Exponential Growth Forever - NOT!

The greatest failing of the Australian people is the failure to understand the basic implications of exponential growth. (paraphrasing/adapting Alfred Bartlett of university of Colorado).

The greatest failure of our leaders is to adequately prepare our children for the Limits to Growth.

There are a couple of basic things we should all know about growth, compounding and the exponential function..

1. The rule of 72 lets you estimate doubling times for any rate of exponential growth by mental arithmetic. Just divide 72 by the rate of growth.
2. During the next doubling period (at whatever rate is used) of resource usage we will use more of a resource than has been used in all recorded history.
3. Estimates of resource life at current rates of usage are highly misleading in the face of annual growth in the rate of extraction.

Let's look at a few simple examples, using assumed numbers.

Assume we have 300 years of coal at current rates of extraction, but extraction is growing at 7% pa. (it has averaged over 10% growth pa over the last decade). The doubling time for the rate of extraction is just over 10 years (72 (from the Rule of 72) divided by 7% is 10.something times).

That means that over the next 10 years we will mine more coal in Australia than has ever been mined in the whole of Australian recorded history.

In very simple terms which significantly underestimate the shortening of resource life in 10 year time the resource life will have halved to 150 years from now. In a further 10 years of the same 7% rate of growth it will have more than halved again to only 75 years, but there are only 55 of those 75 years left.

Add a further 10 years of 7% growth in extraction and we can see that again the extraction rate doubles (its just simple mental arithmetic), we use more than has ever been used before in that decade (for the third decade in a row), the resource life halves again to only 37.5 years but 30 of those years are already gone.

300 years of resource at current rates of extraction are gone in 40 years at 7% compound growth per annum. (if you do this with Excel the exact answer is it runs out in the 45th year.)

If you do this exercise with Excel you will find that at 7% compound per annum the resource runs out in the 45th year, but the importance of this exercise above is to show how simple it is to work out the doubling time of the current rate of extraction and a reasonable estimate of the time of depletion of current resources using mental arithmetic.

You can convert this story to oil, iron ore, copper, brick making clay, concrete components, whatever you like. You can do it for population size, the cost of a loaf of bread. How long will it take your city to double in population at x% growth per annum.

Please don't just take my word for this. Open an Excel spreadsheet and do the numbers yourself.

Now many will say more resources will be found, human ingenuity will overcome etc.  If so, what is the cost of extracting those additional resources going to be? And transporting them if oil is also growing in scarcity or cost of extraction?

Prof Albert Bartlett of the University of Colorado has an excellent video (in 8 parts on Youtube) and a transcript of the lecture available on his website. I commend it to you.

 111. Exponential Function transcript - Arithmetic, Population and Energy - a talk by Al Bartlett on the impossibility of exponential growth on a finite planet

111. Exponential Function - Video parts 1 through 4 of Arithmetic, Population and Energy - a talk by Al Bartlett on the impossibility of exponential growth on a finite planet

Limits of Growth
All this leads to consideration of  "The Limits to Growth", both the book and its principles.
  http://en.wikipedia.org/wiki/The_Limits_to_Growth

This book forecasts the collapse of life as we enjoy it in about 2050 based on increasing resource scarcity.

While it has had many detractors, many of them have not read or understood the book.

In 2008 Graham Turner at the Commonwealth Scientific and Industrial Research Organisation (CSIRO) in Australia published a paper called "A Comparison of `The Limits to Growth` with Thirty Years of Reality".

It examined the past thirty years of reality with the predictions made in 1972 and found that changes in industrial production, food production and pollution are all in line with the book's predictions of economic and societal collapse in the 21st century.

 In 2010, Peet, Nørgård, and Ragnarsdóttir called the book a "pioneering report". They said that, "its approach remains useful and that its conclusions are still surprisingly valid... unfortunately the report has been largely dismissed by critics as a doomsday prophecy that has not held up to scrutiny."

The implications for poor populations (even in developed countries) and poor countries of increasing resource scarcity are profound. Resource wars and colonial subjugation to control resources are clearly possible and probably likely within 50 years. Some would say the Iraq war, East Timor and the Spratley Island tensions are all at least partly about oil.

Coppock Update for End of March

Only Japan has given a BUY on the Coppock Indicator (in its domestic currency, Yen (JPY)).

