Get ready: Here comes the REAL economy

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Will the real economy please stand up?

Something very interesting will begin to happen in 2014; the real economy will start to surface as the Federal Reserve removes part or its entire stimulus program. That begs the question, what does the real economy look like?

Long-term economic cycles are based on a simple premise: The economy is all about people and the way they spend and invest their money. As economists and businessmen we must also accept that distortions to longer term natural economic cycles will exist from time to time; the $4 trillion capital infusion can be deemed to have influenced misrepresentations to natural conditions, but in the end, when the distortions that have occurred since 1900 abate, the economy reverts back to its natural cycle every time.

Because longer-term cycles are all about people, and once temporary offsets abate economies revert back to their natural condition, it is hugely important for us all to understand what the natural state of our economy is, which in turn would shed light on what might happen shortly after stimulus is removed.

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My research on the "Investment Rate" is a demographic study comparing lifetime investment and spending patterns derived from societal norms and compared to economic cycles since 1900. What I've found is that spending does little more than create chaos-like boundaries around longer-term economic cycles, and it is the lifelong natural investment cycles that we experience throughout our lives that govern long-term economic cycles instead.

Unless society changes significantly, people today will continue to live their lives similarly to the way our parents did, and our children will do the same, all technological changes aside. That means we will grow up, go to school, buy a house, raise a family, send our children to college, retire, and by that time our children will start the cycle all over again. This is a societal normality, and the findings of the Investment Rate are predicated on these societal norms, but simple skews to the model can also be made to evaluate societies that do not function as ours does.

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Using our societal norms, and with focus on the US economy, the backdated findings of the Investment Rate match up almost exactly with every major economic cycle in US history, which helps to prove that demographic analysis is really all that matters to long-term economic cycles.

However, we must define what long-term cycles are, and in this case, the average up-period lasts 26 years, and the average down period lasts 11. Thus far, there have only been three major up-cycles in US history, and only two complete down cycles:

  • Up Period: 1900-1928
  • Down Period: 1928-1938 (Great Depression)
  • Up Period: 1938-1969
  • Down Period: 1969-1981 (Stagflation)
  • Up Period: 1981-2007
  • Down Period: 2007-(still going)

The good news for investors is that the trend is up over time and that means even major setbacks will eventually be overcome, although it may take quite a while. For example, anyone who bought at the peak of the Great Depression's stock-market cycle was underwater by 75 percent, and it took 26 years to get whole, but yes, your money would be worth significantly more today if you just held on even from that peak. When financial advisors and brokerage firms tell you to stay invested at all times, even at the peaks of stock-market bubbles, it bugs me, but they are not wrong; the market will head higher over time — eventually. The question is: Do you have the time to wait, and is waiting the best choice?

A differentiation must also be made between buy-and-hold investors and proactive investors, because as much as I know about the real underlying economy and the almost certain reversion to the natural growth rates that exist, I also know that a multimonth market cycle could come before a reversion and without even causing a blip on the decade-long durational cycles. So, I advise proactive strategies that can work both ways, while managing risk, given the longer-term down cycle the economy is in today.

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Eventually this down cycle will come to an end, but before it does, the natural state of our economy, which looks very similar to both the Great Depression and stagflation (when inflation is high but the economic growth rate has slowed), will show its ugly head again. The next time it does may also be the buying opportunity of a lifetime (imagine buying at the bottom of the stock market's cycle during the Great Depression instead), but money must also be available in order to do that. Tip: Raise cash and become proactive.

The Fed is slated to remove its temporary offset to the natural economic cycle and when it does, the weakness will cause growth cycles to come down. That will likely result in margin-debt contraction, multiple contraction, and asset-price reduction.

Clearly the Fed has not yet begun to do this, but when it removes the needle, a short while afterwards the true economy will stand up.

— By Thomas H. Kee, Jr.

Thomas H. Kee, Jr. is president and CEO of Stock Traders Daily and founder of The Investment Rate. Follow him on Twitter @marketcycles.