Mar 15th 2012, 20:32 by A.C.S. | NEW YORK
AGING populations in America and Europe raise many economic concerns. A popular one is whether aging baby boomers will tank the stock market. That's story in this Wall Street Journal article, which says that when baby boomers bought stock to fund their retirement, that drove up share prices in the 1990s. Now, on the cusp of retirement, they will sell their shares so prices must fall. This theory appears to be confirmed by a figure from the San Francisco Fed, which shows a strong correlation between the price/earnings ratio and what they call the M/O ratio, the ratio of people age 40 to 49 to people age 60 to 69.
Does this mean we're doomed for a bearish decade? Perhaps, but I am not convinced. First it's unlikely that each cohort of retiring baby boomers will sell shares en-masse. Most retirees don't annuitise or hold a significant amount of inflation-linked securities, so many will probably keep some equity in their portfolio to hedge against inflation in retirement. And if investors expect liquidity to dry up, wouldn't that already be reflected in prices? Perhaps the number of equity buyers won't fall. Many boomers don't own stock; according to the 2007 Survey of Consumer Finance about 60% of households with a boomer head own some stock. If owning equity becomes more popular then the supply of buyers could increase, even as the population ages. Most people only own shares through their retirement account, so the growing ubiquity of private pension accounts (which covers a larger share of the American population than defined-benefit plans ever did) could increase stock market participation.
Global markets are also more integrated and it's the global population of investors that matters. But people and institutions tend to have home bias when it comes to their stock portfolio, so I'm not sure we can count on Chinese savers to buy American stocks.
Besides, the supply and demand story is not the only thing that determines asset pricing. It may in the short-run, but over the long-run there are other factors. Many of the economic models that show decreased demand resulting in lower stock prices assume a fixed capital stock or capital structure. With a smaller labour force participation rate or population of share buyers, why would the number of shares stay the same? Firms might buy back shares to keep the price high or there may be fewer firms because of mergers or closures. Or if firms can't raise much capital in the equity market they might explore other methods of finance. And if retirees do hold on to their equities they might desire stocks that pay dividends to finance their consumption.
The supply and demand story also ignores the risk. Stock returns are determined by the equity risk premium above bond returns. The risk premium is how much investors are compensated for holding an asset that's riskier than a bond. So a falling stock price demographic scenario presumes that younger generations are more risk-tolerant. Perhaps that's true; risk tolerance can be generation-specific. Children of the Depression were more wary of the stock-market than baby boomers. But if generational risk tolerance determines share prices you'd see higher stock prices in the 1960s and 70s, when Depression children were in their prime saving years, and lower ones in the 1990s, when baby boomers were saving; the opposite happened.
Another way to look at equity prices is as reflecting the discounted value of future cash flows of a company, or future profitability/productivity. That will be determined by the size of the labour force and future gains in productivity from technological innovations. This is the demographic issue that troubles me. As populations age, America and Europe will divert an increasing share of GDP to the old, rather than developing the skills of the young, through state pensions and health care. This might undermine future productivity. Megan McArdle frets that countries with older populations will experience slower growth because older workers may be less innovative and risk-taking. That's not encouraging but need not be our fate; one never knows what new innovation has the potential to transform an economy. Years of history suggest each generation is richer and more productive than the last; why should our future be any different?
It is not clear what demographics will mean for the share prices. The story is more complicated than supply and demand of share buyers. The stock market in the future will be determined by global attitudes toward risk, retirement, and productivity. Whether or not this will result in decades of bear markets is anyone's guess.