As at 30 March only the S&P and Nasdaq are not in negative territory and so not able to give an original Coppock BUY.

All Ords, Shanghai 180, Nasdaq 100 and FTSE 100 are in the lowest quarntile of Coppock values in their history from 1984 and 2000 respectively. The All Ords at a value of only 11 is almost in the bottom decile so one might expect an eventual BUY signal to be reliable.

Based on USD values for US ETF's and in the relevant local currency, each one has given a BUY in MACD (170, 150,20) but this is less reliable than Coppock and would have produced some whipsawing even over the period since 1 October 2011.

From the summaries below (taken from a review on Incredible Charts Free Version)
a) US medium and long bonds seem to have stopped rising in price, as do Gold and Energy.
b) Thailand seems close to giving a BUY,
c) Brazil, Germany, India, Japan, Singapore, South Africa, S&P 500 and emerging markets cyclical falls might be coming to an end, although prices look as they they might be on a short term down.


1-3 year US bond (SHY) Below Zero, Falling
7-10 year US bond (IEF) Above, Rising, Flattening
20+ year US bond (TLT) Above, Rising, Flattening

Australia (EWA) Below, Falling
Brazil (EWZ) Below, Falling, Flattening
Canada (EWC) Below, Falling
China (FXI) Below, Falling, Steepening
Germany (EWG) Below, Falling, Flattening
India (INDY) Below, Falling, Flattening
Indonesia (EIDO) - No Coppock generated (Short history)
Ireland (EIRL) - No Coppock generated (Short history)
Japan (EWJ), Below, Falling, Flattening
New Zealand - No Coppock generated (Short history)
Phillipines (EPHE) - No Coppock generated (Short history)
Singapore (EWS) Below, Falling, Flattening
South Africa (EZA) Below, Falling, Flattening
Thailand (THD) Below, Flattened
S&P 500 (IVV) Below, Falling, Flattening
UK (EWU) Below, Falling


Emerging (EEM) Below, Falling, Flattening
EMU (EZU) Below, Falling

Energy (XLE) Above, Falling
Gold (GLD) Above, Falling slowly

Original data for the above dashboard free from Colin Nicholson's Building Wealth Through Shares

All Ords End March 2012 Update

We are in the balance based on the indicators I follow.

Positive

All moving averages I follow are pointing up, other than 200.

All the moving averages crosses I follow are positive.

Long Term MACD (170,150,20) was a buy on 19/1/2012 according to Incredible Charts Free Version


Europe has created so much liquidity for the next almost 3 years that few expect a crisis for a year or more even though the PIIGS all have budget and trade balance and current account balance problems that are likely to be insurmountable for probably most of them without continuing drip feed by one subterfuge or other.

US is strong and defying Hussman's and ECRI's calls for recession. ECRI's recession call is so old as to be wrong, certainly in the sense that it was so early as to mislead. I think most people have just moved on to calling it a false call without further qualification or explanation.


Causing Caution

Coppock (14,11,10) has not yet signalled a BUY.

Resistance  at 4400 to 4450 in the All Ords is however very strong as can be seen in the graph at the bottom of the Dashboard. The All Ords has run out of steam above 4300 9 times and fallen back below 4300 and it was over 4400 back on 28 October 2011.

My modified Turtle which is set to minimise, but not prevent, whipsawing does not signal a buy until 4470.

China slowdown continues to bring on commentary and the MACD (170,150,20) is looking like it might break down which could reflect into Australia through commodity prices and volumes.

Australian Economy

Australia maintains the two, three or four speed economy, with those sectors not doing so well calling for assistance and interest rate cuts.

Full time employment and GDP growth remain positive(both YOY), house prices are falling only slowly on average (from some of the highest multiples of average incomes in the Anglo world) and not falling significantly in all markets and inflation has averaged above the middle of the target range for about 2 years, so there does not seem to be a clear macro justification for a cut.

Australia has a good safety net for those who have lost employment because of slowdowns in retail and manufacturing and there are opportunities for those with skills willing to move to mining and processing areas.

The Dutch disease, its likely long term impacts, and the situation in which we will find ourselves if we allow a hollowing out of most of the tradables sector remains a concern, but probably more appropriately handled through fiscal and other policies, not monetary policy.


