Practical analysis for investment professionals
21 September 2020

Aging and Equities: Selling Stocks for the Long Term

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” — Friedrich Hayek

“The use of mathematics has brought rigor to economics. Unfortunately, it has also brought mortis.” — attributed to Richard Heilbroner

In finance, everyone loves to make fun of economists. Even economists.

Perhaps the field is simply too complex for our simian brains to grasp: After all, the variables — GDP growth and interest rates, for example — are all interrelated, which makes it difficult to wrap our minds around them. At best, we create a mental map of positive and negative feedback loops. At worst, we develop something like a circular reference in Excel that may cause the spreadsheet to crash.

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But sometimes economists do do obviously illogical and silly things. For example, Haruhiko Kuroda, the governor of the Bank of Japan (BOJ), has been buying up stocks, bonds, and exchange-traded funds (ETFs) to counter what is fundamentally a demographic problem. In his defense, he is not the first BOJ governor to pursue such a course, and he only has monetary power at his disposal. But that power might be put to better use attracting the millions of immigrants who are needed to help Japan avoid eventual demographic collapse.

The headwinds are fierce: Japan’s population is expected to decline by 40% between 2020 to 2100, falling from 126 million to 75 million. Losing 50 million people while stuffing money in the pockets of those remaining won’t stem the tide: It’s more like giving bailing buckets to the passengers on the Titanic.

Unfortunately, Japan is a harbinger of what’s to come across much of the world. And while fewer people may be good for the environment, it is terrible for civilization. Economic growth hinges on an expanding population. And the fabric that holds society together is always torn when the economy unravels.

This trend is also terrible for investors: Old people tend not to buy stocks.

So what exactly is the relationship between stock markets and population growth? Why are demographic trends so critical for equity returns?

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The Drivers of Stock Returns

Simply stated, companies require economic growth to prosper, and gains in productivity and the working-age population are what drives that growth. We haven’t found a way to stop the aging process, so an expanding population is required to replenish and expand the number of workers who contribute to the economy. If that working-age cohort is shrinking, stagnation may set in and firms will have a harder time growing their revenues and earnings. As a consequence, their valuations will decline since they depend on expected growth.

But there is more to this equation: Every transaction has a buyer and a seller. The young and middle-aged tend to buy more stocks: They have a longer investment time horizon and thus more capacity for the risk inherent in equities. In contrast, the elderly are net sellers as they de-risk their portfolios by moving from stocks to bonds. So, as the population ages, who will be left to buy stocks?

One way to visualize the impact of population changes is to calculate the middle-to-old-age and price-to-earnings (P/E) ratios. Zheng Liu and Mark M. Spiegel of the Federal Reserve Bank of San Francisco demonstrated this in “Boomer Retirement: Headwinds for U.S. Equity Markets?

We replicate their approach by using the cyclically-adjusted P/E (CAPE) ratio, which shows that the valuation of US stocks between 1950 and 2020 was largely driven by population changes. When the ratio of middle-aged people, or those between 40- and 49-years old, increased relative to the elderly, or those between 60 and 69, stock valuations rose. In turn, the higher the valuation, the higher the stock returns.

This would also help explain the tech bubble at the turn of the millennium, as the middle-aged grew faster than the elderly cohort and demand for stocks outpaced supply.

Price-to-Earnings and Middle-to-Old Age Ratios in the United States

Line chart depicting Price-to-Earnings and Middle-to-Old Age Ratios in the United States
Source: Robert J. Shiller, United Nations, FactorResearch

Global Population Forecasts

If population growth contributes to economic prosperity and stock valuations, United Nations (UN) population forecasts offer a glimpse of the future. 

A fertility rate of 2.1 — each woman bearing 2.1. children on average — is considered the replacement rate, or what’s required to maintain the current population level.

Global Population Growth Forecasts Based on Fertility Rates (in Billions): 2020 to 2100

Source: United Nations, FactorResearch

Today’s global population is 7.8 billion and is expected to grow by 40%, to 10.9 billion, by 2100. Of course, this outcome depends on which of the potential fertility rate scenarios forecast by the UN materializes. The populations of developed nations are only predicted to grow amid a high fertility rate environment. Failing that, growth is expected to be confined to emerging markets.

In the UN’s medium fertility forecast, Africa is the only region that is anticipated to exceed the replacement threshold over the next 80 years with the rate declining over time.

Fertility Rate Forecast: 2020 to 2100

Source: United Nations (Medium Variant), FactorResearch

Population Gains and Losses

If an expanding population is critical to global economic growth and stock returns, with the world population expected to grow over the next 80 years, why is the outlook so dire?

It comes down to how that growth is distributed. The only developed nation among the top 10 in expected population growth is the United States. Otherwise, the only non-African nation is Pakistan.

