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- Global Aging: More Headwinds for U.S. Stocks?
- Comedians In Cars Getting Coffee: Jimmy Fallon
- Dear Federal Reserve
- The 2014 Festivus Airing of Grievances
- Art Cashin: 2015 Issues to Watch
| Global Aging: More Headwinds for U.S. Stocks? Posted: 25 Dec 2014 02:00 AM PST Global Aging: More Headwinds for U.S. Stocks?
The retirement of the baby boomers is expected to severely cut U.S. stock values in the near future. Since population aging is widespread across the world's largest countries, this raises the question of whether global aging could adversely affect the U.S. equity market even further. However, the strong relationship between demographics and equity values in this country do not hold true in other industrial countries. This suggests that global aging is unlikely to create additional headwinds for U.S. equities. Demographic patterns have a strong historical relationship with equity values in the United States (Liu and Spiegel 2011). In particular, the ratio of those people who are the prime age to invest in stocks to those who are the prime age to sell has historically served as a strong predictor of U.S. equity values as measured by price/earnings (P/E) ratios. Research suggests one reason for this close relationship is a person's life-cycle pattern of investing. An individual's financial needs and attitudes toward risk change over the years. As retirement approaches, individuals become less willing to tolerate investment risks, so they begin to sell off stocks. Thus, the aging of the baby boomers and the broader shift of age distribution in the population should have a negative effect on capital markets (Abel 2001). In theory, global demographic changes may further impact U.S. equity values. For example, Krueger and Ludwig (2007) demonstrate that U.S. returns can import the adverse impact of population aging in other countries. Since the study by Liu and Spiegel (2011), U.S. stock values have increased markedly. Between 2010, which is the end of their sample, and 2013, the Standard & Poor's (S&P) 500 Index has increased by 47% and the P/E ratio has increased from around 15 to nearly 17. However, the bearish predictions in Liu and Spiegel (2011), which were based solely on projected aging of the U.S. population, have worsened. Indeed, extending the Liu-Spiegel model's sample through 2013 suggests that the P/E ratio will decline even more, from about 17 in 2013 to 8.23 in 2025, before recovering to 9.14 in 2030. In this Economic Letter, we investigate the implications of global population trends for U.S. stock values. Other industrial countries are expected to have similarly aging populations in the next two decades, in some cases even more so than in the United States. Given that equity markets are integrated across industrialized countries (see, for example, Chan et al. 1992), one would think that this change in foreign conditions might also have adverse implications for U.S. stock values. However, our results suggest that the tight historical relationships in the U.S. data are not mirrored in other countries. Thus, global aging is unlikely to add to the demographic headwinds facing the U.S. market. Demographic trends in industrialized countries Following Liu and Spiegel (2011), we use Bloomberg's P/E ratio for the United States, which is the ratio of the end-of-year S&P 500 Index levels and the average earnings per share over the previous 12 months. We measure the age distribution using the ratio of "middle-age" people between 40 and 49 years—the group most likely to buy stocks—to those in the "old-age" group from 60 to 69 years—the prime age to sell. We call this measure the M/O ratio. Liu and Spiegel (2011) showed that this measure of the age distribution has been highly correlated with U.S. P/E ratios, outperforming alternative demographic measures, such as the ratio of middle-age to young adults studied by Geanakopolous et al. (2004). We extend the Liu-Spiegel study by examining the historical correlations between the M/O ratios and the P/E ratios in other industrialized countries, specifically those in the Group of Seven (G-7). For these countries—Canada, France, Germany, Italy, Japan, and the United Kingdom—we construct the M/O ratios using United Nations (UN) population data and P/E ratios from Global Financial Data. Figure 1
Source: Haver, United Nations. Dashed lines are UN projections. Figure 1 shows the M/O ratios in G-7 countries from 1954 to 2010, extended to 2013 for the U.S. sample. The figure also shows the projected M/O ratios through 2030 based on the UN population projections. The M/O ratios in most G-7 countries peaked by the mid-2000s and are expected to decline through at least the mid-2020s. For several countries, the declines are expected to be even larger than in the United States, which is projected to decline from 0.76 in 2013 to 0.60 in 2024. For example, the Canadian M/O is projected to decline from 0.82 in 2010 to 0.53 in 2024, and the German M/O is expected to decline from 0.90 to 0.48. A notable exception is Japan, where the M/O ratio is expected to increase over the next 10 years, driven primarily by expected declines in the size of its old-age cohort. However, this surprising trend is limited to the specific demographic indicator we use in this study. If we broadened the indicator to the ratio of middle-aged to the combined middle- and old-aged, Japan's pattern would also decline. Moreover, beyond 2024, population aging in Japan is expected to drop rapidly regardless of which demographic indicator is used. Global demographics and equity values In theory, the rapid aging of the global population is likely to have additional adverse implications for U.S. stock values. Ang and Maddaloni (2005) find that using the fraction of retired people in the population predicts excess returns in the four largest equity markets outside the United States. Evidence also suggests that U.S. and foreign markets are integrated. This implies that if a tight relationship exists between the M/O ratio and P/E ratios in foreign economies, their demographics are likely to impact U.S. equity values as well. We examine the specification used in Liu and Spiegel (2011) for the remainder of the G-7 countries. In particular, we estimate the statistical relationship between the log of the P/E ratio and the log of the M/O ratio for each country. Figure 2
