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The Nasdaq 100 ETF is in the midst of its longest uptrend in history: 138 consecutive trading days above its 50-day moving average.

On CBNC today (click here to view) I discussed a number of factors that are signaling a potential end to this historic run (click here for my recent post on gray skies). If the streak is indeed coming to an end, what does that mean for the market? Is it a signal of a top, a bottom, or nothing at all?

To answer that question, let’s take a look back in history at the end of prior uptrends in the Nasdaq 100 ETF (QQQ).

2010 – 2011

Streak ends with an 8% correction. New highs soon follow.

1999 – 2000

Streak ends with a 36% correction, marking the start of the 2000-2002 Bear Market.

2003

Streak ends with a 7% correction. New high soon follow.

2014

Streak ends with an 8% correction. New highs soon follow.

2006

Streak ends with a minor 4% pullback. New highs soon follow.

2004-2005

Streak ends with a 14% correction. New highs are not hit until November 2005, 11 months after the prior high.

2007

Streak ends with a 10% correction. New highs soon follow, culminating in the bull market peak in October 2007.

What Happens When a Long Uptrend Ends?

Most of the time, there’s a pullback/correction which is followed shortly thereafter by new highs. We saw this in 2011, 2003, 2014, 2006, and 2007. Why does this tendency to run right back to new highs occur? One theory: the many participants who missed out on the uptrend finally get their chance to buy the dip, and once it starts moving higher again they jump on board. This is what seems to happen most of the time.

But most of the time is not always. In 2005, a deeper correction of 14% ensued which took some time (11 months) to reach new highs again. The most bearish example was after the 1999-2000 uptrend which saw an initial 36% correction that marked the start of a devastating bear market.

Which will occur this time around? I don’t know. Nobody does. The only thing I would say is that such a break will likely coincide with higher volatility in markets. We illustrated the relationship between moving averages and volatility in a research paper last year, showing that volatility tends to increase when indices are trading below commonly referenced moving averages such as the 50-day and 200-day.

Over the past two months, the Volatility Index (VIX) has seen 9 out of its 19 lowest closes in history. Given the mean-reverting nature of volatility, we should expect to see higher levels in the back half of the year. A break below the 50-day moving average would only strengthen that case.

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Related Posts:

From Silver Linings to Gray Skies

Is This as Good as It Gets?

Leverage for the Long Run

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This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

GDP growth has only two basic components: growth in productivity and growth in the workforce size. That’s it. There are two and only two ways you can grow an economy: increase the (working-age) population or productivity.

There is no magic fairy dust you can sprinkle on an economy to make it grow. To increase GDP you have to actually produce more. That's why it's called gross domestic product.

Therefore—and I'm oversimplifying quite a lot here—a recession is basically a decrease in production (as, normally, population doesn't decrease). Two clear implications emerge: The first is that if you want the economy to grow, there must be an economic environment that is friendly to increasing productivity.

Productivity growth, unfortunately, is slowing down in much of the developed world and there’s no reason to think the trend will change soon.   Let me offer a few rather disconcerting charts showing the continuing decline in productivity and major shifts in demographics that are worsening the situation.

Annual productivity growth is below the 1947–2005 average of 2.1%

Productivity grew at an annual rate of less than 1% in each of the last five years. The average annual rate of productivity growth from 2007 to 2015 was 1.2%, well below the long-term rate of 2.1% from 1947 to 2015.

  Productivity grew only 0.6% over the last two years

The next chart shows that actual productivity has grown less than 0.6% in the last two years. The numbers suggest that productivity growth has become hard to achieve in the developed world.

Part of the problem for the developed world is that the services sector makes up much of its economy.

Getting higher productivity in dry cleaners, restaurants, and hairdressers is much harder than it is in manufacturing or in agriculture. While productivity grows in the services sector, that sector alone cannot deliver significant increases in the overall productivity rate.

Now, let’s look into major demographic trends to understand the roots of this slowdown.

Working-age populations are shrinking and the dependency ratio is growing

Here’s a chart from Eurostat on the projections for the EU population from 2014 to 2080.

Some 65.9% of the EU was aged 15–64 in 2014, or what we might call “prime working age.” The number shrinks steadily to around 56% by 2050 and then levels out.

Why does it level out? The forecasters basically assume that birthrates won’t drop much lower and that there is a limit on how long people will live. But in this next chart, we see the steep rise in the percentage of the elderly compared to those of working age, all over the developed world.

  The number of children (ages 0–20) changes only slightly in the decades to come.

The big change occurs in the top two segments on the previous chart, those aged 65–79 and 80+. Combined, they will grow from 18.5% of the population in 2014 to 28.7% in 2080.

In 2014, 66% of the EU working population supported the 34% who were not working because they were either too old or too young. By 2040, the EU is projected to have 58.5% working to support 41.5% who are dependents. About two-thirds of the dependents will be those age 65 and over.

Active labor force in the US has plunged

The number of people aged 15 to 65 doesn’t really equal the number of workers. We measure the number of actual workers by something called the participation rate.