Perhaps this century will belong to Africa and the continent’s emerging economies will evolve into developed ones. Unfortunately, history suggests this is not altogether likely. Of the world’s most advanced nations in 1900, 90% were still among the most economically developed 100 years later. Japan and South Korea moved from poor to rich and Argentina went from rich to poor, but otherwise the ranks of the developing and developed remained largely static.

And Africa has struggled to realize its potential. None of its 54 nations has made a leap like South Korea, which was poorer than many African states in the 1950s, but developed into an industrial powerhouse. Offering cheap labor is a classic development model, but that hasn’t worked in Africa. 

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Further dampening the outlook, fertility rate estimates are also more likely to be over- than understated. A stalled economy can quickly turn a rapidly expanding population into a declining one. For example, Iran’s fertility rate dropped from 5.6 between 1985 and 1990 to below 2.0 in less than two decades.

In contrast, fertility rates have not increased dramatically anywhere. Nor are they expected to. So population declines are more realistic than increases.

In such wealthy countries as Italy and Spain, the forecasts are especially stark. They are expected to lose 34% and 29% of their populations, respectively. The reverberations for the global economy will be severe as demographic decline sets in throughout many of the world’s wealthiest nations. Shrinking populations also make governing more difficult as public services like education and health care become more expensive.

Top 10 Population Gains and Losses by Country (in Millions): 2020 to 2100

Source: United Nations (Medium Variant), FactorResearch

The Long-Term Outlook for Valuations

Given these forecasts and the relationship between population dynamics and stock valuations, what is the outlook for markets in the United States? Unlike much of the world, the United States is expected to grow its population in the current century, but that population will be older on average.

Naturally, the valuations-to-population interplay is not a linear relationship and currently the CAPE ratio is well above its historical average and isn’t where it should be based on population dynamics. But as more US workers retire, they will swap equities for bonds, which does not bode well for the long-term demand for stocks. Every seller needs a buyer. 

US Price-to-Earnings Ratio: Forecasting the Next 80 Years

Source: Robert J. Shiller, United Nations, FactorResearch

Further Thoughts

These demographic trends have both good and bad news for investors.

Fortunately, most of the dramatic population declines are expected after 2050. Before that, only Japan is affected significantly. Perhaps it’s finally time to short Japanese government bonds?

Otherwise, these forecasts make a strong case for not only selling stocks for the long-term, but also selling all asset classes that are bets on economic growth. That means bonds, real estate, and private equity.

This requires investors to evaluate traditional asset allocation frameworks and consider strategies that are less dependent on a healthy global economy and an expanding population. That means anti-fragile portfolio strategies and securities that are truly uncorrelated to traditional asset classes or, even better, benefit from increased economic and financial volatility.

Like passengers on the sinking Titanic, investors have no place to hide and no safe harbor from which to wait this out.

For more insights from Nicolas Rabener and the FactorResearch team, sign up for their email newsletter.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: Getty Images / urbazon

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About the Author(s)
Nicolas Rabener

Nicolas Rabener is the managing director of Finominal, which provides quantitative solutions for factor investing. Previously he founded Jackdaw Capital, a quantitative investment manager focused on equity market neutral strategies. Previously, Rabener worked at GIC (Government of Singapore Investment Corporation) focused on real estate across asset classes. He started his career working for Citigroup in investment banking in London and New York. Rabener holds an MS in management from HHL Leipzig Graduate School of Management, is a CAIA charter holder, and enjoys endurance sports (100km Ultramarathon, Mont Blanc, Mount Kilimanjaro).

16 thoughts on “Aging and Equities: Selling Stocks for the Long Term”

  1. Paul OBrien says:

    I broadly agree. But:

    Capital structures are not fixed. If investors prefer debt claims, companies will lever up to provide more. The remaining equity will be riskier, sure, but also offer better expected returns.

    Anti-fragile strategies are great. They just aren’t macro consistent. The world is fragile, and so will be the average portfolio. Most investors will have to accept that.

    1. Hi Brian,

      Thanks for sharing your perspective. A counter-argument would be that more risky stocks did not generate higher returns historically, which is well-documented by the low volatility factor. Leverage has been great in the last 30 years where rates have been declining and global GDP growth positive, but I would speculate that leverage becomes much more problematic in a world where economic growth is structurally declining.

      Best regards, Nicolas

  2. Michael Falk says:

    I think that is a good start but there isn’t much more to this topic that I think could be discussed constructively. First and foremost if the stock is in a sustainable business and the very same company chose to pay a dividend… the stock could be a more durable yield device than bonds given the current state of bonds in today’s world

    1. Nicolas says:

      Hi Michael, there will naturally always be businesses that survive and prosper, but identiying these beforehand seems almost impossible, as otherwise mutual fund and hedge fund managers would generate (more) alpha.