Note: The U.S. sample covers the years from 1954 to 2013. The samples of other countries range from 1954 to 2010. The solid lines denote the estimated relation between the P/E ratio and M/O ratio. Figure 2 summarizes these results, omitting Canada to conserve space and including the United States for reference. Although the U.S. figure confirms a strong positive statistical relationship between the P/E and M/O ratios, this relationship does not hold up well for the other G-7 countries. The positive correlations for France and the United Kingdom are modest and statistically insignificant, while Germany, Italy, and Japan yield negative correlations. We also used Ang and Maddaloni's (2005) alternative demographic measure of the retired population to predict excess returns in international equity markets. Consistent with our finding using the M/O ratio as a demographic measure, the fraction of retired people in the population has a significant negative relationship with the P/E ratio for the United States, but not for the other G-7 countries. Therefore, the correlation between demography and equity values that holds tightly for the United States cannot be extrapolated to the other G-7 countries. Formal derivations of these results are available at: http://www.frbsf.org/economic-research/publications/economic-letter/2014/december/baby-boomers-retirement-stocks-aging/el2014-38-technical-appendix.pdf. Emerging market economies Our analysis has been focused on G-7 countries. What about other countries, especially emerging market economies such as China and Korea that are increasingly important globally? Indeed, M/O ratios in both China and Korea are projected to decline over the next decade. When we repeat our exercise using the M/O ratios and P/E ratios in China and Korea, the results are mixed, similar to those for the G-7 countries. Korea has a negative correlation between the P/E and M/O ratios. Our estimate for China shows a positive and statistically significant correlation, but it is about half the size of the U.S. correlation. Moreover, our data are very limited for China due to its relatively recent development. We only have 24 years of data for China's P/E ratios (from 1990 to 2013), and it is likely that the Chinese government imposed tight restrictions on private equity holdings during that period. Overall, it is unlikely that the strong relationship between demographic patterns and equity valuations that we have identified for the United States can be extended to the rest of the world. Conclusion In this Economic Letter, we revisit the relationship between the aging population and U.S. equity values. Noting that global population trends are even more ominous than those in the United States, we also investigate whether the rest of the G-7 countries are expected to experience adverse effects on future stock market values similar to the United States. We first extend the U.S. sample studied by Liu and Spiegel (2011) to include more recent data, demonstrating that the projected declines in stock values based on these data have become even more severe. Our current estimate suggests that the P/E ratio of the U.S. equity market could be halved by 2025 relative to its 2013 level. We then focus on international concerns. Populations in the rest of the G-7 countries are expected to age even more in the next decade. We examine whether this demographic trend has adverse implications for stock values in those countries and, given the international integration in equity markets, for values in the United States as well. Our results reveal that none of the other G-7 countries demonstrate the positive and significant relationship found for the United States. We therefore do not find evidence that foreign demographic trends should be an extra drag on future U.S. equity values. Of course, factors other than demographics may play important roles in determining future U.S. equity values. For example, it remains unclear what implications capital account liberalization in China may have for U.S. equity values. While liberalization may reduce demand for U.S. assets by the Chinese government, private Chinese citizens may respond by acquiring larger amounts of U.S. stocks to diversify their current portfolios. The expected net impact on U.S. equity values is thus unclear. There is also considerable uncertainty about the prospects for U.S. productivity growth over the near term, with some researchers suggesting that trend productivity growth has returned to a slower pace (for example, Gordon 2012 and Fernald 2014). Furthermore, facing longer life expectancy, U.S. investors may choose to draw down their equity holdings more slowly (Poterba 2014). These other factors may have important independent implications for the future of U.S. equity markets. Zheng Liu is a senior research advisor in the Economic Research Department of the Federal Reserve Bank of San Francisco. Mark M. Spiegel is a vice president in the Economic Research Department of the Federal Reserve Bank of San Francisco. Bing Wang is a research associate in the Economic Research Department of the Federal Reserve Bank of San Francisco. Reference Abel, Andrew B. 2001. "Will Bequests Attenuate the Predicted Meltdown in Stock Prices When Baby Boomers Retire?" Review of Economics and Statistics 83(4), pp. 589–595. Ang, Andrew, and Angela Maddaloni. 