Population change and capital markets: Should we be worried?

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Population ageing and capital market performance: Should we be worried?

March 2014 Dr. Paul Kielstra

Deutsche Asset & Wealth Management

S3 SPECIAL ISSUE

Population Ageing and Capital Market Performance2

Deutsche Asset & Wealth Management’s Global Finan-

cial Institute asked the Economist Intelligence Unit to

produce a series of white papers, custom articles, and

info-graphics focused specifically on global capital

market trends in 2030.

While overall growth has resumed, and the value

traded on capital markets is astoundingly large (the

world’s financial stock grew to $212 trillion by the end

of 2010, according to McKinsey & Company) since

the global financial crisis of 2008, the new growth

has been driven mainly by expansion in developing

economies, and by a $4.4 trillion increase in sovereign

debt in 2010. The trends are clear: Emerging mar-

kets, particularly in Asia, are driving capital-raising; in

many places debt markets are fragile due to the large


Introduction to “Global Capital Markets in 2030“

component of government debt; and stock markets face

weakening demand in many mature markets.

In short, while the world’s stock of financial assets (e.g.

stocks, bonds, currency and commodity futures) is grow-

ing, the pattern of that growth suggests that major shifts

lie ahead in the shape of capital markets.

This series of studies by Global Financial Institute and the

Economist Intelligence Unit aims to offer deep insights

into the long term future of capital markets. It will employ

both secondary and primary research, based on surveys

and interviews with leading institutional investors, corpo-

rate executives, bankers, academics, regulators, and others

who will influence the future of capital markets.

Population Ageing and Capital Market Performance3

About the Economist Intelligence Unit

The Economist Intelligence Unit (EIU) is the world’s lead-

ing resource for economic and business research, fore-

casting and analysis. It provides accurate and impartial

intelligence for companies, government agencies, finan-

cial institutions and academic organisations around the

globe, inspiring business leaders to act with confidence

since 1946. EIU products include its flagship Country

Reports service, providing political and economic analy-

sis for 195 countries, and a portfolio of subscription-

based data and forecasting services. The company also

undertakes bespoke research and analysis projects on

individual markets and business sectors. The EIU is head-

quartered in London, UK, with offices in more than 40

cities and a network of some 650 country experts and

analysts worldwide. It operates independently as the

business-to-business arm of The Economist Group, the

leading source of analysis on international business and

world affairs.

This article was written by Dr. Paul Kielstra and edited by

Brian Gardner.

Dr. Paul Kielstra is a Contributing Editor at the Economist

Intelligence Unit. He has written on a wide range of top-

ics, from the implications of political violence for busi-

ness, through the economic costs of diabetes. HIs work

has included a variety of pieces covering the financial

services industry including the changing role relation-

ship between the risk and finance function in banks, pre-

paring for the future bank customer, sanctions compli-

ance in the financial services industry, and the future of

insurance. A published historian, Dr. Kielstra has degrees

in history from the Universities of Toronto and Oxford,

and a graduate diploma in Economics from the London

School of Economics. He has worked in business, aca-

demia, and the charitable sector.

Brian Gardner is a Senior Editor with the EIU’s Thought

Leadership Team. His work has covered a breadth of

business strategy issues across industries ranging from

energy and information technology to manufacturing

and financial services. In this role, he provides analysis as

well as editing, project management and the occasional

speaking role. Prior work included leading investiga-

tions into energy systems, governance and regulatory

regimes. Before that he consulted for the Committee

on Global Thought and the Joint US-China Collabora-

tion on Clean Energy. He holds a master’s degree from

Columbia University in New York City and a bachelor’s

degree from American University in Washington, DC. He

also contributes to The Economist Group’s management

thinking portal.


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Deutsche Asset & Wealth Management invites you to

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made relevant and reader-friendly for investment pro-

fessionals like you.

