Middle aged people impact equity markets the most

The world is undergoing a major demographic transition with population growth slowing and populations aging as life expectancy increases and fertility rates fall. However, this transition is occurring at very different rates in different regions of the world.

Our analysis suggests that these changing demographics could have a significant impact on equity markets – demographic trends are a key fundamental driver of valuation over time.

In particular, we find a strong relationship between equity valuations and the relative size of the middle aged population. This relationship can be attributed to the ‘life-cycle’ of savings and investment. Middle aged people are the most likely to invest in equities, and so changes in the size of the middle age population lead to changes in equity demand.

Most emerging markets have supportive demographics with their middle aged segments continuing to increase over the next 20-30 years. However, major exceptions to this are China and Korea where the middle aged segment peaks this year.

In the developed world demographics are much worse – in most markets the middle aged share of the population has already peaked. Other factors such as immigration and increasing global demand for equities could offset the effect, but history suggests negative demographics will hold down developed market valuations over the coming years. This supports a view that emerging markets will outperform developed in the medium term.

Most of the academic literature on the topic attributes this relationship to the “life-cycle hypothesis”. This suggests that saving and investment patterns vary with age as people look to smooth consumption over their lifetime. It divides life into three broad segments: young, middle aged and old.

When people are young they have little wealth and they are more likely to borrow to consume than to save. In middle age, they are at the peak of their earnings potential. They continue to consume and repay earlier debts, but also begin to save and invest for retirement. Finally, in old age, they retire and so dissave and run down their assets.

In addition to this, changing risk aversion leads to changes in asset allocation over time. Demand for risky assets such as equities rises as people age, before declining as they reach retirement. So, not only are middle aged people most likely to invest, they are also most likely to invest in equities given that their risk aversion is relatively low.

Given this, any increase in the relative size of the middle aged population leads to an increase in the overall demand for equities. This increase in demand puts upward pressure on prices and so drives up equity valuations.

This argument appears to be supported by data from the Federal Reserve’s Surveys of Consumer Finances. From this data it is clear that equities are far more widely owned by middle aged families than any other segment, and that these families allocate a far greater proportion of their total assets to equities.

So it follows that the size of the middle aged segment is a key factor in the overall demand for stocks. As the relative size of the middle aged segment rises a greater proportion of wealth is allocated to equities.