can't believe I typed that) in one day, the Dow Jones went down 22.6%! This was a very big day.

At the time it was blamed on too much portfolio insurance. I know, how can too much insurance make things fall apart? Wall Street always has a nice answer to each major catastrophe. I think they love putting a name and reason on each big crash to give us that feeling that it was all expected, no worries. This round it is too many subprime loans, underwritten and bought by the wrong people. I can’t wait to hear the next excuse in 2010, but more on that in a moment.

One thing I learned at Lehman, all crashes are caused by the big boys running for the exit at the same time and trying to slam the slow guys fingers in the door. This round, Goldman Sachs and JP Morgan Chase made it to the door first, Bear Stearns was a little too old and fat. The good news, Wall Street is not going away, the bad news, we are.

Out of all the clutter I have read by over educated economists that are long on theory and short on real experience, Harry Dent’s work really stands out. He is a Harvard chap, we don’t hold that against him, but he has cut his teeth as a fund manager and has a elegantly simple answer that is eerily correct over the past 50 years.

The stock market is controlled by demographics.

I know not earth shattering breaking news for some, overly simple you might say. I love simple. Here is the theory. We go through economic cycles as individuals from the moment we pop out of the womb to the time they stick us in a pine box. Studies have shown that between the age of 46 and 50 we peak in our spending patterns. His theory was, if I project ahead 48 years and overlay the stock market on the birth cycle, it should correspond.

More consumption= more production= higher stock prices.

Check out the chart on the top (Click the chart to see a large version). Do you see that giant red top like a bloody roller coaster? That is 2010. That is when the herd of baby boomers will have passed their prime economic spending and each year after that we take a long slow painful decline for 12 years until Gen-X enters their prime spending. Twelve years!? It will make the crash of 1987 look like a speed bump.

This not only has corresponded with each blip in births for the last 50 years it makes total sense. Our economy is a scary 80% consumer spending now and 20% savings and manufacturing. If the spending slows down, prices will go down. As we start out we don’t spend much until we get to high school. In college the cash starts getting consumed even as we live like a monk. Next we get our first jobs and need fancier clothes, eat out more, need a car. Next I am getting married; need a house, bigger car, more spending…when we get to about 48, things turn over. We pull our horns in and realize we will not live forever and we take less risk, spend less and prepare for the day we need to live off of equity, not add to it. (See chart).

If Harry is right, by 2010 you better have a solid 10 year plan.

So where do we go for opportunity in all of this. The answer might surprise you. Friday I will dive into how we can capitalize on getting into the right demographic markets internationally and what are the hot franchise opportunities domestically after 2010. Next week, I will be interviewing some CEO’s that are running businesses that will thrive while most sectors will be in triage for the next decade.

Buckle up, it is going to be a bumpy ride!