Do demographic changes matter for financial market returns?

Be careful when predictable factors appear to shape financial market returns, but nonetheless this result, written up by Robert Arnott and Denis Chaves,is intriguing:

It seems natural that the shifting composition of a nation’s population ought to influence GDP growth and perhaps also capital markets returns. Entrepreneurialism, innovation, and invention tend to be associated with young adults. Accordingly, GDP growth should perhaps be best when there is a preponderance of young adults in a population. Investing for retirement is associated with middle-age, with a shift in preferences toward bonds with late-middle-age. So, stock and bond returns might be best in populations with growing rosters of these age groups, respectively. Our data – spanning over 60 years and 22 countries in our main tests and roughly 175 countries in out-of-sample robustness checks – support all of our priors.

We confirm what others have already demonstrated, but we extract markedly more statistical significance by adapting a polynomial curve-fitting technique pioneered by Fair and Dominguez (1991), to this new purpose. In our work, we find that a growing roster of young adults (age 15-49) is very good for GDP growth, a growing roster of older workers is a little bad for GDP growth, and a growing roster of young children or senior citizens is very bad for GDP growth.

This is in accord with some of Brink Lindsey’s recent observations.  For the pointer I thank Sami, a loyal MR reader.


stock and bond returns might be best in populations with growing rosters of these age groups [ middle-age and late- middle-age], respectively.

I didn't understand the reasoning here: If a lot of people invest in a particular type of instrument why would it improve returns on that instrument? Intuitively, I would expect the returns to do down because of competition. What gives.

More people, in this case younger people, buy stock xyz, the price goes up. What is hard to grasp about that? You say "competition" would cause returns to go down. What do you mean?

Of course demographics matter. I have made this point at various points in these types of discussions, particularly at Thoma's blog, about the influence of baby-boomers as they moved through the demographic data like large prey through a snake and all I ever got was condescending replies coupled with hands on ears and over eyes. Nearly every notable economic moment....from stagflation to the prolonged prosperity afterward to the late 90s surge and now dismal economic data on either indirectly caused by or intensified or exacerbated by the presence of boomers at a particular stage in their life.

People like to talk about boomers as it related to public in its implications on Medicare....but appreciation of its effects on economic history from 50s to the present is usually ignored...whether willfully or not.

What's the alternative, though? A society hardly has the option of enjoying the high GDP phase of a young adult heavy demographic without being stuck by the old baby boomers 30 years later. One might be tempted to recommend a flat demographic (i.e. a society that always works with replacement fertility levels) But is there empirical proof that such nations do any better?

Good post, John V.

And Rahul: the simple alternative is immigration (mostly young adults) to prevent a Japan and Europe-style age bomb. We got nothing on those areas for demographic problems.

Hmm...I'm a bit confused now; some research totally changed my preconceived notions of the baby boomer crisis. The age distribution plot of the US looks quite flat and nice:

Why are we so concerned? From this it would seem we have a equal number of young ones to support the aging. Any more young ones, and you are just creating a problem for 30 years later. What is the ideal distribution?

To my eyes US looks as ideal as can be! Tried lots of nations but could find nothing with a flatter distribution than the US.

Because our institutions and assumptions are based on having lots of young ones to support fewer of the aging. We didn't have as much problems with 'pulses' because we had continued population growth.

A flat age distribution should be stable once society adjusts, but getting there from here won't be pretty.

Of course. Because young immigrants are so eager to pay taxes for a bunch of stupid old white people who didn't bother to have children of their own.

It's not about eagerness. They don't have a choice. You have to deal with the devil sometimes.....

You ever been in the construction or restaurant business? Hell yes they have a choice. Or they can just choose net tax consumption.

"we extract markedly more statistical significance by adapting a polynomial curve-fitting technique" Hmmm, that doesn't inspire confidence. Sounds like they were working hard to confirm their priors...

Most twittable sentence I read all week: "Be careful when predictable factors appear to shape financial market returns"

Has "twittable" made it to the OED yet?

Wouldn't it be 'tweetable'?

I guess China is screwed.

I suppose in a closed economy with a younger population, holding cultural factors and financial market sophistication constant, there is more demand for money and less supply in the form of savings, since it wis well known that young people tend to be net borrowers and older people tend to be net lenders. That would support higher capital market returns. But in the real world, economies are not completely closed, except maybe to the extent the government has instituted capital controls (and then it wouldn't matter because you couldn't invest). None of the evidence in the article relates to financial markets, only GDP. So my answer to the title of the post is no. Although I expect countries with younger populations would tend to be emerging markets which have strong market returns, but that is mainly due to convergence with developed world living standards.

Actually, Lou, there's a great deal of emerging work showing that China may indeed be screwed, or at least run into some very serious demographic problems due to the one child policy.

Much of their current boom is demography-fueled, and the numbers start to work against them starting in 10 years or so. This is one of the many reasons why people that simply forever extrapolate current Chinese growth rates in wealth and output and so on are way off.

I have no doubt you're right about that.

Flat population spread is bad when most programs were developed to support a much larger young adult to older population. Coupled with a period of time when VC money is tightened and the concept of entrepreneurism is viewed as too risky by dreamers and entrepreneurs are viewed villains or the targets of potential income grabbing.

'Spengler' (David Goldman) has been arguing this relationship between demography and financial markets for at least the past ten years. For example here is one from 2003 on the causes and effects of demographic collapse in Europe.

One may not always agree with him, but he has remained worth reading to me over all these years. Tyler does not seem to like him, though.

Being banned from GNXP by you know who, I have my own thoughts about this. data != 'data' for some.

Do you think the emerging markets boom had a lot to do with the shifting age structure of BRIC and Frontier Markets?

Rodolfo Acuna (professor of Chicano studies at Cal State Northridge) “There’s a growing feeling ‘Why should we pay for all these senior citizens’ if the majority of them are white and all they were willing to pay for was prisons?” [Jonathan Tilove, Generation Gap Becoming Racial Gap, San Francisco Examiner, Nov. 23, 1997, p. A17.]

People are NOT fungible. You are going to learn that the hard way, real hard. So will your kids.

That would support higher capital market returns.We got nothing on those areas for demographic problems.

“Be careful when predictable factors appear to shape financial market returns”

Usually good advice, but demographics changes are exactly the kind of thing that modern financial theory would expect to generate predictable returns- by changing the stochastic discount factor.

This shows which they last very much lengthier and thus saving you income which could otherwise are actually utilized to purchase new ones.

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