2005. "Do Demographic Changes Affect Risk Premiums? Evidence from International Data." Journal of Business 78(1), pp. 341–379. Chan, K.C., G. Andrew Karolyi, and Rene M. Stulz. 1992. "Global Financial Markets and the Risk Premium on U.S. Equity." Journal of Financial Economics 32, pp. 137–167. Fernald, John G. 2014. "Productivity and Potential Output Before, During, and After the Great Recession." NBER Macroeconomics Annual (forthcoming). Geanakoplos, John, Michael Magill, and Martine Quinzii. 2004. "Demography and the Long-Run Predictability of the Stock Market." Brookings Papers on Economic Activity 1, pp. 241–307. Gordon, Robert J. 2012. "Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds." NBER Working Paper 18315, August. Krueger, Dirk, and Alexander Ludwig. 2007. "On the Consequences of Demographic Change for Rates of Return to Capital, and the Distribution of Wealth and Welfare." Journal of Monetary Economics 54, pp. 49–87. Liu, Zheng, and Mark M. Spiegel. 2011. "Boomer Retirement: Headwinds for U.S. Equity Markets?" FRBSF Economic Letter 2011-26 (August 22). Poterba, James M. 2014. "Retirement Security in an Aging Population." American Economic Review 104(5), pp. 1–30. More Economic Letters Opinions expressed in FRBSF Economic Letter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System. This publication is edited by Anita Todd. Permission to reprint must be obtained in writing. Please send editorial comments and requests for reprint permission to Attn: Research publications, MS 1140 |
| Comedians In Cars Getting Coffee: Jimmy Fallon Posted: 24 Dec 2014 02:00 PM PST Here is my Christmas Eve Holiday gift to you:
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| Posted: 24 Dec 2014 08:30 AM PST Dear Federal Reserve: As we approach your last get together of the year I first want to wish you all great holidays and a happy and healthy new year. I also want to extend my utmost respect for the time you have given to public service in your contribution of what is the Federal Reserve system with the best intentions. But, as they say with the best intentions, it leads to roads unforeseen to put it nice. As it is year end it's always a good time for reflection and let's look in the mirror together. The predominant investing rallying cry over the last 15+ years of the 'Greenspan (now Fed) put' and 'search for yield' without regard to risk is again showing its darker side, this time in the energy patch. We of course saw it first in technology land in the late 1990's, to be repeated in a different fashion in the mid 2000's via credit and housing and now in the US oil and gas industry. Thanks to those two sayings, the US economy has become the US 'boom and bust' economy. Your sole focus on consumer price inflation has again shifted your attention from the negative repercussions of excessive asset price inflation that inevitably always mean reverts. This time, an epic bond bubble is showing some big time cracks in corporate land. Without rehashing the two previous bubbles, let's talk about the new one and focus on the 'search for yield' without regard to risk syndrome that again created extreme asset price inflation and again got hold of parts of our economy. Via another one of your cycles of interest rates well below the rate of inflation, the manhandling of longer term interest rates with QE and amazing American ingenuity and technology, anyone with a drill bit and a land lease was able to get a loan as long as oil prices levitated north of $80. Bloomberg estimates that since early 2010, $550b loans and bonds were issued by the oil and gas industry. Give me yield or give me death was essentially the mantra for this and many other investments. And, the money kept flowing, the drilling kept coming and all of a sudden the spurt in supply bumped up against a slowing global economy and then poof. The bubble burst essentially in a crash with crude prices falling by 46% over the past 6 months, not coincidentally either just as QE was ending. Which brings us to another one of your meetings this week where the debate now and for 2015 is when and how do you normalize interest rates and whether your focus should be the better labor market and the improvement in wage gains in November or more so the sudden drop in commodity prices mostly driven by lower oil prices. The irony of this discussion though hopefully won't escape you. Cheap money that you created fueled a drilling boom that oversupplied a market that now has shrinking demand. Now with lower oil prices, headline inflation and inflation expectations as a result, you may actually use low inflation as an excuse to keep rates low for longer, the same policy that previously created the boom and now the bust. In your desire for higher inflation, cheap money instead lead to malinvestment and over capacity that inevitably lead to a downside and lower prices. Those fiber optic cables would have been laid anyway, those homes would have been built anyway and those shale wells would have been drilled anyway but the 'Fed put' and 'search for yield' rallying cries brought so much of this activity together at once in their respective time periods that the boom it created inevitably lead to the busts that followed. You know excessively easy monetary policy not only buys time, it steals economic activity from the future. Buy