Many countries across the world are getting older with a higher proportion of retired people relative to working-age people. This is changing patterns of consumption and may also affect equity and bond markets. What are these effects likely to be, how will they affect returns and can we find any evidence that these effects are happening already?
As the proportion of people who are retired relative to those who are working (the dependency ratio) increases this could have effects on an economy and markets
The usual assumption is that
Older people prefer bonds to equity
As populations age this increases demand for government bonds
That Pushes down bond yield
Equity valuations fall as there’s less demand for long-term growth
The question included a reference to this programme which you can listen to if you’re based in the UK https://www.bbc.co.uk/sounds/play/m0018wz7 (from 21 minutes and 20 seconds into the programme)
Manoj Pradhan author of “The Great Demographic Reversal” argues that dependents are inflationary as they produce demand by consuming but don’t add supply to the economy
Dependents consume more than they produce (they don’t produce anything in an economic sense)
Workers consume less than they produce (paid less than the value they create)
More workers reduces inflation
More dependents increases inflation
The economic integration of the labour forces of China and Eastern Europe increased the supply of labour by 120% which reduced inflation
As baby boomers retire and Chinese population ages the the number of workers is shrinking which may increase inflation
Globalisation keeps prices down (a larger labour market, goods made in the cheapest location) so its reversal may increase inflation
There have been suggestions that P/E ratio keeps in line with dependency ratio e.g. Federal Reserve Bank of San Francisco | Boomer Retirement: Headwinds for US Equity Markets? (M/O is the ratio of middle-aged to old population)
This predicted that P/E would fall into the 2020s which, as we know, was way off
In practice the effect of demographics on asset returns is weak e.g. this paper “Demographic Structure and Asset Returns” (James M. Poterba. The Review of Economics and Statistics , Nov., 2001, Vol. 83, No. 4 (Nov., 2001), pp. 565-584)
Investigates the association between population age structure, particularly the share of the population in the “prime saving years” (40 to 64), and the returns on stocks and bonds.
The paper is motivated by recent claims that the aging of the “baby boom” cohort is a key factor in explaining the recent rise in asset values, and by predictions that asset prices will decline when this group reaches retirement age and begins to reduce its asset holdings.
This paper begins by considering household age-asset accumulation profiles.
Data from repeated cross sections of the Survey of Consumer Finances suggest that
whereas age-wealth profiles rise sharply when households are in their thirties and forties
they decline much more gradually when households are in their retirement years.
When these data are used to generate “projected asset demands” based on the projected future age structure of the U.S. population, they do not show a sharp decline in asset demand between 2020 and 2050.
The paper considers the historical relationship between demographic structure and real returns on Treasury bills, long-term government bonds, and corporate stock, using data from the United States, Canada, and the United Kingdom.
Although theoretical models generally suggest that equilibrium returns on financial assets will vary in response to changes in population age structure, it is difficult to find robust evidence of such relationships in the time series data.
This is partly due to the limited power of statistical tests based on the few “effective degrees of freedom” in the historical record of age structure and asset returns.
These results suggest caution in projecting large future changes in asset values on the basis of shifting demographics.
Although the projected asset demand does display some correlation with the price-dividend ratio on corporate stocks, this does not portend a sharp prospective decline in asset values, because the projected asset demand variable does not fall in future decades.
I think one of the false assumptions of these models is that older people want to own more bonds (inflation-linked bonds) and less equity as they age e.g. this is from “Demographics and Capital Market Returns” by Robert D. Arnott and Anne Casscells in 2003
“More retirees than ever before selling assets to a proportionately smaller roster of potential buyers (workers and their pension plans) than ever before equals pressure on asset values. Buyers will want total return, including income and growth; sellers will favor a fixed income and fixed purchasing power”
“Retirees favor some assets more than others. They tend to rely less on growth assets, such as stocks, and favor fixedincome assets. The very last assets retirees will want to sell are those that provide a fixed purchasing power, such as TIPS (officially, Treasury InflationIndexed Securities). Indeed, retirees may liquidate other assets in order to buy bonds and TIPS as a way of improving the reliability of their retirement income and reducing their portfolios’ risks.”
The crisis that they expected by 2015 simply didn’t materialize
“When should the impact of demographics on asset values begin to take effect? The ratio of retirees to workers begins to rise in roughly 2008–2010 and starts to soar around 2015. So, overt selling pressure on risky assets should begin in perhaps 10 years—if the prospective retirees and the capital markets themselves do not seek to anticipate the future. Therefore, the sensible approach is to deem that a demographic crisis, which begins in earnest in fewer than 10 years, is already beginning to have an impact on the capital markets. The problem is now, not 10 years from now”
One rate which many economists agree demographics does have a large effect is the neutral interest rate
The neutral (or natural) rate of interest is the real interest rate that would prevail when the economy is at full employment and stable inflation; it is the rate at which monetary policy is neither expansionary nor contractionary
This is where rates end up once central banks achieve their 2% inflation rate
It is widely believed that this has fallen since the 1980s and a big driver is demographics, as shown here from Vanguard’s 2022 Outlook