4

Ageing: A developed- and emerging-market trend

Rapid streams of numbers flashing across electronic

screens in trading rooms and brokerage offices worldwide

seem to reflect the deeply impersonal nature of the world’s

capital markets. Ultimately, though, these exchanges

are driven by the decisions of individuals – whether

executed as one-off trades or adopted as strategies

programmed into machines. Therefore, the attributes of

the people buying and selling assets, as well as of the wider

populations in which they live, are intrinsically linked to

how markets perform. This is most evident during a bubble

or an ensuing panic, where emotions can quickly inflate or

destroy the value of any number of securities overnight.

More generally, though, any widespread changes to the

prevailing needs, wants, productive capacity or views on

risk in a society are likely to feed through, sooner or later,

to asset prices on capital markets.

Several such shifts may be driven by societies’ ageing.

One economically important result of this demographic

change is the increase in the proportion of people who are

retired and a reduction in their working-age populations.

In 2010 in the developed world, according to data from

the United Nations Population Division, 16% were already

65 – a common retirement age – or older. In the oldest

societies, such as Japan, Germany and Italy, the figure was

over 20%. In the years ahead, for the developing world as

a whole, the total number of the over 65s is expected to

rise by about 2% annually, so that it reaches 22% of the

population by 2030.

This issue also has particular resonance in Asia. Because

China’s retirement age is 60, the proportion of people

beyond normal working years is 15% and is expected

to reach 24% by 2030. This makes the issue much more

immediate there than in the United States, where the

equivalent figures are 15% and 20%. As the Chinese

example suggests, one way to reduce the impact of these

changes could be to increase the age at which employment

typically ends. The political difficulties of doing so, however,

raise questions about whether increases in the retirement

age will keep up with advances in life expectancy.

A policy challenge

Older populations will require societies to make a wide

range of adjustments, many with direct impacts on

national economies and, indirectly, on capital markets.

According to respondents to a survey conducted by the

Economist Intelligence Unit of 353 senior executives of

companies actively involved in capital markets, one of

the biggest predicted impacts of population ageing will

come from increased government spending to cover the

associated costs in areas such as healthcare and pensions

(cited by 41% of respondents).

James Poterba, Mitsui professor of economics at the

Massachusetts Institute of Technology, believes that

“the greying of the population in the United States is an

important driver of long-term [government] spending to

GDP. We are seeing that today.” America is far from alone.

This spending in turn presents societies with a fundamental

choice. Alexander Ludwig, professor of macroeconomics at

the University of Cologne and an expert on the economics

of ageing, explains that governments can choose debt or

taxes to fund the coming spending needs for the elderly.

Too high a tax burden, though, will reduce savings by

those in their middle years, and therefore investment in

capital markets. Too high a level of government debt, on

the other hand, may crowd out demand for other relatively

risk-free assets. Furthermore, if households foresee that

higher debt today will have to be financed by increased

taxes in the future, private spending will also go down.

Population ageing and capital market performance A collaboration between Deutsche Asset & Wealth Managment‘s Global Financial Institute and Economist Intelligence UnitMarch 2014

Population Ageing and Capital Market Performance Global Financial Institute

Written by

5 Population Ageing and Capital Market Performance

According to Professor Ludwig, “it is certainly true that

increased government spending will have an impact on

capital markets one way or the other”. The shape of that

impact, though, will depend on the specifics – and the

success or failure – of the policies chosen to address the

changing needs of ageing societies.



A people challenge?

The difficulty in predicting what capital markets will

look like in a world where investors, like the population

in general, are older is that the world has never seen

population ageing on the current and predicted scale.

Hard data about what will happen do not exist. Expressions

of concern tend to begin with references to the life-

cycle hypothesis. This holds that, as individuals attempt

to smooth out consumption over the years, they save

during their working lives and spend those savings in

retirement to cover living expenses. A higher proportion

of retirees in the population therefore means that there

are more people selling off accumulated capital assets

and fewer interested in buying, leading to a general drop

in asset values. Another issue – which survey respondents

identified – is a shift by older, more risk-averse individuals

into traditionally safer investments, such as government

bonds, from more volatile ones such as equities. Done en

masse, this would reduce share prices and lower interest

rates, as more retirees seek security in debt instruments.