 Nothing is certain in this world, but my expected outcome is no rate cut in April and none unless the are clear national problems with negative employment growth YOY, major falls in house prices, inflation below the target range (or a clear indication it is very likely heading there).

Sharemarket Outlook

My 3 main scenarios are:
1. continue range trading from a top not higher than 4450 back towards 4000
2. breakout above 4470 but a false break out and no Coppock trigger or a very shortlived trigger undone by the next European, US or Chinese concern. (Spain, Portugal and Ireland are in focus here)
3. breakout above 4470 and a medium term rise of 10 to 30% over 2 years.

If the market breaks out above 4470 I will be in for, say, 50% and if there is a Coppock signal I will be in for the next, say, 50%, but still wary of a crisis induced breakdown.

Market to GDP Ratios - Can Australia Soar?

The Australian market could soar based on its current Market Capitalisation to GDP percentage ratio. Australia's ratio is the closest to its medium term minimum of 21 markets considered at GuruFocus' Global Market Valuation page (http://www.gurufocus.com/global-market-valuation.php).

The whole page is worth a read as it considers GDP growth, dividends in addition to the historical range and current Market to GDP before projecting a growth rate for the stock market over coming years. While I think there may be significant diiferences in outcomes to those projected, the methodolgy and inputs are worth consideration.

The chart on historical GDP growth alone is worth a look:
http://www.gurufocus.com/modules/market-valuation/market-valuation.php?w=500&h=300&ser=growth


Does Market to GDP compared to the prior low show Australia will soar?
Here is our current interest, the current ratio of Market to GDP ("M/G")  compared to medium term historical minimums of that percentage. Colours generally help identify the 6 highest and 6 lowest in each column. In the "Years" data column it shows those that might not have a single full cycle and those that clearly have multiple cycles, although only the US data has 1974 and the first oil shock.

From the table above, Australia is the country with the lowest  ratio of current M/G to historical low M/G in the years covered by the data. (Column "Now / Min")

11 countries are closer than Australia to the highest M/G ratio (Column "Now / Max") they have had in the years covered by the data and 9 are further from the historical high so Australia is near middle of the range on this measure.

We should note however that Australia has the second highest historical minimum after Singapore and so could be being rerated internationally because of concerns re housing markets, near extreme high resource prices and currency about 2 standard deviations above long term trend against USD.

If you are looking for a country that has likely above average GDP growth and a low M/G ratio compared to its historical low and in relative terms, China is worth watching.

If you think that Europe will move over time to improve its outlook and grow then Italy and Spain are near their historical lows.


Or Is It A Warning?
One could take the view that the countries regarded by the international investing community as likely to have worse problems  in the near future are the ones with the lowest "Now / Min". If China has a hard landing it would certainly have a bad impact on Australia, and we already know that Italy, Spain, Belgium and France have problems already and they are likely to have shrinking GDP or zero growth if austerity is maintained.

As an aside, if the low M/G is a warning it seems that few believe that US will impose austerity in 2013 as is  the outcome of budget deals already done, defaults on reaching deals and expiring Bush tax cuts. The table below from the Congressional Budget Office shows the dramatic austerity based on current settings. I have little doubt that budget outcomes like these would cause a recession in the US before mid 2013 which would last till at least mid 2014 and that there would be little the Fed could do to alleviate it. If imposed it would be a "recession we had to have" to get debt under control.

                       2011    2012     2013     2014
                  
Revenues        2,303    2,456    2,968    3,283
Outlays           3,603    3,627    3,580    3,668
                     _____    _____    ____    ____
Total Deficit   -1,300    -1,171    -612    -385

And of course, if the US goes into recession other countries either have to stimulate through increased budget deficits or will likely also have to endure recession (and have the automatic stabilisers increase deficits anyway.)

Note on methodology
Because of the differing ranges for differing countries and the apparently different average relativity of the Market to GDP (see Italy which is low at 22.5 and Singapore which is high at 254), I felt it was more likely to be meaningful to look at the ratio now compared to the low point in the ratio. On this measure Australia is the closest to its lowest ratio of Market to GDP based on the last 12 years data (which includes the lows of  of 2002 and 2009 (a dramatic low) and the highs of 2001 (a modest peak) and 2007 (a dramatic high in terms of 5 year growth and compared to GDP).

