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(Susana Vera/Reuters)
(Susana Vera/Reuters)

Strategy

Markets and the lure of a demographic dividend Add to ...

Spain, Ireland and Greece are investing basket cases now – but they just might turn out to be among the hottest destinations for stock and bond investors over the next decade.

Sound crazy? Not if you look closely at the age of the populations of these downtrodden markets.

A new study from Robert Arnott and Denis Chaves of California-based investment firm Research Affiliates LLC – using a broader range of historical demographic and market data and more intricate statistical techniques than past research – found that the age makeup of a population may have a bigger impact on stock and bond returns than previously thought. Certain age groups are more prone to investing than others, and even modest changes to the number of people in key age groups can significantly boost or lower overall market returns.

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“Stocks perform best when the roster of people age 35-59 is particularly large, and when the roster of people 45-64 is fast-growing,” the researchers wrote. “Bonds follow a similar pattern, with an age shift: They’re best when the roster of people age 50-69 is growing quickly.”

They found that at peak age group for stock investing – 45-49 – a 1-per-cent increase in the size of that age group has historically translated into about a one-percentage-point increase in the long-term average of stock market returns. On the other hand, a 1-per-cent rise in the population older than 70 reduced those returns by about 1.5 percentage points.

In the bond market, a 1-per-cent increase in the population aged 45 to 49 translated into a 0.5-percentage-point rise in average returns, while the biggest drag was in the 15-to-19 age group, where a 1-per-cent population rise reduced returns by about 0.6 percentage points.

By extrapolating those findings to demographic forecasts for leading economies around the world, Mr. Arnott and Mr. Chaves identified the countries whose changing populations should provide their stock and bond market returns with the biggest lifts or impediments over the next 10 years. Some of the biggest winners look to be Singapore, Ireland, Spain and Greece – while the aging populations in Japan and the Nordic countries should be a drag on their stock returns over the next 10 years.

Oh, Canada

The researchers found that Canada – whose aging population is nevertheless younger than some of its developed-world counterparts – stands to get a moderate lift from these demographic effects on its equity market returns, but an even bigger lift in the bond market.

However, Mr. Chaves warned in an interview that Canada’s demographic shift toward the older age cohorts is coming particularly rapidly, which, the research found, could put additional strains on the markets to mitigate these apparent benefits.

“In Canada, for every citizen that is retired, there are 4.5 citizens that are working age,” he said. “But by 2030, that number is forecast to decline to 2.5. Canada is catching up [to other aging economies]pretty fast.

“The faster the changes, the more positive or negative the effects can be.”

The study, which mined 60 years of market and demographic data from countries all over the world to come up with its results, largely confirms some of the most commonly held beliefs in the financial community about the optimal age of investors and the types of assets they are likely to invest in.

“It does make intuitive sense,” said Steve Foerster, a professor of finance at the Richard Ivey School of Business at the University of Western Ontario. “At various times in our lives we differ in the amount of [investment]risk we are willing to take on.”

It may also help explain one big trend emerging from the recession and recovery – a drift by mutual fund investors away from pure equities and toward balanced and bond funds. This may merely reflect a defensive response to the heavy losses felt by many investors in the financial crisis, but it may also be evidence of the early stages of this demographic shift in investing priorities, as the first of the Canadian baby-boomer generation reaches retirement age.

Ajay Kapur, chief Asian equity strategist for Deutsche Bank, has argued that these demographic trends should help many emerging markets. A couple of years ago, Mr. Kapur developed the Demi-Ashton Ratio – named for Hollywood couple Demi Moore (in her 40s) and Ashton Kutcher (who was in his 20s when they married in 2005) – to identify countries whose ratio of 40-something to 20-something citizens is on the rise. He said that this is “highly correlated” to superior equity market performance.

“Happily, most emerging markets qualify – indeed, we think these … demographic drivers are the only two reasons to be bullish on the asset class over the long run,” he wrote in a report this week.

But others caution that age demographics are just one example of a wide range of forces behind stock and bond returns, and that other factors could delay or even sideswipe any predictions derived from them.

“You could easily be off by 10 or 15 years in making these kinds of predictions,” Mr. Foerster said.

Mr. Chaves and Mr. Arnott themselves cautioned that their forecasts should be taken with “not a grain, but a shakerful of salt.”

“We should not focus too much on the forecasts – on the magnitude of the numbers,” Mr. Chaves said. “But they are a strong indication that … the demographic changes that are happening right now could have potentially very significant impacts.”

Support Ratios



1950

1980

2010

2030

2050

Japan

10.0

6.7

2.6

1.8

1.2

Germany

6.2

3.7

3.0

2.0

1.6

Canada

7.1

6.2

4.5

2.5

2.1

United States

7.0

5.1

4.6

2.8

2.6

Singapore

20.3

11.8

6.5

2.0

1.6

China

11.6

10.3

7.8

3.8

2.4

Brazil

15.3

11.3

8.6

4.6

2.6

India

15.7

13.0

11.0

7.2

4.5

The support ratio is the number of people 20 to 64 divided by the number of people 65 and over. Based on preliminary research conducted by Research Affiliates, LLC.

Source: Research Affiliates, LLC, based on data from the UN Population Division.

 

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