Sunday, April 4, 2010 0 comments ++[ CLICK TO COMMENT ]++

Does the working population drive asset returns?

It probably isn't a surprise to many that my favourite column in the business weekly, The Economist, is the Buttonwood column. It closely parallels my interests, with a blend of macro views intermingled with investing. I have no idea how useful any of it is to investing but I like reading it :)

A few weeks ago, Buttonwood had an interesting column, "The very long view," talking about how asset returns typically depend on when you invest. This isn't true for stockpickers since they will do well in any conditions if they are right. Indeed, it's hard to say what type of environment suits someone like Warren Buffett or Walter Schloss, given their strong performance in almost any environment. Yet, for the general public, it is likely true that your returns will depend heavily on the timing.

The article quoted a Barclays Capital analyst, Tim Bond, as saying that asset returns are strongly correlated with the 'saving age' portion of the population. Buttonwood suggest, in my view a bad guess, that the poor returns in the last decade may have been due to the decline in the 'saving age' population. Let me quote the relevant portion:

Tim Bond of Barclays Capital argues that demography may be to blame. The key “saving age” is the cohort of 35-54 year-olds. As they prepare for retirement, they pile into the asset class du jour. Mr Bond shows that since the second world war there has been a close correlation between American equity valuations and the proportion of 35-54 year-olds in the population. That the “noughties” proved to be a dismal decade for equities was hardly surprising. The number of retirees (who run down their portfolios) was rising relative to the number of savers.

I don't access to the quoted report but I thought I would take a quick look to see if there is any correlation.
The following data plots the total returns of S&P 500 and the T-bond, along with the percentage of population that is in the 35 to 54 age category. I have also shown a best-fit polynominal curve for the two assets.
The choice of the polynomial curve is highly subjective and I just picked something that fit reasonably well and captured the behaviour of asset returns (a moving average or a different curve may produce slightly different results.) My analysis here is very simple and doesn't use any complicated statistical methods (such as attempting to cancel out other factors.)
The 'saving age' population is shown in green dots and you can see how it is starting to decline with the onset of the retirement of the baby boomers.
Based on this graph, there doesn't seem to be any relationship between the 'saving age' population and the stock and bond markets. I don't know if I'm doing anything wrong here but I have zero confidence that the 'saving age' population has anything to do with asset performance.
The correlations using the data in the chart is shown below:
The top part is the R value, while the bottom is the R-squared value, which is supposed to be a measure of the relationship between two variables. The R-squared value is less than 1% and is essentially saying that one variable doesn't influence the other.
To sum up, I see no merit in the view that the 'saving age' proportion of the population drives asset returns. Even if it did influence returns, the impact appears very minor, to the point of being negligible. In my opinion, ignoring the political elements (such as war or asset seizure by the government,) the #1 driver of asset returns is valuation. The baby boomers will likely start liquidating assets and/or shifting towards less risky assets but there is little evidence that necessarily means poor returns.


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