and invest today maybe what you would have done tomorrow but tomorrow always comes. Why isn't this lesson ever learned? I will sum up with this: history is replete with the bad economic consequences of trying to manipulate human behavior with government induced price controls. Over the last 15 years especially it's been control over the price of money and current policy is as if we have an economic five alarm fire. I'm not calling for you to quickly normalize policy immediately. I just believe that the process must begin, however slowly, as soon as possible and asset price inflation should no longer be ignored or only acknowledged with vague comments about overvaluation in select asset markets. Words and macro prudential regulation are not going to do it. The path ahead will be disruptive but that can no longer be avoided as 6 years of ZIRP and a 5 fold increase in your balance sheet has already way overstayed its welcome. The longer you wait, the worse the consequences will be when you do. Again, happy holidays and happy 2015. Sincerely yours, Peter Boockvar |
| The 2014 Festivus Airing of Grievances Posted: 24 Dec 2014 05:00 AM PST The 2014 Festivus Airing of Grievances
Well, it's that time of the year again for the airing of grievances. And I've got a lot of problems with you people! First of which are those of you (PK, NYT?) who insist that the Fed's QE did not result in any inflation. It all depends on your definition of inflation. If your definition is restricted to the prices of goods and services, you are right. No matter how you slice it or dice it, there has been no discernible upward trend in the price changes of consumer goods and services since the start late 2012 start of QE III, as shown in Chart 1. Chart 1
If, however, you expand the definition of inflation to include the prices of assets, then there has been a discernible pick-up in inflation since late 2012. For households, their holding gains on assets (stocks, bonds, houses, e.g.,) scaled against the market value of their total assets have moved up noticeably since the onset of QE III in late 2012, as shown in Chart 2. In fact, asset inflation in 2013, according to this measure, was approaching the housing-bubble highs of 2005-06. Chart 2
You don't think that QE had anything to do with asset inflation starting in late 2012? Check out Chart 3, which shows the behavior of credit granted for the purchase and carrying of securities and thin-air credit, i.e., the sum of credit created by depository institutions and credit created by the Fed in the form of depository institution reserves held at the Fed and their vault cash. Perhaps asset-price inflation will moderate in 2015 as growth in thin-air credit does. Chart 3
My next grievance with you people is your dark-cloud reaction to the recent decline in petroleum prices. When these prices rise, the talking heads warn of dire economic consequences. When they fall, the talking heads also warn of dire consequences. My approach to ascertaining whether the recent decline in energy prices is a "good" economic development for the U.S. economy, in particular, and the global economy, in general, is to keep in mind that more is better than less. That is, if more energy is available, then more of the final goods and services we consume can be produced. Think of an agriculturally-based economy. Which will contribute to higher standard of living for the residents of this economy – a bumper crop or a lost crop? The bumper crop, obviously. Similarly, more energy production is better than less energy production with regard to our standard of living. Chart 4 shows that U.S. energy production has been soaring in recent years. That's a "good" thing, economically speaking. Chart 4
Another grievance I have with you people is your Keynesian (probably not Keynes, himself, rather his subsequent interpreters) view of saving. How many times have you heard that if extra income goes to the rich, they will just save it, which won't stimulate total spending in the economy? But if income goes to the less rich, they will spend it, which willstimulate total spending in the economy. This popular view is that when people save, funds somehow disappear from the total spending stream of the economy. This popular view of saving is often advanced as an economic argument to buttress a moral argument for government-mandated income redistribution. But except in one case, this popular view of saving is fallacious. What does it mean to increase your saving? It means you cut back on your current spending on goods and services relative to your income. When you cut back on your goods/services spending, what do you do with that saved income? You typically, directly or indirectly, purchase equities or bonds. In other words, you transfer some of your income, which you have voluntarily chosen currently not to spend on goods and services, to another entity, perhaps a business, a government or even another household, that currently wants to increase its spending relative to its income. So, in this case of increased saving by you,total spending on goods and services in the economy does not decline. Rather yourdecrease in current spending on goods and services is offset by an increase in spending by the entity that ultimately received the funds with which you purchased the stocks or bonds. So, if rich people are earning relatively more income than less rich people, total spending in the economy need not go down if the rich people save relatively more of their income. Rich people's increased saving enables other entities to increase their current spending. The saved income does not vanish from the spending stream, as today's Keynesian talking heads would have