The Demographics of Stock Market Returns Part I
Many articles and academic papers have been written on the link between demographics and stock market returns. For example, a widely-circulated paper of 2011 from economists at the Federal Reserve Bank of San Francisco suggests a price to earnings ratio of 8.4 in 2025 for the US, which would mean a soon-to-be 50% stock market plunge that never recovers.
Are we doomed by domestic demographics?
There are 2 multi-trillion dollar questions:
- Is this true/credible/probable?
- If it is, WHEN will this correction happen and what form will it take?
First, if it is true, the implication is that stocks should plunge approximately 50% and essentially never really recover, on average. Second, it means that we are really going to fall off a cliff soon, and it would be wise to get out of stocks now and hold low-return cash or quasi-cash such as AAA bonds for a decade. Let’s look into this a bit, shall we?
The idea of the model
The general approach to all demography-based models for stock market forecasting is simple and intuitive: all else equal, the more “buyers” there are relative to “sellers”, the more it is good for stock prices and stock indices. Since retired people tend to be “sellers” of stock, a decreasing ratio of buyers-to-sellers due to an aging population would put inexorably strong downward pressure on stock markets.
This makes a lot of sense: the most likely buyers of stock are people in their 40s that are established in their career and want to prepare for retirement, and the sellers are people in their 60s who want to get away from stock market risk and hold their wealth in less-risky forms.
To capture this effect, the researchers have taken an interesting approach: they approximate the “buy group” as the age group 40–49 and the sell group as the age group 60–69. They then make a strong case for the relation between the proportion of buyers per seller and the price to earnings ratio, with historical data from the 1950s until 2011: their “buyers-to-sellers” ratio explains the general trends of bull and bear markets. According to this metric, we are currently in a secular bear market that should hit bottom around 2025–2030.
Scenarios and predictions
Many people have used demographics to call incredibly low and high values for stock indices that were never reached. Others (or the same ones!) are now using this same demographic approach to call a decade of bear markets everywhere, with some empirical proof to this claim.
Fact 1: China, the USA, and all industrialized economies have recently tipped into a 20-year trend of decreasing ratio of working age population (15–64) relative to total population.
Fact 2: The ratio of 65+ relative to total population will increase for the next decade and more in China, the USA, and most industrialized economies.
Fact 3: Japan and Germany will have a significant absolute contraction (not just relative to total population) in the working age population for the next decade.
The history of extreme predictions
The end of time has been predicted before… for centuries and millennia! These predictions never came to be. Yet the predictors in question kept saying “it will happen, it is a matter of time”… and we are still waiting, 5, 50, 500 years later!
Recession calls and extreme market calls are serious business, because if people listen to these calls, they allocate their funds based on these “convincing” calls for a DOW at 40 000 or a crash to 5000 that would never recover. If you are a “buy and hold” type and you read a convincing report that calls for a 10–15 year bear market, you get out now and move to the low-yield bond market.
Many doom predictors have called for the end of stock markets, the end of the USD, or an oil price at 300$ per barrel every year for the past 15 years. Recently, since 2012, there are calls of the crash of the US stock market that will be the mother of all crashes, even worse than the Great Depression, and more doom for the USD.
Trying scenarios
Since I am an economist who has an honour’s bachelor’s degree in math and loves analyzing data, I tried other scenarios. We’ll try a few scenarios in Part II, but here is a simple one: I took the number of employed aged 18+ (including 65+) as an approximation for stock buyers and the number of non-working retired as an approximation for sellers of stock.
This captures the fact that there will be an increasing proportion of 65+ individuals who will continue working, and may be buyers (or holders) of stock even if they are older. I used the BLS and Fed projections for unemployment rates and participation rates by age cohort for the 2015–2030 period.
I essentially got the same result: my measure of “buyers-to-sellers” ratio contracts from 3.26 now to 2.26 in 2030: we lose one full buyer per seller over the next 15 years, suggesting a general secular bear market for the next 10–15 years.
This got me thinking: should we all get out of stocks and essentially wait a decade to come back? Is a secular bear market upon us? Will all this be priced in during the next stock market crash, marking the end of stocks for a decade? We’ll explore this in great detail in Part II, so stay tuned :) Like and share! Regards. PB
