FOR STOCKS, 16 LEAN YEARS / BARRON´S FEATURE ( RECOMMENDED READING )

Feature

MONDAY, MARCH 15, 2010

For Stocks, 16 Lean Years

By THOMAS H. KEE JR.

THE THIRD MAJOR "DOWN" PERIOD IN U.S. history began in 2007, and could last 16 years. The Investment Rate, a proprietary measure of normalized demand for investments in the U.S., tells us the market, which has rallied since March 2009, will start falling again before 2010's end, and the decline will accelerate in the years ahead. Understanding the Investment Rate helps the future of the economy and stock market become clearer.

Instead of focusing on interest rates, housing starts, business inventories or other econometric models, the Investment Rate measures the core of all economic activity, people. It is based on the assumption that when people reach a certain age they begin to invest systematically and aggressively, which swells the flow of funds into the market.

I took a backdoor approach to determining that age by gauging when most people finish paying for major life expenses. Normally, people begin to invest more money when they finish putting their children through school and when retirement is near. At this age -- 48 in today's economy, though it will change as societal norms change -- money and motivation exist simultaneously.

By studying demographic data, I developed a growth-rate model and adjusted it for this "Kee" age. I introduced the Investment Rate early in 2002, when the stock market was in freefall. This metric indicated normalized demand for investment hadn't stopped, and wouldn't peak until 2007.

Today a new trend is in place, and the Investment Rate has turned down (see chart). In up cycles, more new money is available to be invested each year, and the economy can recover quickly from setbacks. Now, the opposite pertains.
THE INVESTMENT RATE SUGGESTS growth will be difficult in coming years, and the risks will be high. Massive debt levels, Social Security and Medicare expenses, and the retirement of the baby boomers are just some of the added burdens associated with this down period, which could last until 2023. We can't expect the market to make new highs in this span, because it won't, although it could bottom well before 2023.

When I backdated the Investment Rate, it defined the Great Depression, the stagflation of the 1970s and the up periods in between. Indeed, the stock market and economy have followed this leading indicator since 1900.

The Investment Rate defines short- and long-term cycles. Periodic oscillations provide excellent trading opportunities; the tail end of one exists now.

To determine short-term cycles, I evaluate actual demand for all asset classes, using recent investment flows as one guide. Then I compare current demand to the normalized demand implicit in the IR. If current demand is higher than normalized demand, the economy may be overheated and the market overextended. If actual demand is below normalized demand, buying opportunities usually surface.

Actual demand is now on par with normalized demand, but hasn't exceeded it yet. Once it does, the declines associated with the third major down period in U.S. history will resume.

THOMAS H. KEE JR. is president and CEO of Stock Traders Daily.

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