This theory, however, is far from airtight. While it has

substantial predictive value, this hypothesis ignores two

important investor motives: precautionary savings by the

elderly, who know neither how long they will live nor all

the expenses they might face; and the bequest motive.

As Professor Poterba notes: “Research of the last decade

has shown that late life behaviour isn’t driven only by

drawing down capital. A simple life cycle model is an

oversimplification.”

Similarly, any movement away from risk may be more

apparent than real. For many individuals, pensions and

annuities form a significant proportion of personal assets

in retirement. Increasingly, however, the pension fund

managers and insurance firms which oversee the assets

used to fund private pension payments are finding that

traditionally safe government bonds – long a default

asset for the industry – now pay far too little to meet their

obligations to pension and annuity holders. Therefore,

managers are buying a wider range of assets, including

alternative investments, in the search for yield.

Furthermore, underlying assumptions about retirement

ages – and therefore the time when retirement-related

expenditures begin – are not as solid as they seem, in part

because people are, on average, healthier and therefore

able to work longer. For example, in the United States

between 2003 and 2013, even without pension reform, the

Bureau of Labour Statistics reports that the labour market

participation rate of those aged between 65 and 69 rose

from 27% to 33%. Indeed, of those Americans still working

at 65, the majority do not retire. And according to Statistics

New Zealand, the labour market participation rate in that

country for those over 65 doubled between 2002 and

2012, from just under 10% to 20%. Cultural differences

may slow change. International Labour Organisation (ILO)

data show that European countries, although they too

have seen some increase over the last decade, still have

very small labour market participation rates among the

elderly. Nevertheless, as Professor Ludwig notes, even

there, “if you live longer, and need higher savings, the

average retirement age will probably increase without

regulatory reforms”.

Looking for evidence

These problems with the theory may explain why it has

been difficult for researchers to find conclusive evidence

– although population ageing has been taking place for

some time – of an impact on capital markets. A study by

Professor Poterba, for example, found very little, if any, sign

of a link between the changing age structure of the US

population over several decades and the value of equities

or government debt in the United States. It also found

that, although household asset holdings do rise when

people are in their 30s and 40s, they remain largely stable

throughout retirement except for defined benefit pensions

- which decline by design.1

The best evidence so far of a link between ageing and

equity values relates not to asset prices specifically, but to

the price/earnings (P/E) ratios of equity assets. Research

carried out by economists at the Federal Reserve Bank

of San Francisco found a surprisingly tight positive

correlation between average US P/E ratios and the ratio

of middle-aged people – which the study defines as those

aged between 40 and 49 – and the old-age cohort likely to

be selling off shares – those aged 60 to 69.2 Presumably,

1 James Poterba, “The Impact of Population Aging on Financial Markets in Developed Countries”, in Gordon H Sellor Jr, ed., Global Demographic Change: Economic Impact and Policy Challenges, Federal Reserve Bank of Kansas City, 2005, pp. 163-216.2 Zheng Liu and Mark M Spiegel, “Boomer Retirement: Headwinds for U.S. Equity Markets?”, FRBSF Economic Letter, August 2011.



where the number of middle-aged people is higher, their

greater interest in shares compared with other securities

drives up prices.

Even with such an apparently good data fit, however, the

study warns that many other factors could obliterate this

effect. Moreover, Mark Spiegel, vice president, economic

research at the Federal Reserve Bank of San Francisco

and one of the study’s authors, explains: “It is correct that

a lot of people hold a lot of scepticism. The study works

off very clear patterns in historical data, but you can tell a

special story for the sub-periods going back to the 1950s

for each of the big swings in the trends. The ultimate test

[of whether there is a link] is if it shows up in data [in the

coming years].”