      We agree that bonds are not the solution, but we would be skeptical that equities will be attractive in the long-term given negative demographics (we’re not even talking about debt, another concern).

      It’s worth recalling that most investors suffer from survivorship bias by focusing on the US, arguably the most successful equity market. There are plenty of countries were stock markets suffered decade-long declines and were closed. The Credit Suisse Annual Investment Year Book is an excellent study for getting a long-term perspective on the riskiness of stocks.

      Best regards, Nicolas

      1. Michael Falk says:

        Indeed. (short enough?)

  3. Alan Underdown says:

    People like to predict the future. It’s certainly a good way to end up looking foolish. How many of us, a year ago, thought the world would look like it does now? I won’t bore you with a longer list of expert prognostications that were way off the mark. We all know them.

    But supposing the future will be a low-growth/no-growth world:

    People will still need goods and services.
    Firms will still need investment capital.
    Equity investors will still be compensated for accepting a risk premium.
    A higher percentage of total return will be from dividends.
    Business risk will be mitigated by diversification among investments.
    Oldsters won’t want to run out of money during their lifetimes.
    Inflation is liable to show up unexpectedly.

    Also, the picture used in this story is kind of …… well, you know.

    Alan Underdown

  4. Kirk Cornwell says:

    10 years ago I would have totally agreed with this article. Now I dare (yes, it’s still daring) to say “Things are different now.” The recent parabolic increases in liquidity make the “Greenspan Put” look insignificant. The combined actions of the Fed and Treasury have not done as much for the masses as they claim, but the boost to financial assets is unprecedented, and fully able to outweigh retiree selling.

    1. Nicolas says:

      Hi Kirk, we can take Japan as a case study where negative demographics have already set it. The BoJ and Japanese government have been fighting this with unprecedented monetary and fiscal policies for almost 20 years, but neither economic growth, inflation, or stock market returns have been particularily impressive.

      Best regards, Nicolas

      1. Kirk Cornwell says:

        Thanks, Nicolas,
        I tend to think the US market will remain boosted by continued liquidity (nice word for currency debasement) both here here and worldwide as national funds take larger stakes in the most successful US companies. Not a bull market like 1982-1999, but enough of a floor to handle retiree selling. I also hear those who envision the need for dividends to replace the “safety” of bond income that becomes harder to find.

  5. Kunal` says:

    The whole arguement is misconstructed. In an environment of negative interest rates, older people may have no choice but to invest in stocks. Also, declining global population is great for the world as a whole. Technology will drive productivity going forward.

    1. Nicolas says:

      Hi Kunal, naturally we agree that bonds have become far less useful in asset allocation, but are not sure that this implies that investors will allocate more to equities, especially elderly ones that depend on their savings for their livelihood.

      For example, global pensions funds have not changed their bond allocations from 2000 to 2020, despite US 10Y yields declining from 5% to below 1%. Please see the chart “Global Pension Asset Allocation” in this article:

      Furthermore, despite all the technological improvements, productivity growth has been slowing for decades:

      Best regards, Nicolas

      1. Michael Falk says:

        The behavior of pensions plans… dare I say is a lagging indicator.

        Proper retirement planning – which I am on record with my methods (RF Monograph, chapter 3 and in a Morningstar interview) could enable greater stock allocations for retirees.

  6. You forgot to mention the elephant in the room. Natural disasters, demographics, social pressures, political and biological Black Swans will force investors to accept higher risks and lower returns, and, yes, higher taxes. If you are a stock broker make sure you have a fast getway car.

  7. klaus wu says:

    a reply from china,
    at that time, when the situation of less people,less economic scale is come in, on the whole,the growth and margin of listed corporation will still better than average of general industry sector.
    there will be opportunites very different from present time. new story will attract new money. old money need to learn or loss,because what i can predict is those growth opportunities may be priced very very high at that time.
    but p/e ratio is technically unpredictable when your country’s FED and treasury tend to intervene the finance market even more often when GDP growth rate loss impetus by less population
    and the innovation impacts is also unpredictable, that have influence on P/E ratio

  8. Read your “From the Archives” piece in Saturday’s (11/6/22) CFA “Enterprising Investor” and wondered how you thought the paper “What explains the deline in r star ? Rising inaequality versus demographic shifts.” (Mian, Straub & Sufi, August 2021) might impact on your thinking on this important issue ?

  9. Hi Nicolas,
    Cannot agree more with your final conclusion pro anti-fragile crisis alpha investments as a remedy, gaining from increased insecurity and resulting volatility. It seems to be as obvious and foreseeable as the turn around of interest rates, due after falling for 40 years. As the great Samuelson said, markets are micro-efficient but macro-inefficient.

    How has this worked out in Japan? Is this comparable at all as it was still surrounded by a much larger expanding world?

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