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Welcome to Demographics School Presented by Rodney Johnson President HS Dent, an Independent Economic Research Company. HS Dent. Independent Economic Research Company Forecast economic change based on three key tools: 1. Demographics and demographic trends
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Welcome toDemographics School Presented byRodney JohnsonPresidentHS Dent,an IndependentEconomic Research Company
HS Dent Independent Economic Research Company Forecast economic change based on three key tools: 1. Demographics and demographic trends 2. Predictable consumer spending patterns, and 3. Technological innovation acceptance rates
Forecasting Doesn’t Always Work Out I think there is a world market for maybe five computers. - Thomas J. Watson, 1943, Chairman of the Board of IBM We don't like their sound, and guitar music is on the way out. - Decca Recording Co. rejecting the Beatles, 1962 With over 50 foreign cars already on sale here, the Japanese auto industry isn't likely to carve out a big slice of the U.S. market. -Business Week, 1958
Especially In Finance We’re looking for home sales to turn upward before mid-2008, on a national average basis, and we expect recoveries in housing starts and construction spending to commence before the end of the year. The Longer-Term Housing Outlook Is Excellent! David F. Seiders, NAHB Chief Economist, 1/9/08 Stocks reached a “selling climax” on July 15 (2008), which will be seen as the bottom for the current market.”BusinessWeek, August 2008 Jeremy Siegel — the famous Wharton School professor
What You Will Learn Background of Economics The sources of our research The statistics involved (good and bad) What the Average American looks like Three main tools of HS Dent research – demographics, predictable spending patterns, technology innovation and acceptance How these tools are applied to forecast changes in the markets and real estate What changes are expected around the world
What You Will Be Able To Do Describe how modern, industrialized economies work Help your clients see the next economic “season” Use the tools to forecast changes in your local area Explain how businesses will be impacted Highlight the opportunities and risks that face clients and prospects in the next 3, 5,10 and 20 years
Economics Malthusian Economics Classical Economics Keynesian Economics Austrian School
Malthusian Economics Scarcity Current technology Population (crowd-out)
Classical Economics Input of Labor All inputs are incremental Always moving toward full employment by shifting inputs to where needed
Keynes’ Animal Spirits The colorful name that Keynes gave to one of the essential ingredients of economic prosperity: confidence. According to Keynes, animal spirits are a particular sort of confidence, "naive optimism". He meant this in the sense that, for entrepreneurs in particular, "the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death". Where these animal spirits come from is something of a mystery. Certainly, attempts by politicians and others to talk up confidence by making optimistic noises about economic prospects have rarely done much good. Economist.com
Basics of Hayek(Austrian School) Free markets allow best allocation of resources Government intervention (interest rates and other monetary policy ) causes mal-investment Those mal-investments must be worked out of system over time
Hayekian Triangle Mises Institute
Amended Monetary Act 1913 …the Fed "shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." • www.federalreserve.gov • www.federalreserve.gov/kids
Target Fed Funds Rate January 2003 – October 2010 Fed Funds Rate Percentage Source: Federal Reserve
30-Year, 10-Year, and Fed FundsJanuary 88 through October 2010
Federal Reserve Balance Sheetas of 10/20/10 in $ millions Source: Data from Federal Reserve
What We Know About The Fed Mandate – what they are SUPPOSED to do Tools – Fed funds, discount rate, money supply, and speeches/testimony, trading illiquid assets for reserves, loans, purchasing of mortgage-backed securities Effects, and lack thereof Website of interest: www.federalreserve.gov
Average Immigrants per Year by Age 1945-2000 Source: US Census Bureau
The Immigration Adjusted Birth Index Immigration Adjusted Births
Demographics How many people born in each year The numerical effect of immigration Composition of US population by age groups Where the information comes from (NCHS, Census) Websites of interest: www.cdc.gov/nchs/www.census.gov
Statistics And Other Math Dispersion Correlation Coefficients Normal Distribution
Normal Distribution (Bell Curve) Gaussian distribution needs only two parameters to describe – mean, and variance 68.26% of observations fall w/in 1 standard deviation of the mean 95.44% w/in 2 standard deviations of the mean 99.74% w/in 3 standard deviations of the mean
The Normal Distributionaka, the “Bell Curve” Number of Observations 68% fall within +/- 1 standard deviation -4 -3 -2 0 1 2 3 4 -1 Standard Deviations Source: H.S. Dent Foundation
The Normal Distributionaka, the “Bell Curve” Number of Observations 95% fall within +/- 2 standard deviations -4 -3 -2 0 1 2 3 4 -1 Standard Deviations Source: H.S. Dent Foundation
The Normal Distributionaka, the “Bell Curve” Number of Observations 99% fall within +/- 3 standard deviations -4 -3 -2 0 1 2 3 4 -1 Standard Deviations Source: H.S. Dent Foundation
Assuming Returns Are “Normal” Financial software assumes that investment returns are normally distributed around a mean, or average, return (9% for Large Cap Stocks, per SBBI through 2007) This assumption is made because it is true – usually.