you believe. Rather, it gets transferred to others who are eager to increase their current spending. As an aside, if the increased saving by rich people funds spending on capital goods, all else the same, the economy's future potential to produce goods and services is enhanced. In sum, increased saving is not a "bad" economic thing in the short run and is potentially a "good" economic thing in the long run. Income redistribution generally will not stimulate total spending in the economy. If income is taken from the rich and given to the less rich, the rich will react by either cutting back on their current spending and/or cutting back on their saving, which implies less spending by some other entity. Either way, the increased spending by the less rich will be offset by the decreased spending and/or saving by the rich. Thus, income redistribution will not result in a net increase in total spending in the economy. Again, there may be a moral argument for income redistribution, but there is not a macroeconomic reason for it. Now, there is one case in which an increase in saving can lead to a decrease in total spending in the economy. If you increase your saving and choose to use your extra unspent income to increase your balances at depository institutions, total spending in the economy will decline, all else the same. But wait, doesn't the bank lend the increase in funds it received from you? Probably. But the income you received but chose not to spend now came to you from the bank of some other entity. That bank has lost funds and, thus, has to reduce its loans. So, the result of you using increased saving to build up your deposits is net decline in goods/services spending in the economy. In the 1930s, when Keynes was advancing Keynesianism, this type of saving was referred to as hoarding "money". Back in the Great Depression, when many businesses and depository institutions were failing, people preferred to save in the form of currency and/or in deposits at super-liquid banks because of the safety of principal of these types of assets. This saving in the form of cash, or hoarding, is what motivated Keynes to have a dim view of saving in his Keynesian macroeconomic theory. Although I suspect that Keynes understood the different implications regarding total spending in the economy between an increase in saving that took the form of stocks and bonds and an increase in saving that took the form of currency and deposits, it is not clear that current adherents to Keynesian macroeconomic theory understand this difference. For whatever reason, the term "hoarding" has gone out of fashion. We now refer to saving in the form of cash (either currency or bank deposits) as a decrease in the "velocity" of money. If a decrease in the velocity of currency and deposits is not countered with an increase in the supply of currency and deposits, then nominal spending in the economy will decrease. I have one last grievance to air. This one, however, is not with you people. Rather it is withme, people! Throughout 2014, I had been telling you people to steer clear of bonds, especially investment-grade bonds, because I had thought that bond yields would rise. The reason I had thought bond yields would rise is that I also thought that 2014 growth in domestic nominal spending on goods and services would be stronger than the Fed and the consensus expected as a result of increased growth in thin-air credit. I figured that the Fed would be reluctant to pre-emptively raise the federal funds rate in 2014, but that market participants would anticipate more aggressive funds rate increases in 2015, which would result in higher bond yields in 2014. Well, growth in domestic nominal demand did turn out to be relatively robust in 2014, save for a weather-depressed first quarter. And the Fed did not raise its policy interest rates in 2014 nor even seriously threaten to do so. But Treasury bond yields did not rise during 2014. As Chart 5 shows, Treasury bond yields actually fell. The yields that did rise were those on shorter maturity Treasury coupon securities, as represented by the yield on the 2-year Treasury security in Chart 5. Perhaps market participants believe that the Fed will raise its policy interest rates in 2015 sufficiently to slow growth in economic activity in 2015 and 2016 such that goods/services price inflation will stay in check. And given the pronounced slowdown in the growth of thin-air credit in the closing months of 2014, this market "bet" might be right. Chart 5
But I was dead wrong on the direction of bond yields in 2014. So, I've been pinned. That means that the airing of grievances is over for 2014 and the Festivus celebrations can now begin in earnest. Gather around your Festivus poles, preferably made of aluminum because of its high strength-to-weight ratio, and join me in singing the Festivus Carol.
A Festivus Carol (Lyrics by Katy Kasriel to the melody of O' Tannenbaum) O' Festivus, O' Festivus, This one's for all the rest of us. The worst of us, the best of us, The shabby and well-dressed of us. We gather 'round the 'luminum pole, Air grievances that bare the soul. No slights too small to be expressed, It's good to get things off our chest. It's time now for the wrestling tests, Feel free to pin both kin and guests, Festivus, O' Festivus, The holiday for the rest of us.
Paul L. Kasriel http://www.the-econtrarian.blogspot.com |
| Art Cashin: 2015 Issues to Watch Posted: 24 Dec 2014 03:30 AM PST I am never a fan of forecasts, but I am interested in an informed discussion from knowledgeable people like Art Cashin who have have a half of a century experience on the NYSE floor: |
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