The participation rate is a measure of the active portion of an economy's labor force. It defines the percentage of the population that is either employed or actively looking for work.

Let’s look first at the actual Civilian Labor Force Participation Rate for the United States.

This rate has been falling since 2000. A big part of the drop-off reflects Boomers retiring, but there is something odd going on besides it.

We see a decline in the participation rate of 25 to 54 year-olds (prime working age), though the rate for this group had risen continually for 50 years.  

And now we delve into an even stranger phenomenon. Young people, 20 to 24, are increasingly opting out of the workforce.

Research tells us that a lot of those people are still going to school. But there are other things happening here, and we need to try to understand them.

Look at this chart from the Atlanta Fed.

Notice how many young people are out of the labor force because they are taking care of family. That brings us back to the increasing dependency ratio I talked about earlier. It also shows that shrinking working-age populations already have a visible impact on economic growth.

Central banks are powerless

Here’s a chart that wraps up everything.  

This one shows the percentage change in the labor force participation rate year over year. The rate has declined since the late 1970s, except for a few years of very modest growth within the last 16 years.

The trends we have looked at are not likely to change much, which means we are facing a long period of restrained GDP growth throughout the developed world.

This demographic cast iron lid on growth helps explain why the Federal Reserve, ECB, and other central banks seem so powerless.

Can they create more workers? Not really. They can make a few adjustments that help a little—confident consumers are more likely to have children, but it takes time to grow the children into workers.

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You often hear me harping on the dangers of too much debt, and I keep my eyes peeled for significant work that backs up my concerns.

In my recent Outside the Box, good friend Dr. Lacy Hunt of Hoisington Investment Management gave us more ammunition to take on those who just don’t seem to get that the endless piling up of debt is not a sustainable way to run an economy.

The most striking feature of the US economy’s performance in 2015, according to Lacy, was a massive advance in nonfinancial debt that kept the economy stuck in the doldrums of subpar growth. 

US nonfinancial debt rose 3.5 times faster than GDP last year. (Nonfinancial debt is the sum of household debt, business debt, federal debt, and state and local government debt.)

Lacy also points out unfavorable trends in each component of nonfinancial debt.

Household debt:

Delinquencies in household debt moved higher even as financial institutions continued to offer aggressive terms to consumers, implying falling credit standards. Furthermore, the New York Fed said subprime auto loans reached the greatest percentage of total auto loans in ten years. Moreover, they indicated that the delinquency rate rose significantly.

Business debt:

Last year business debt, excluding off balance sheet liabilities, rose $793 billion, while total gross private domestic investment (which includes fixed and inventory investment) rose only $93 billion. Thus, by inference this debt increase went into share buybacks, dividend increases, and other financial endeavors…. When business debt is allocated to financial operations, it does not generate an income stream to meet interest and repayment requirements. Such a usage of debt does not support economic growth, employment, higher paying jobs, or productivity growth. Thus, the economy is likely to be weakened by the increase of business debt over the past five years.

Federal debt:

US government gross debt, excluding off balance sheet items, gained $780.7 billion in 2015 or about $230 billion more than the rise in GDP…. The divergence between the budget deficit and debt in 2015 is a portent of things to come. This subject is directly addressed in the 2012 book The Clash of Generations, published by MIT Press, authored by Laurence Kotlikoff and Scott Burns. They calculate that on a net present value basis the US government faces liabilities for Social Security and other entitlement programs that exceed the funds in the various trust funds by $60 trillion. This sum is more than three times greater than the current level of GDP.

State and local government debt:

State and local governments … face adverse demographics that will drain underfunded pension plans…. The state and local governments do not have the borrowing capacity of the federal government. Hence, pension obligations will need to be covered at least partially by increased taxes, cuts in pension benefits or reductions in other expenditures.

Lacy adds this note on total debt, which includes nonfinancial, financial, and foreign debt:

Total debt … increased by $1.968 trillion last year. This is $1.4 trillion more than the gain in nominal GDP. The ratio of total debt-to-GDP closed the year at 370%, well above the 250–300% level at which academic studies suggest debt begins to slow economic activity.

The key point he makes is that over-indebtedness impairs monetary policy, not just in the US but globally:

The Federal Reserve, the European Central Bank, the Bank of Japan, and the People’s Bank of China have been unable to gain traction with their monetary policies…. Excluding off balance sheet liabilities, at year-end the ratio of total public and private debt relative to GDP stood at 350%, 370%, 457% and 615%, for China, the United States, the Eurocurrency zone, and Japan, respectively…. The debt ratios of all four countries exceed the level of debt that harms economic growth. As an indication of this over-indebtedness, composite nominal GDP growth for these four countries remains subdued. The slowdown occurred in spite of numerous unprecedented monetary policy actions—quantitative easing, negative or near zero overnight rates, forward guidance and other untested techniques.

Now think about this, gentle reader. We’re digging a great big hole that is likely to cave in on us before we manage to claw our way back out of it. We need to “war game” how we respond in our personal lives. That is going to be a big focus of my letters in the coming months.