Notes re years of data 
The data for Australia does not capture the lows of 1974 or 1987 which might have had lower Market to GDP ratios, but these years are captured for some other countries, so some caution is warranted. The Data for all countries other than Belgium captures the 2007 high and 2009 low. The data for all countries other than Italy, Russia and Belgium captures the full cycle from the 2002 low through the 2007 high, 2008/9 low to this year.
The exact date of the last update of GDP figures is not known and so the potential variation is significant for countries that are contracting like Spain or expanding quickly like China.
The last update of the market capitalisation is not known and it is not known whether it is based on the ETF referenced or the total capitalisation of all publicly listed stocks.

Coppock, MACD and Dashboard Update

The month end summary is:

1. Coppock says not yet for All Ords
2. Coppock now says BUY for Nikkei 225 in Yen
3. MACD says BUY for All Ords
4. Modified Turtle says not yet for All Ords
5. Virtually all moving averages say BUY for All Ords
6. 2 Month growth SMA's say pause or fall likely for All Ords

My interpretation is that for a medium term investor, don't buy more until the All Ords breaks 4470 and at present there is a significant risk of a fall of 10% as 2 month growth rates reached rarely sustainable levels (84th percentile at daily peak) and the 10 day and 30 days SMA's of 2 month growth have rolled/are rolling over.

Here are the tables:


Coppock and MACD (some Major International Markets):

Note that only the Nikkei has a positive BUY (for Yen or hedged international investors). All other Coppocks lost ground and the early March figures already show another fall other than for Nikkei, so the end of month figures weren't mere window dressing. The falls for S&P, Nasdaq and FTSE are technically meaningless as the only true Coppock signal is turning up from bleow zero and these indices had Coppocks aboev zero at 29 Feb.

The other major note is that all long term MACD's have already shown buys, but this is a slightly more volatile indicator. Will Coppock follow? Time will tell.

All Ords Dashboard:

The SMA's are generally indicating an uptrend has commenced both on direction of their trend and on most crosses.

Growth percentiles indicate the market is not likely to be overpriced. The 3 year growth and percentile is an artifact of the 2009 bottom and will shortly start to revert as we move more than 3 years from the 2009 bottom, but the 4 year figures will start to look higher as the 3 year figures fall.

2 month growth is slightly elevated above median but is falling from recent highs. It's cycle could indicate a fall of around/near/more than 10% as it's 10 and 30 day SMAs have/are rolled/rolling over.

1 and 2 year performance continue to indicate we are near a median bottom (at Sept 2011) based on data since 1984.

Performance against  GDP also suggest that the market is not overvalued.

Earnings Yield against 10 year Bond Yields indicates the market is cheap compared to most of the modern (post 1960) period, but it should be noted that in the US the Dow (DJIA) went for very long periods where investors demanded higher yields on shares than bonds out of fear of losses based on recent experience, uncertainty and patriotism.

Recoveries

The pattern of recoveries since 1984 also indicates we may well be in a continuing major up trend but there is one major fly in the ointment. The recovery from the bottom in 1987 was terminated by a loos of almost all the gains as we moved to 1991. The 1987 fall takes some relevance as it was the last fall of 50% in the All Ords prior to 2008/9.

The range of possibilities for the future is wide (less so if reindexed to the current day past the bottom and most recoveries continued largely positive from this point, other than the 1987 descent to 1991.

Modified Turtle
My modified Turtle breakout indicator has not yet been broken. I have modified the rules and numbers to reduce chance of being whipsawn, but it comes at a cost of likely lower returns for having missed a section of upturns and selling later in any major fall. The chart above shows the sideways pattern for the last few months and that the All Ords faces stiff resistance around the 40% above the bottom mark which as the following chart shows is at around 4400.From my dashboard above you can see that my modified Turtle says I should have been out for months and not get back in until 4470 (based on being interested in medium term cycles, not trading.)

As volatility has decreased so has the distance between the buy and sell lines. The upturn in various SMA's of the All Ords can also be seen in the chart below.

Action.
Being loss sensitive because I am in drawdown phase I am waiting to see if the current peaking of the 2 month cycle leads to declines, waiting for a Coppock BUY signal and waiting for a modified Turtle break out.

Building Approvals Review

Building Approvals by Value jumped dramatically in January 2012. The jump is in the 99th percentile of monthly growth since 1974.