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China livestock Market Review & Outlook 2010-2011 China's livestock industry experienced dramatic changes in 2010, including the supply of live pigs shifting from surplus to the balance of supply and demand, from long-term losses to a high profit, accompanied the inventory decline of pigs and sows inventory; broiler breeding also shifting from high profit to low profit and some losses; layers breeding turning from long-term losses to high profit, coupled with layers inventory continuous decline; beef cattle entered the slow recovery process; sheep herds recovered. At the policy level, the state continued to subsidize the investment and construction of standardized large-scale farms and started purchasing and throwing storage of pork for many times; at the same time carried out investigations of anti-dumping and anti-subsidies on chicken from the U.S. and imposed heavy tax on the latter, completely offsetting the latter's price advantage in Chinese market; under this impact, the problem of beef smuggling has also been proposed by large enterprises of the industry and the State may take actions in the next year. Regarding breeding, animal diseases are still serious, frequently leading to pigs and chickens slaughter and selling in advance and abnormal elimination out of laying hens, leading to a decline in breeders and losses with hatcheries, reducing the supply of seedling chicken and laying hens. http://www.bharatbook.com/market-research-reports/commodity-market-resea...
The Financial Analysts Journal has just published a paper on just this subject -- i.e., the historical link between demographics and stock and bond market returns. It's "Demographic Changes, Financial Markets, and the Economy" by Rob Arnott and Denis Chaves. Go to this link:
http://www.cfapubs.org/doi/abs/10.2469/faj.v68.n1.4
PE ratios may continue to decline to the levels of the late 1970's because investors are more afraid of the stock market. But that doesn't mean we'll have a bearish decade. It just means the PE ratios won't soar to ridiculous levels that it did in the late 1990's.
On the other hand, if price inflation picks up as some expect, especially Schlaes (bloomberg.com/news/2012-03-14/watch-bernanke-s-little-inflation-capsize-u-s-amity-shlaes.html), then profits will soar with price inflation and stocks will follow.
Stocks are a good hedge against price inflation.
"PE ratios may continue to decline to the levels of the late 1970's because investors are more afraid of the stock market."
I think those of us who've been through a couple of these bubbles, and who didn't keep a substantial amount of cash on hand to ride out the cycles, are more afraid.
However, if the market continues to rise (as it did again today), over time fear abates and greed kicks in, folks bail on the bond markets and jump into equities, and we're off to the races.
Which in short is why Kramer says it's time to buy, and get in on the rush now.
I think the fear of runaway inflation is misplaced. The financial market is too open for that to happen. The US dollar is backed by strong institutions. Excess money created by the Fed will more likely end up circulating outside the country rather than creating inflation at home. Investors are not stupid, after all. Just because real interest rate is negative at home doesn't mean they will invest in bullshit yielding 2%. They can always take their money to emerging markets for a much bigger return. It's a no brainer, really. Invest in America, you get low yield and watch it get eaten away by the inflation that you investment is causing. Invest abroad, you get higher yield and gain from the appreciation of the local currency against the dollar as well.
You're liable to lose your shirt buying stocks to hedge against inflation that doesn't materialize. In 1994, the Nikkei 225 was around 20,000. Today it finished at 10,123.
Would you say that the 1994 PER on the nikkei were in a similar situation in 1994 as it is today on the S&P 500? I am trying to understand if the comparison is justified
Isn't 70 the new 60? Besides, Baby Boomers are going to have to work and chase cap gains forever, because they didn't save anything. Remember? Why save when we're all going to get rich by selling our houses to each other?
And that spotlights the flaw in the theory. It assumes that the Baby Boomers saved (i.e. bought stock) to fund their retirement at the same rate as the previous couple of generations. Whereas the evidence appears to suggest that saving for retirement is lower with my generation than with our parents'.
At which point, the correlation breaks down -- because it's not the age ratio vs. stock price, but rather the stock held by the older generation vs stock price. Can't sell what you didn't have the wit to buy.
Funny! That was the plan!
"Why save when we're all going to get rich by selling our houses to each other?"
Great idea.
I'll sell you mine if you sell me yours. :)
Interesting, thoughtful post.
In the meantime, yesterday on CNBC, Kramer had the following suggestion:
BUY! BUY! BUY!
Just yesterday I was thinking if being at nearly 35% in international funds in my 401k was too much...but this post confirms my decision.
In this blog, our correspondents consider the fluctuations in the world economy and the policies intended to produce more booms than busts. Adam Smith argued that in a free exchange both parties benefit, and this blog's aim is to encourage a free exchange of views on economic matters.
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