Examinations of other types of assets yield a similar

combination of possible pressure on asset prices owing to

ageing, alongside high levels of uncertainty about what

might actually happen. Real estate is one of the more

studied, as housing, along with pensions, is among the

most widely held assets for retirees. A Bank of International

Settlements (BIS) working paper which looked at house

prices over 40 years in 22 countries found a link between

ageing and lower prices. It therefore predicted downward

pressure on prices resulting from older populations.

The paper stressed, however, that projected house price

“headwinds” would be insufficient to produce an asset

meltdown and offered the well-deserved caveat: “Long-

run projections and estimates should be treated very

cautiously as their track record is dismal.”3

The international dimension

Capital markets are not just about long-term assets, but also

about flows of money. International differences in the rate

of ageing might affect these transfers and, indirectly, asset

values in different markets. In particular, economic theory

would suggest that investment should flow from wealthier,

older countries with surplus capital and restricted labour

supply towards developing, younger ones, where capital

will be more productive and yield a higher return.

Questions of international labour and capital availability

go beyond demographics to include areas such as pension

and labour market reform. To address how this range

of issues might interact with ageing to affect capital

markets in an internationally open economy, Professor

Ludwig and his colleagues have put together a complex

model.4 Its projections, though, vary dramatically based

on government policy and individual lifestyle choices. In

scenarios in which people take advantage of opportunities

to work later in life and where governments do not reduce

spending on pay-as-you-go pensions, the model suggests

that asset returns will drop by about 5% between 2015 and

2030, but then rise by the same amount again by 2050.

However, without a change in labour regulations and

working habits but with a shift to funded pensions, which

increases the capital available, asset returns could drop by

over one-quarter. Put simply, the policy response is likely

to define how asset returns, and therefore capital markets,

react to ageing.

Like most experts, Professor Ludwig advises caution. The

study itself suggests that continued high growth in Asia

would counteract any downward pressure and more than

compensate for reductions in asset returns in several

scenarios. Moreover, he warns that the available data

are based on the “baby boom” and “baby bust” years in

developed countries, which are insufficient to draw firm

conclusions. “This is why we have to work with simulation

models grounded in economic theory,” he adds.

Whatever the other uncertainties, Professor Ludwig, citing

existing, separate research, feels confident that differential

ageing patterns promote the flow of capital from older,

wealthier countries to younger, emerging markets.5 Others,

though, are less certain. If this were the case, says Professor

Poterba, “you would have expected North America and

Europe to be large saving countries, to be lending to other

parts of world. That is not what we see. This reminds us that

many other factors also affect capital flows – demography

is not everything.”

The most relevant economic theory, however, raises red

flags about population ageing. It could place some pressure

on asset prices in the coming decades, and while the full


3 Előd Takáts, “Ageing and asset prices”, BIS Working Papers No 318, August 2010.4 Axel Börsch-Supan and Alexander Ludwig, “Aging, Asset Markets, and Asset Returns: A View From Europe to Asia”, Asian Economic Policy Review, 2009.5 See, for example, Melanie Lührmann, “Demographic change, foresight and international capital flows”, Mannheim Research Institute for the Economics of Ageing, Discussion Paper 38-03, 2003.


scope is unclear, the extent does not seem likely to cause a

crisis. Moreover, such evidence as exists does not provide

solid support for strong predictions. It may be unlikely ever

to do so: demographic changes are highly predictable. A

market made up of rational actors should foresee them

and may have already priced in any relevant risk. Similarly,

companies facing a reduction in labour capacity can alter

their production models to ones that optimise the likely

future mix of labour and capital.

What applies to rational markets hopefully applies to

rational policymakers. Capital markets are not facing an

unavoidable “silver tsunami”. Population ageing may well

affect asset values, just as it will affect society in general,

but the way it does will be shaped largely by choices

those societies make addressing the new demographic

environment.


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Economy & Finance

Population change and capital markets: Should we be worried?