The Best Way to Predict the Stock Market and the Economy

Daniel Arnold may have discovered the single best way to predict what the stock market and economy as a whole will do.

Arnold is not an economist, and his technique does not use traditional charting tools like Elliot Wave or stochastics. Arnold is just a smart guy (electrical engineer with a master's in bio-mechanics, who became a manager and then consultant at General Electric, started a successful manufacturing company in Silicon Valley which got bought out by a bigger company, and did well enough to retire in his mid-40's) who wanted to get a handle on investing.

Big Spender

So what's Arnold's forecasting method?

He simply charts the number of 45-54 year olds in the population at any given time. This number is easy to calculate from census or birth records, and immigration numbers (immigrants average a certain age when they arrive, from which you can estimate how many will turn 45, 46, etc., in a given year).

Indeed, the number for any given period can be predicted fairly accurately several decades in advance.

Why 45-54 year olds?

Its nothing magical.

It is simply that people on average spend by far the most during this time of life, which is - on average - when they are paying for their kids' college, paying mortgage on the biggest house they will own during their lifetime, and otherwise shelling out more cash than at any other time in their lives.

It turns out that there is a stunning correlation between the number of 45-54 year olds and the stock market and economy as a whole, as explained in Arnold's Book, "The Great Bust Ahead". Specifically, the 45-54 year olds are the "big spenders" who drive the economy. When there are more as a percentage of the population, the economy as a whole, including the stock market, goes up. When there are less, it goes down. As Arnold writes:

Consumer spending accounts for about 60% to 70% of the economy as expressed by the GDP (Gross Domestic Product), and more like 90% when indirect spending of our income as taxes by the government(s) is included. When coupled with demographic analyses focused on who does the “big spending” within the population, the economic past, stretching back for about a century, is almost effortlessly accounted for with stunning accuracy.

Says Who?

Take a look at the following chart:

(there are better charts in the book).

The red line represents the number of 45-54 year olds in the U.S. population. the black line represents the Dow Jones Industrial Average, invested for inflation.

The correlation is pretty good for most of the chart, right?

Arnold describes the slight divergence during the early 30's as being an effect of the New Deal, and the point where Dow first starts permanently underachieving the demographic trends is when the Nasdaq became popular, sucking money from the Dow (the two indexes added together would presumably track the demographic trends more precisely). But even without these explanations, the correlation is really very good.

But the Dow Won't Hit 20,000 in 2012, So Isn't Arnold Wrong?

People like Harry Dent have tried to explain why Arnold's model has gone of the rails in the last year or so (the 20,000 figure for the Dow in 2012 is looking pretty unlikely given that we're already in a Depression). Dent adds a bunch of other cycles less grounded in common sense to explain the change in trends.

But I think Arnold's own explanation makes more sense:

• 2008 was the victim of a self inflicted sub-prime financial crisis. This has nothing to do with the demographics based massive depression that is yet to come, as described in the book. The sub-prime consequences are however very similar though mild so far compared to what is coming our way. The book clearly spelled out that along the way unpredictable short-term (1 to 3 years) disruptive events could happen. The sub-prime crisis is just that. It should be regarded as the “warmer upper” or “hors d'oeuvre” for the big one that is now rapidly closing in on us all.

• The great unknown at this point is whether the sub-prime based crisis will drag on beyond 2009 and then blend into the demographics based massive decline which, per the book, could begin as early as 2009-10. Being short-term by definition, this period is totally unpredictable.

• There is the strong possibility that we will see an interim recovery manifested as a “last hurrah” rally in 2009 of perhaps 30% on the Dow after a new low of around 7,000. However, this is very speculative. The only historical certainty is that in the long-term the Dow always returns to the demographic. This lends some credence to such a rally as the immutable demographic, as you can see from the chart, remains in a very strong upswing as it moves toward its 2012 peak before crashing. Also waiting in the wings ready to surge back into the markets are trillions of dollars earning very little in money market funds.

If Arnold is right - and my hunch is that he is, given how close the correlation is between 45-54 year olds and the Dow - then the American economy will not only suffer from the collapse of the world's biggest speculative bubble in history, multiple financial crises caused by credit default swaps financial fraud and overleverage, lack of savings, and massive debt, but also from a drastic decline in the number of "big spenders" (45-54) who can drive the economy. Indeed, Arnold's demographic model predicted the greatest Depression in history simply from demographics, without taking into account the other crisis factors.

And if Arnold is right, using his demographic forecasting method may prove invaluable for deciding where to invest both during the Depression and afterwards.

Arnold's book is only $8.95 and only 57 pages long. Read it for yourself to see what you think.

Note 1: Arnold - like Dent - are proponents of holding bonds. They might be right, but I still think they underestimate how much political instability will drive up the price of gold.

Note 2: A reader said that Dent came up with this demographic theory, not Arnold. If so, Arnold seems to have tested it more thoroughly than Dent. In any event, credit where credit is due.

Note 3: I am not an investment advisor and this should not be taken as investment advice.