The Flaws of Return Estimates(Why Returns Are Not Always “Normal”) Returns are not independent of each other Returns can be “clustered,” as individual returns are influenced by the same outside variable Dispersion renders return estimates unusable
Volatility Clustering Returns are not independent, they rely on underlying economic events and trends These trends can occur over long periods Tech Bubble Tech Bust 9/11 Recent Credit Crisis Central Bank Actions
Returns Gain Momentum(not independent) Most days on equity markets are marked by small, incremental changes. Large percentage changes, however, tend to be followed by large changes. This is called “volatility clustering”, indicating that exceptional volatility happens in sequence.
True Distribution of Returns Instead of being Gaussian, or Normal Curve, investment returns fall along a Cauchy Distribution, which exhibits a higher mean, less observations along the curve, and “fat tails”.
Stock ReturnsNormal Distribution Assumed 1987 Crash was 20 standard deviations past the mean – a statistical impossibility if returns were truly normal! 1933 “impossible” one-day rally Monster Bear Market Rally in July 2002 Back-to-back “long tail” days during 1929 Crash
Daily Price ChangesDJIA 1928-2010 Credit Crisis Returns vary wildly over time Tech Boom and Bust 1940s-60s: Low Volatility Low Volatility Roaring 20s and Depressionary 30s: High Volatility 1987 Crash: Unprecedented Volatility Source: Bloomberg
Impossible Market Days Chance of August 31st, 1998 – 1 in 20mm Chance of the 3 declines in August 1998 – 1 in 500mm Chance of October 19th, 1987 – less than one in 10 to the negative 50th power, a number that does not occur in nature
What We Know AboutMarket Risk “Average Return” is poor guide of what will happen – variance and standard deviation too great Returns are not “Normally” distributed, instead the distribution has “Fat Tails” Returns are not Independent, there is clear evidence of clustering of returns
Markowitz Sticks by His Theory Those who say a normal distribution shouldn't be used "don't know what they're talking about," said Harry Markowitz, the developer of MPT, who now runs an eponymous San Diego consulting firm. "If the probability of distributions [on a portfolio] is not too spread out, from a 30% [loss] to a 40% gain," it's OK to use a normal curve, he said. • Modern portfolio theory may face more skepticism • By Dan Jamieson March 10, 2008, Investment News
Investing is Riskier Than Commonly Described Because investment returns exhibit “fat tails”, the extreme observations or returns are more likely than we would assume. We value loss more than we value gains (2x). These two facts together mean that investing in equities is much riskier than we normally describe.
The Human Model of Forecasting “We won’t have recessions anymore” “It’s a soft landing” “Things are so bad they will never improve” Source: H.S. Dent graphic interpretation of data in 2002 Schweser CFA Study Program, Chapter 15, pp 144-45.
Investing Is NEVER Satisfying We tend to estimate what will happen based on most recent experience When our accounts are up, we compare to others (relative income hypothesis) When our accounts are down, we feel greater loss because we value loss at 2x gains
It’s Hard For Us To Stay True to a Model, Even Mr. Markowitz “Mr. Markowitz was then working at the Rand Corporation and trying to figure out how to allocate his retirement account. He knew what he should do: ‘I should have computed the historical co-variances of the asset classes and drawn an efficient frontier’... But, he said, ‘I visualized my grief if the stock market when way up and I wasn’t in it – or if it went way down and I was completely in it. So I split my contributions 50/50 between stocks and bonds.’” Can We Turn Off Our Emotions When Investing? Joe Nocera, 9/27/07, NYT, quoting Jason Zweig’s book, “Your Money & Your Brain” (Simon & Schuster)
