There are many reasons that contribute to long term trends in financial markets. Elements such as productivity and technology, regulations and of course supply and demand are all part of the price discovery process that leads to major moves.
In addition, there is one significant variable which, while simplistic and obvious in nature, it is often overlooked: demographics. Very long-term trends in financial assets are cemented by trends in population growth by age segments. This should be clear as our savings and spending patterns are naturally the result of where we are in our life cycle. Also generally expanding demographics do tend to favor economic growth and rising asset prices.
Mark Hulbert, a contributor to Barron’s, has recently posted an interesting analysis of recent studies on the relationship between demographics trends and equity performance. Studies on the link between stock markets and demographics go back to the early 2000s with the work by Geanakoplos, Magill and Quinzii. The interesting element is that demographics trends are generally predictable and therefore if a correlation can be found with equity prices, the value of such relationship from a forecasting angle is very appealing.
In his analysis, Hulbert mentions a specific demographic data, the MY Ratio which is calculated by dividing the number of people aged 35-49 (middle age) into those aged 20-34 (young). The idea behind this ratio is that an expanding middle-aged group relative to young people will translate into more savings and investments, a favorable background for equities.
The model seems to have validity. A look at historical data going back to the 1950s reveals a clear correlation between an increasing MY Ratio and above average equity returns and vice versa it shows below average returns when the MY Ratio was decreasing. In fact, long term bull markets were positively correlated to rising MY ratios in the 1950s to the early 1960s and again in 1980 to 2000. Conversely, the ratio decreased significantly in the 1970s and then again since 2001 to 2014, two periods of below average returns for equities.
Interestingly, the MY Ratio has turned up again and it is predicted to continue to rise until 2035. While it will not reach the previous peak in absolute terms, it is the direction and consistency of the trend that seems to matter.
An additional validation of this study can be found in Japan. Their MY Ratio has been rising since 2002 and that has coincided with a tripling of the Nikkei 225 index.
Of course, even conceding that this correlation will continue in the future, we cannot discount shorter term volatility and possible exogenous events that may alter the path of equities. However, these studies seem to build a positive case for a long-term equity overweight.
Feel free to call us should you want to discuss this topic further. For a look at the original 2002 study, please click on this link