Finance blogger wisdom: demographics and equity returns
- June 19th, 2014
Abnormal Returns is on hiatus this week. However that does not mean that we are content-free. As we have done in previous years we asked a panel of highly respected independent finance bloggers a series of (hopefully) provocative questions. Yesterday’s edition focused on whether individual investors are missing out the action in the private markets. Below you can see the blogger’s name, blog name and Twitter/StockTwits handle. We hope you enjoy these posts as we do.
Question: Rob Arnott has made a lot of noise about the role of demographics on asset returns. Given that the demographic outlook for much of the developed world is pretty bleak (and relatively predictable) should we be worried? (Answers in no particular order.)
Demographics are a headwind, especially in the gap years between when baby boomers retire and millennials ascend to their prime earning years. Granted, this gap may narrow or disappear if baby boomers work longer than planned. The utility of demographic data in an investment strategy/allocation is hard to determine. Because of the better demographic trends in select emerging and frontier markets (and because equity market valuations in those regions are attractive at the moment), emerging markets deserve an allocation in a long-term portfolio.
Harry Dent’s demographic-based ETF didn’t exactly fare so well, but you can’t completely write off these types of trends. The problem is that higher rates of economic growth don’t always translate into better standards of living just as lower economic growth rates don’t always factor in gains from efficiency and technological advances. Also, second level thinking tells us that expectations and relative growth rates matter much more than absolute levels. And it’s impossible to know exactly how much a long-term variable such as demographics is “priced into the market” at any given point in time.
There will be winners and losers among countries and regions because of the role of demographics, but there are a host of other issues involved. As Bill Gates pointed out in his most recent annual letter, slowing rates of population growth are actually a positive for many emerging counties because it usually means living standards are improving through higher levels of education and a decrease in child mortality rates.
It’s can be very difficult to use a single variable like this to draw concrete conclusions.
If the demographic profile of investors leads them to prefer bonds instead of stocks then the natural response will be for companies to borrow cheap money in order to buy back (presumably-cheap) stock, which is what we’ve seen over the past few years. It’ll work out. Companies tend to opportunistically fade the asset class mix of households.
Understanding demographics is largely a function of geography in today’s world. The new macro world requires an understanding of how the developed world is changing relative to the emerging world. And while it’s true that there is population stagnation in much of the developed world, there remains a population boom in much of the emerging world. A new middle class is developing and these consumers want the lifestyle they see in the developed world. There is a powerful convergence between the accessibility of technologies made in the developed world and the demand from the emerging markets that is transforming the world into a new macro environment. Investors and businesses need to position themselves accordingly.
I was going to attempt to answer this question but when the piece in question started off by talking about imposing a “smooth and parsimonious polynomial curve across all age groups,” my cerebral cortex momentarily shut down. Who the f*ck talks like that? Plus they inserted what looked like the quadratic equation into the article. Don’t do that. Just don’t.
Of course it’s worrying, but I think the data is mixed to this point and the future isn’t as necessarily as bleak as Rob suggests.
Right now, US stocks account for about 50% of the world’s equity market capitalization. Europe and Japan are another 20% or so each. The balance is split between Emerging Markets and Frontier Markets. You’d have to be crazy to think that the latter two categories aren’t going to gain prominence (and global market cap share) relative to the developed markets – it’s a matter of when and how much, not if. And so the important thing is not to fret about the aging developed markets, it’s to rejoice at all of the opportunities we have elsewhere.
I think it’s an incredibly important factor, both in economic growth and investor behavior, but I can’t judge the impact. All else being equal, it should probably make you more cautious than normal, but all else is never equal.
I’m very familiar with the source research, since Rob’s co-author–Denis Chaves–is a close friend and fellow Chicago finance Ph.D. We’ve talked in detail about this research on a few occasions. Demographics might matter, but the degree to which they matter depends on the integration and efficiency of capital markets. A simple unrealistic example: assume we live in a country with 99% of the population entering their retirement years, starting next year. All retirees decide to dump their stocks and transition from equity to fixed income. Equity markets will crash and bonds will get too expensive. That’s one version of the story. However, if capital markets are open and integrated, all the young emerging millionaires and billionaires in countries like India and China will gladly scoop up stocks being dumped by the retirees and prices might hot be affected at all. This is obviously a simple example, but the point I’m trying to highlight is that the complexity associated with understanding how demographics affect asset prices is unwieldy and prone to informed SWAG (silly wild ass guess) that may or may not prove true.
We must be careful in our time frame for worrying. While the demographics may be predictable, the behavior and policies will change –perhaps a lot. People are already working longer. The U.S. will eventually develop a rational immigration policy, helping the advanced economy that is already least threatened. We can only guess about the growth generated in emerging markets and what changing roles will be and what new technologies will contribute. Most of the potential positives are difficult to specify and nearly impossible to quantify. There is a danger in focusing on what is “predictable” and easily measured. This will be interesting to watch as it plays out.
Demographics do mean a lot. But, I think there are other deflationary pressures on the economy that are more prevalent. It will be interesting to see how the printing of money interacts with the deflationary pressures. Government debt might be a bigger deal in the long run.
Thanks to everyone for their participation. Stay tuned for another question tomorrow.
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