Demographic trends can predict investment yields
According to a new study, investors can use demographic trends to predict both stock and bond market yields.
US stock and government bond markets followed surprisingly similar paths since the Second World War, according to researchers from Warwick Business School and Copenhagen Business School.
Yields from both markets followed a similar 20-year boom and bust cycles as the US population, reflecting changes in the number of young borrowers and middle-aged savers.
As both rely on the same population trends, the findings suggest the widespread practice of splitting portfolios across stocks and bonds may not provide the level of protection previously expected.
It also means analysts could use census data to forecast long-term market trends.
As a result, investors may aim to maximise their returns by spreading their funds across a more diverse portfolio, including international markets.
Dr Arie Gozluklu, Associate Professor of Finance at Warwick Business School, said:
“Many wealth managers invest a portion of their fund in stocks and some in bonds, but the common demographic trends can reduce the benefits of such diversification, especially in countries where financial markets play a significant role to smooth consumption over time.
“Clearly, this cannot explain all movement in the financial markets, especially in the event of crashes, but the effect of the population structure is too important to be dismissed.”
The findings were published in the paper “Stock vs bond yields and demographic fluctuations”, in the Journal of Banking and Finance.
Researchers used more than 100 years of data from a large cross-section of countries.
One trend that was found is that stock and bond prices tended to be lower, with a potential for higher yields when there were more young workers, who would typically borrow and spend more, relative to those in middle-age.
Consequently, when more middle-aged workers were looking to invest and save, higher demand drove up stock and bond prices, which resulted in lower yields.
Therefore, following the population trends, this created a pattern of rise and fall in the market. The results were particularly striking since the end of World War II.
As different countries have varied population cycles, their markets follow different trends, so wealth managers could use demographic data from around the globe to help them decide where to invest.
Dr Gozluklu said:
“Many investors tend not to look beyond their native markets. There may be many reasons for this home bias, such as information or language barriers to investing overseas.
“However, these demographic trends show that investors should consider international markets to maximise their returns, especially if they come from countries with small markets.
“That way, they can invest in the market at a favourable point in that nation’s demographic cycle, instead of being constrained by the prevailing pattern in their home country.”