Note: For the latest research on Equity Market Valuations, see our latest list of white papers at our post, "The Shiller PE and Economic Conditions"
Assessing the impact of an ageing population on equity and bond markets
There are many factors driving asset prices and equity market valuations. Some influences are temporary - a political scare, a flurry of M&A activity or a technical rally. Some factors are driven by the business cycle, such as company earnings, the level of interest rates and bond yields. Other factors may be part of a secular trend, for instance the profit share of GDP or forces driving the asset allocation decisions of large institutions.
As with any market, equity market valuations are a function of supply and demand. Some factors which impact the long-term supply and demand for equities are impossible to forecast in advance, while others are entirely predictable.
The most predictable secular forces to impact asset prices are demographic. In the US, for instance, it is straightforward to chart the progress of the baby boomer generation. Middle-aged workers tend to accumulate assets, while those in retirement tend to sell assets to fund their spending. In the long-run, this can be an important factor influencing the long-term range for stock market valuations.
The challenge, of course, is to understand how changing demographics influence supply and demand and to accurately model the impact of an aging population upon equity markets and the pricing of other major asset classes.
On the Savvy Investor site we have a number of papers which examine the interaction between demographics and asset prices. Rob Arnott of Research Affiliates argues that the "historically unmatched" economic growth enjoyed by developed nations over the past 60 years has been driven by an abnormal growth in the working-age population, supporting both a declining number of young people and an as-yet modest cohort of seniors. In other words, we have enjoyed an unrepeatable demographic dividend of huge proportions.
For a tactical asset allocator working on a 3-12 month time frame, there will be other far more pressing and significant factors to consider within the timespan over which their performance will be measured.
But for a long-term investor crafting a strategic asset allocation framework, changing demographic pressures may be one of a myriad of influences that they should begin working into their long-term thinking.
References and recommended reading on demographics and asset pricing:
This is the most comprehensive report on equity markets and demographics that we have come across. Quietly released by the Society of Actuaries earlier this year, this survey reviews the evidence from sixty different papers, covering asset classes across equities, fixed income and property. The general consensus of these papers is that the retirement of the baby boomer generation will slowly but surely depress asset prices over time.
In this fascinating paper, Rob Arnott and Denis Chaves argue that the "historically unmatched" economic growth enjoyed by developed nations over the past 60 years has been driven by temporary and abnormal demographic conditions: an abnormal growth in the working-age population, supporting both a declining number of young people and an as-yet modest cohort of seniors. In other words, we have enjoyed an unrepeatable demographic dividend of huge proportions.
Amlan Roy of Credit Suisse is one of the world’s foremost authorities on the interaction between demographics and financial markets. In this report he explores the relationship between demography and asset prices, through a review of academic literature and fresh empirical evidence. The paper goes on to discuss the mechanisms by which demographic factors feed through into asset prices; equities, fixed income and property.
This April 2015 paper from Absolute Return Partners looks at the structural factors that drive equity prices, including dividends and share buy-backs, Corporate Profit as a share of GDP, interest rates, demographics and valuations.
This paper looks at five demographic “megatrends” impacting real estate: urbanisation; the shift of economic power from the "West"; the rise of the global middle class; ageing demographics; global interconnectedness.