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Wednesday, 9 June 2010

Looking for a Demographic Dividend

Listen to the Non-Economists

A few years ago that noted economist P. J. O’ Rourke opined that deciding whether to buy stocks or not was easy. He pointed out:
“We baby boomers have caused everything since 1946. We’ll keep buyings stocks until we retire. But when we hit sixty-five, we’re going to sell stocks. And the stock market is going to go down. And we’re going to wet ourselves.” (Eat the Rich)
As usual, PJOR was more right than the real economists, whoever they are.

BEGS 2010

The recent Barclays UK Equity-Gilt Study (which unfortunately isn’t available on-line although you can buy it at £100 a pop, if you’re especially interested) makes some interesting observations about the effect of demographics on markets. You might expect that when the surge of post-war Baby Boomers starts to retire and begins looking for income then you’d see a decline in the funds invested in stocks and a surge in those invested in bonds. As the study points out this, in fact, is exactly what was seen in Japan in the 1990’s and now appears to be what we’re seeing in the US: the fit of the curve of people approaching retirement, saving hugely for it and then slumping into a blissful Third-Age is very close to that of the changes in US market valuations.

Of course the lessons of Japan aren’t especially encouraging – the massive run up in asset valuations in the late 1980’s and early 1990’s presaged a bust of biblical proportions and a long, long uphill struggle for equity markets. It also led to the oddity of the yen carry trade as the Japanese Central Bank cut interest rates to zero to encourage Japanese savers to invest in the economy. Instead investors, desperate for income, and speculators, greedy for easy profits, borrowed very cheap yen and invested in higher yielding overseas securities.

Demographic Nosebleeds

Estimates of how much was staked on this currency arbitrage vary but it’s certainly in excess of several trillion dollars. Some of this found its way into various other Ponzi schemes like US sub-prime property: what goes around, comes around. Worse, it’s always been hot money because investors are scared that exchange rates may go against them – on the slightest sign of a problem the money’s repatriated.

Some of the direct ramifications of this demographic effect in Japan have been quite jaw-dropping: at one point the property valuation of Ginza, a small district in Tokyo, exceeded that of the whole of California. It’s since fallen by over 95%. Meanwhile from its peak in 1989 through to its nadir twenty years later the Nikkei fell an awe-inspiring 82%. That’s one hell of a nosebleed.

Demographic Downturns

Returning to the US, research by Amit Goyal from as far back as 2004 predicted some of the effects we're seeing:
“Forecasts … predict an increase in outflows from the stock market over the next 25 years to provide cash returns for retiring baby boomers. Not only are the outflows projected to increase over the next 25 years, but they also remain at high levels for almost a decade.”
Although this sounds extremely gloomy it doesn’t appear to mean that stocks will actually decline overall, merely that the returns to be expected from the markets will be lower. Indeed it’s fairly easy to postulate a scenario where cash-strapped governments faced with declining tax revenues and increased healthcare bills from a surge in retirees will need to push bond yields up. All things being equal that’ll lead to an increase in equity yields and, obviously, a relative decline in stock prices.

Age and the Stockmarket

The idea that demographics and stockmarket declines are inexorably linked isn’t universally agreed. James Poterba in The Impact of Population Aging on Financial Markets points out that there’s bound to be some linkage between age based cohorts and various market movements but the time varying nature of these makes it very difficult to identify definite correlations: basically people’s behaviour changes as the situation changes. He does suggest that as people age they may look for more dividends from their stocks but, essentially, the relationship between demographics and asset returns over the last seventy years of the twentieth century were quite weak.

The recent evidence appears to be suggesting that the bulge of baby boomers moving through the ages is changing that relationship. Boomers on the verge of retirement have been throwing funds at assets, fuelling a boom, which has come to an abrupt end as they retired and sold off. It’s not entirely implausible that this search for excess income was what led to some of the more extreme and bizarre behaviours of financial institutions in the run-up to the market implosions of 2008: having too much money and nowhere to put it will do that to an institution.

Follow the Trend

If retirees are set to drive the future movements of markets then finding stocks that capitalise on these aged, wealthy and unoccupied boomers is an obvious course of action. So we should invest in stuff like healthcare, alcohol, plastic surgery, personalised light adventure holidays (aka Las Vegas), more alcohol and, of course, financial services. Presumably the latter are signed for in blood and secured on people’s souls.

Of course this all nicely accords with the way most of us are thinking, doesn’t it? Unfortunately this is often a sign that we’re failing to look for disconfirming evidence: the dangers of confirmation bias lurk seductively in every corner. All we really know is the demographic profile of people currently in developed economies: that can’t change much because it’s governed by the physical laws of nature. Everything else is up for grabs.

Disconfirming Demographics

So, maybe the US is set for a twenty year period of slow growth, but maybe enhanced immigration will change the population profile. Maybe the aging population will want to party their lives away on cruise ships, but maybe the falling value of their retirement income will force them to opt for a pedalo on the local duck pond instead. Maybe drug companies can look forward to a boom in sales to geriatrics but maybe cash-strapped governments will legislate to make them look more like utilities than Klondike gold-rushers. Maybe government bonds will be a bust, but maybe inflation will remain subdued due to overcapacity in the face of a declining market for consumption.

Meanwhile Asian societies continue their quest towards self-sustaining economies and as their wealth increases their appetite for Western assets continues to grow. Maybe this growth will be checked by internal problems or environmental constraints but maybe it won’t. Overall there are a lot of maybes which mean that the straightforward expectation that demographics will lead to a reduction in market returns isn’t quite so obvious as we might expect.

Prediction is never straightforward, but we can be fairly assured that the hoards of grey-pated elders streaming towards retirement are going to be looking for safe income streams. That’s probably where we should start to look for a demographic dividend.

Related Articles: The Malthusian Prophesy, The End of the Age of Retirement, Retirees, Procrastinate at Your Peril


  1. Meanwhile from its peak in 1989 through to its nadir twenty years later the Nikkei fell an awe-inspiring 82%. That’s one hell of a nosebleed.


    But they're still kicking.

    That part gives me hope. Humans can take an 80 percent loss and still keep at it. That's the other side of the story.


  2. You ignore the most obvious conclusion, which is to buy Treasuries.

    10Y yields in Japan have been 1.3% for a decade, which makes US 10 years at 3.3% a bargain by comparison.

    U.S. households and institutions own almost no long duration government bonds. In an income starved world, a meaningful allocation out of equity risk premium assets into bonds can drive yields much lower than any of the current msinformed bond bears can imagine.