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How demographics are working against stocks

Stocks may be in the midst of a summer rally, but it doesn't look like retail investors have gotten on board.

In fact, they haven't really gotten behind the market recovery of the past four years.

Even amid a rising market, U.S. retail investors continued to pull money out of equity mutual funds in July, handing those funds their 15th consecutive monthly net outflow. Bond funds, on the other hand, saw net inflows.

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It's part of a broader trend that's been going on for years, said National Bank Financial chief economist and chief strategist Stéfane Marion. What's more, he argued, "We believe that this dynamic is here to stay."

A time for bonding

In a research note this week, Mr. Marion wrote that over the past 15 months, $207-billion (U.S.) has left equity funds, while $261-billion has flowed into bond funds. Within bond funds, investors have demonstrated "a clear preference" for corporate bonds, which offer much higher yields than government bonds, whose yields are near historic lows.

Many pundits have argued that the financial crisis of 2008 has made investors increasingly risk-averse, and driven them to higher-yielding investments as a way to maximize their returns in an era where longer-term gains from the prices of stocks alone have proven elusive.

However, retail investing dollars have been generally flowing away from equities, and toward bonds, since the middle of the last decade – well before the financial crisis. Investor skepticism from the 2008-2009 market plunge can't fully explain the trend.

But, Mr. Marion suggests, demographics can.

The age of risk aversion

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"With a record 21 per cent of the U.S. work force now aged over 55 … and 36 per cent of households' total financial assets earmarked for retirement, the asset mix of the general population is structurally biased towards instruments that generate an income stream," he wrote.

That not only has affected the flows of retail investing money, but has ramped up the premium investors are demanding to invest in stocks, Mr. Marion said. Charting the relationship between the age of the work force and the equity risk premium since 1955, he found that the risk premium has typically been higher when the working population is older, and vice versa.

(Equity risk premium is defined as the spread between corporate bond yields and earnings yield – which is earnings per share as a percentage of stock price, essentially the inverse of the price-to-earnings ratio.)

With the percentage of older workers still rising as the baby-boom cohort nears retirement age in increasing numbers, this trend looks likely to continue, Mr. Marion argues. That means the flows away from equity mutual funds, as well as the pressures on stock valuations, look to be long-term trends that aren't going away.

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About the Author
Economics Reporter

David Parkinson has been covering business and financial markets since 1990, and has been with The Globe and Mail since 2000. A Calgary native, he received a Southam Fellowship from the University of Toronto in 1999-2000, studying international political economics. More


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