Wednesday, June 18, 2008

Demographic trends and the market

One of my loyal readers asked for my thoughts on how the market might be affected by population trends such as Baby Boomer retirement and the growing middle class in emerging economies. I appreciate the question because it's encouraged me to actually look at the numbers. It also gives me an opportunity to put another spin on my overall stock market philosophy.

There is some tantalizing evidence that Boomers have already influenced the stock market. Depending on exactly how you measure it, the Baby Boom birthrate in the U.S. peaked sometime between 1957 and 1960, and the excess number of births at the peak was about 50% higher than the long-term rising trend throughout the 20th century. Someone born around 1958 would start to build a meaningful stock portfolio in the mid 1980's or 1990's, and that's just when we had our historically unprecedented bull market. The Dow 30 rose 1200% between 1982 and 2000, which works out to an average of 15% per year - significantly higher than the historical average of around 10%. If the Baby Boomers had no effect on the stock market, then it's a curious coincidence that the market chose that period for a record bull run.

At the other end, the folks born in 1958 will be retiring en masse around 2023, potentially making that the worst year for "cashing out." However, I suspect that any retiree sell-off will be spread out over may years due to a gradual shifting of assets from stocks into bonds, annuities, and other fixed-income investments. Indeed, the strategy recommend by most investment advisers today is to gradually reduce one's exposure to stocks well before retirement, so the Baby Boom sell-off may already be under way.

But the Baby Boomers are not the only story in town any more. Thanks to the internet, economic globalization, and rapid modernization in many countries around the world, the distinction between markets or investors on different continents is vanishing. Today anyone in the United States can invest in Chinese stocks, and vice-versa. ETFs that are indexed to countries or regions have made this particularly easy: one click in an online account can get you a diversified portfolio of hundreds of stocks of companies that you've probably never even heard of. The best evidence of this merging of markets is shown in the chart below, which compares the last 12 months of stock market performance in North America (blue), Europe (red), and Asia (green):

This coherent movement of stock markets reflects that the economies of these regions are increasingly linked, and that the average stock trader is buying and selling stocks with little regard for the geographical location of the underlying company.

To the extent that there are increasingly more people around the world with access to stock markets, there will be an increase in demand for stocks which will at least partly offset any effect from the Baby Boom sell-off. More to the point, when two billion people in China and India are becoming both more productive and wealthier to the tune of 8% or more per year, it can't help but have a positive effect on the global economy and on stock markets.

Now, I'm not clever enough to know which effect will be stronger for the next two decades (retirees vs. global growth), but the fact that there are two offsetting trends tells me not to worry about it too much. A large bear market from 2000-2002 was immediately followed and erased by a bull market in 2003-2007, and I doubt that any struggle between Boomers and new Chinese investors had much to do with either trend. Sure, the value that the S&P 500 and other indexes reach in 2030 will be affected to some degree by retirees in North America and middle class investors in Asia, but my hat is off to anyone who can see a number that far into the future. Besides, between then and now there will be more bear markets, bull runs, and bubbles that burst, and as long as dividend yields remain as low as they are today, I think there's far more money to be made in those trends than buying-and-holding through the major dips.


adventurerneil said...


Glad to hear you felt inspired to think about and research some of these emerging macro trends. Definitely appreciate it, and agree that the oldies should counter-balance the new guys. I recently learned that donating stock shares is a good way to avoid being taxed.. not sure how possible it is to do so from person to person, but perhaps this will have some effect on inheritance and estate planning.

What degree(s) do you hold?


Jody said...

Ph.D. in Astrophysics
B.S. in Physics, Astronomy