Demographic Changes, Financial Markets, and the Economy

Robert D. Arnott and Denis B. Chaves

Financial Analysts Journal, 2012, vol. 68, issue 1, 23-46

Abstract: Using a large sample of countries and 60 years of data, the authors found a strong and intuitive link between demographic transitions and both GDP growth and capital market returns. Unlike previous researchers, who used ad hoc and restrictive demographic variables, the authors imposed a smooth and parsimonious polynomial curve across all age groups. They also performed robustness checks and produced forecasts for the coming decade, with all the necessary caveats. View a webinar of this article. It seems natural that the shifting composition of a nation’s population ought to influence GDP growth and perhaps capital market returns as well. As the Baby Boomers have aged, many people have studied past demographic data in an effort to extract indications for the future influence of the Boomers on many aspects of the economy. We extend this body of literature by analyzing the effect of demographic changes on three measures of great importance for countries all over the world: real per capita PPP-adjusted GDP growth, stock market excess returns, and bond market excess returns.We confirmed what others have already demonstrated, but we extracted markedly stronger statistical significance by adapting a polynomial curve–fitting technique to this new purpose. In our study, we found that a growing roster of young adults (15–49) is very good for GDP growth, a growing roster of older workers is a little bad for GDP growth, and a growing roster of young children or senior citizens is very bad for GDP growth.We found surprisingly powerful results when we applied the same technique to exploring the links between demography and capital market returns, net of the strong and well-documented effects of valuation and yield levels. Stocks perform best when the roster of people aged 35–59 is particularly large and when the roster of people aged 45–64 is fast growing. Bonds follow a similar pattern, with an age shift: They are best when the roster of people aged 50–69 is growing quickly. We carried out three different forms of robustness tests, each of which provided statistical significance in different ways: by applying different country weights, testing alternative demographic variables, and confirming GDP results on out-of-sample countries.Forecasting the future on the basis of these results would be dangerous. We would tacitly be assuming that past relationships between demography and either GDP growth or capital market returns will remain unaltered in the future. Given the high levels of statistical significance in the historical relationships, however, exploring the possible implications for future GDP growth and capital market returns is too tempting to resist. These implications—with all the caveats that must necessarily be offered—are sobering, to say the least.

Date: 2012
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DOI: 10.2469/faj.v68.n1.4

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