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A Long Run Demographic Stock Market Outlook

March 23, 2010 • Posted in Big Ideas

Does demographic mix of a set of investors affect aggregate demand for yield, and thereby total returns, from equity investments? In the December 2009 version of their paper entitled “Demographic Trends, the Dividend/Price Ratio and the Predictability of Long-Run Stock Market Returns”, Carlo Favero and Arie Gozluklu investigate the relationship between the aggregate stock dividend yield and the ratio of middle-aged (40-49) to young (20-29) populations in the U.S. (M/Y). Using U.S. demographic and aggregate equity dividend and price data spanning 1900-2008, they conclude that:

  • The dividend yield, corrected for a slowly drifting mean determined by M/Y, significantly forecasts long-run real stock market returns. This demographical effect helps explain the mixed evidence on the forecasting power of the dividend yield.
  • The best demographic model for real stock market returns derives from combining:
    1. M/Y to predict mean dividend yield drift.
    2. Deviations of consumption from its long run relationship to to dividends and labor income to predict dividend growth.
  • A projection of M/Y indicates a long-run real U.S. stock market return in the range 8%-10% during 2010-2050 (see the chart below).

The following chart, taken from the paper, compares M/Y (left scale) and annualized real U.S. stock market returns over the prior 20 years (right scale) during 1920-2050. The 20-year (one-generation) return represents a natural horizon for a demographic model.

In summary, demographic projections suggest a reasonably stable long run real U.S. stock market return over the next 40 years.

With increased global economic integration, might world demographics be more important for the U.S. equity market now than in the past?

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