Are stocks long in the tooth?

The effect of demographics on investment patterns is pretty straightforward – people get more conservative as they get older and they don’t care much when they are young. An article in The Economist, aptly titled “Betting on Ben”, cites research by Barclays Capital about the relationship between population variables and equity markets. The key causal relationship is between low savers, 25-35 year olds buying houses and people 65 plus, who are running down their capital. The second category is the 35-54 age group. The high savers peaked in about 2000, when the baby boomers were saving. The low savers are now rising in importance. The conclusion is pretty bleak for the US stock market – as the low savers start to increase in proportion, the stock market will struggle. Barclays predicts equity returns of 3% a year in real terms and 5% in nominal terms. Even that may be too high.

It is easy to see a similar dynamic playing out in the non-resources and agriculture sectors of the Australian stock market. At the present, the super funds are continuing to funnel money into the market (see the Deutsche Bank report in my blog (Australia underpriced). Discretionary super contributions are trending up, although they are nowhere near the highs of 2007. Households are continuing to opt for the safety of bank deposits over the direct purchase of equities, but the overall demand for equities is reasonable. But Australia will be experiencing the same kind of ageing issues facing the United States, and the world’s housing bubble is ensuring that the young “low savers” will struggle to find any spare capital when they enter the supposedly high saving years of 35-54. They will still be forking out too much on their mortgages. It does not augur well long term for non-primary industry stock market returns.

The counter balance is the extraordinary shift in commodities. A JP Morgan report notes that Australia’s terms of trade has risen to the highest level since the wool boom of the 1950s, which is triggering a virtuous cycle of high national income flowing through the economy. JP Morgan is tipping a dip in coal and iron ore prices later this year, but thinks there will be a rise in 2012. Such huge income flows could result in high saving from companies and government, which would counter the probable low trends in the household sector. But neither directly invest in shares (except for M&As in the case of companies).

That is the domestic scene. But about two fifths of the local market is foreign investment, and it is very possible that the ASX soon will be the Singapore Exchange. That will put Australian shares in play in a region that is moving sharply away from its dependence on bank debt as the main form of capital. As 2009 McKinsey report shows, in developed economies there tends to be a balance between equities, bank capital, bonds and government debt instruments. In emerging economies – and for that read the Asian region ex-Japan – equity markets, and, to an even greater extent corporate bond markets, tend to be thin. It is very possible that an ASX-SGX tie up could become the centre for a rebalancing towards equity capital for the region. It would certainly be part of that dynamic. That would shift the dynamic way beyond the patterns of Australian savers, and even the behaviour of Australian super funds.

Conclusion? The global picture for stock markets looks poor, because it looks poor in America – America still dominates the world stock market capitalisation. But the Australian stock market is part of Asia’s boom, both in its commodity stocks, and soon, probably, a massive region-wide shift of the capital structure towards equities and bonds. It is a key to emerging economies’ financial stability. The key difference between bank lending and stocks or bonds, is that bank lending cannot reprice without crashing the system (see any number of Latin American debt crises) whereas stocks or bonds can reprice easily – they act as a shock absorber

A strategy with an eye to these Asian trends is likely to be the best play.

JPM_Australia’s Virtuous Cycle of a Rising Terms of Trade_2011-02!28!554886


  1. I think Buffett himself is on record stating that the S&P500 will not go up more than 6% p.a for the long term, because of the factors you outline S.O.N

    Demographics are interesting, and without pointing to Japan’s lost decades, one needs to work out what fundamentally drives markets (apart from drugged up central bankers and their rah-rah followers)

    The main driver is earnings – and earnings increase when GDP increases. The stock market is an (unreliable and volatile) measure of underlying GDP, more so in the long run.

    What are Australia’s demographics like, and moreover, what is the prospensity of the “available spenders” to spend?

    You hit it on the head with the current mortgage slaves – and Leith has shown quite clearly that this generation of slaves must spend a greater totality of their discretionary income servicing their mortgages, compared to the Baby Boomers and Greatest Generation (both of whom only needed the 1 wage too…)

    There is one caveat. If the Gen Y and Z’s start saying “stuff this, I’m better off renting” (which they should), that means A LOT MORE discretionary spending available, which should boost retail stocks.

    Unfortunately, our Ponzi economy is so weighted to the financial sector (3 times the size of the mining sector) and the unsustainable construction sector (which provides almost all working age men their jobs), that this structural shift away from “renting from the bank” to would be deflationary anyway.

    Asian, African and sub-continent stock markets have much greater potential than our own, or European or the US, as their emerging middle classes and better (?) demographic pyramids start the debt train.