Thursday, 25 August 2011

Demographics and the Stock Market

There is some interesting recent research out of the San Francisco Fed on the relationship between demographics and the stock market.

"Historical data indicate a strong relationship between the age distribution of the U.S. population and stock market performance. A key demographic trend is the aging of the baby boom generation. As they reach retirement age, they are likely to shift from buying stocks to selling their equity holdings to finance retirement. Statistical models suggest that this shift could be a factor holding down equity valuations over the next two decades."

The authors, Zheng Liu and Mark M. Spiegel, estimate an error correction model for the p/e ratio and the M/O ratio and then use this model for forecasting the p/e ratio. The details are in their paper. The M/O ratio is the middle-age cohort, age 40–49, to the old-age cohort, age 60–69.

" The model-generated path for real stock prices implied by demographic trends is quite bearish. Real stock prices follow a downward trend until 2021, cumulatively declining about 13% relative to 2010. The subsequent recovery is quite slow. Indeed, real stock prices are not expected to return to their 2010 level until 2027. On the brighter side, as the M/O ratio rebounds in 2025, we should expect a strong stock price recovery. By 2030, our calculations suggest that the real value of equities will be about 20% higher than in 2010."

It is hard to argue with demographics.

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