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Demographics paint grim outlook for equities

The historically strong correlation between demographics and the stock market could make this the most depressing market outlook piece we've ever written.

This chart displays the work of two economists, Zheng Liu and Mark Spiege, from the San Francisco Federal Reserve. Their study noted an extremely close relationship between the average age of the U.S. population and the price-to-earnings (P/E) ratio of the S&P 500.

Specifically, they looked at the percentage of the population in their peak earnings years – 40-to-49 years old – compared with the size of the 60-and-over age group. When this middle-age-to-older-age ratio is mapped against the P/E ratio for the S&P 500 over the past few decades, there is strong evidence that an aging population goes hand-in-hand with sharply lower multiples for the S&P 500.

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The logic behind the correlation is that equity investment rises along with the relative size of the 40-to-49 group because that age cohort is at their career highs in terms of income and also at their peak levels of saving for retirement. Once people hit their fiftieth birthdays, their incomes and their investment levels decline, on average. Demand for equities – and the price that people are willing to pay for a dollar in earnings – fall in tandem.

Data for the Canadian population and equity prices are less available, but in this chart, the link between age and price-to-earnings ratios appears to hold, if only loosely, for domestic markets. That is not good news for investors.

The model developed by the Fed economists suggests that the Baby Boomer generation's move into the 60-and-over age group will drag down the P/E ratio of the S&P 500 to about five by 2020 from where it is today, namely 14. Extrapolating the growth rate of earnings for the past five years and applying a five times multiple puts the S&P at around 800 in 2020, 42 per cent lower than today.

To be sure, the historical pattern may not hold. Mass immigration may change the demographic outlook, and emerging market investors may keep demand healthy for North American stocks. But aging boomers now have one more thing to worry about.

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About the Author
Market Strategist

Scott Barlow is The Globe's in-house market strategist. He is a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth (MPW). He was a highly ranked mutual fund analyst for 10 years and then, most recently, the head of a financial adviser support team at MPW. More


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