Demographics predict stock and bond yields, study shows
Investors can use demographic trends to predict both the stock and bond market yields, a new study shows.
Researchers from Warwick Business School and Copenhagen Business School found US stock and government bond markets have followed surprisingly similar paths since the Second World War.
Yields from both markets followed similar 20-year boom and bust cycles as the US population, reflecting changes in the number of young borrowers and middle-aged savers.
The findings suggest the widespread practice of splitting portfolios across stocks and bonds may not provide the level of protection previously expected, as both rely on the same population trends.
It also means analysts could use census data to forecast long-term market trends.
The findings may encourage investors to spread their funds across a more diverse portfolio, including international markets to maximise their returns.
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 an important 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.
They found that when there were more young workers, who tended to borrow and spend more, relative to those in middle-age, stock and bond prices tended to be lower, with a potential for greater yields.
When there were more middle-aged workers looking to invest and save, greater demand drove up stock and bond prices, which resulted in lower yields.
This created a pattern of rise and fall in the market, following population trends. The results were particularly striking since the end of the Second World War.
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.”
This article was originally written for and published on the Warwick Business School website, whose London location at The Shard offers an ideal base for executive learning including an Executive MBA and Distance Learning MBA option as well as the online Global Central Banking and Financial Regulation qualification.