There are also some concerns about the YOY and MOM jump in value in Victoria and SA.

	NSW	Vic	Qld	SA	Total
MOM	-9.1%	75.3%	-6.2%	1043.8%	51.0%
YOY	-3.2%	85.6%	-0.7%	774.2%	61.5%
	WA	Tas	NT	ACT
MOM	-27.5%	-23.2%	-34.2%	-64.9%
YOY	-15.1%	-46.1%	76.8%	-48.2%

 Trends

The main point of this article is to look at the trends and whether we are looking at an employment recession, particulalry in Victoria and NSW.

The chart below is deflated at 7.5% . This is 3.5% for inflation, 2.0% for population growth and 2.0% for increases in real wealth (which leads to bigger more expensive buildings and more space per person in a building. The result of choosing these deflators is that the use of a 7.5% total deflator gives a virtually horizontal linear trend, putting slowdowns in sharp relief.

From this chart of deflated building approvals, the current 12 month moving average is about the level of the 2001 bottom. 2001/2/3 was a period of very slow growth in Real GDP.

Jun-2001	0.6%
Sep-2001	1.6%
Dec-2001	0.8%
Mar-2002	1.4%
Jun-2002	1.1%
Sep-2002	0.5%
Dec-2002	1.0%
Mar-2003	0.3%
Jun-2003	1.2%

While GDP might be supported by the resource boom, there is a real chance that employment in the most populous states will not as older more experienced workers with construction experience will be less mobile, while younger, more mobile workers will have less experience and it might not be regarded as sufficient for more complex resource project construction.

The possible solution to lower employment in Sydney & Melbourne will be fly in, fly out (FIFO)but with lower wages than might otherwise be the case as construction unemployment bites harder. FIFO will bring its own problems for families and resource companies but would ameliorate the labour and employment problems that will otherwise exist.

Now is the time for construction workers in Sydney and Melbourne to be increasing skills relevant to resource construction and operations, including vehicle and equipment licences, specialised welding skills and the like.

Could the Reserve Bank be keeping rates high to encourage savings to fund the resources boom and to cause concern for developers to allow some unemlpoyment in construction to assist in providing labour for the resources boom, or is it just a happy congruence of events?

Is This Why Whitlam "Had To Go"?

Maybe it was a backlash against rapid social change, maybe it was a reaction to some very poor/naive ministerial thinking like the Khemlani Loans Affair, maybe it was because of the proposed "buying back the farm" (well mining projects actually) by RFX Connor, maybe it was because of the destabilising effects of inflation, or maybe it was because the owners of businesses could see themselves going backwards compared to nominal GDP growth.

Since about 1960 to now the Australian All Ords has grown at just over twice the rate of GDP. But it grew far slower than that during the Whitlam years. In fact GDP went up by 95% from September 1959 to September 1974 and the Stock market was back at it's 1959 level.

From June 1972 to September 1974 the All Ords fell from 414 to 194 (over 50%) while GDP grew by 6%.

It looked terrible for owners of shares. But from 1975 to 1987 were the golden years for shareholders as PE ratios were rerated from 5.4 to 20.1. Since 1987 PE's have fallen back to about 15 but that has been offset by GDP growth over the period.

The Whitlam years coincided with some of the worst years ever for shareholders in terms of shareprice growth compared to GDP growth. Look at the increase in cumulative under performance from late '72 to '75. December 75 was -100 on the chart. It didn't get much worse than during the Whitlam years. (I am not arguing causation, as that must be considered in light of the first oil shock.)

(When the edge of the purple area is sloping down to the right shares are getting a lesser share of GDP growth over the last 10 quarters, when the edge of the purple area is sloping up to the right shares are growing much faster than GDP over the last 10 quarters).

The chart also provokes the question, "In a just and equitable society should", or alternatively "Does efficient capitalism really demand that" equity holders get a return that grows at twice the rate of GDP?"

"In a self centred society are workers entitled to use whatever means they can to maximise their share of production, income and wealth in the same way owners of capital are so entitled?"

Or as Ayn Rand might say the proper moral purpose of a one (worker)'s life is the pursuit of one's own happiness (or rational self-interest), ......even if it means forming unions and demanding an unsustainable share of the fruits of production and service.