A recent Barclays study suggests demographics and baby boomers may keep equity valuations down for another 20 years.

True investment bubbles used to come along only once every generation or two.  But the past 10 years have seen two epic crashes.  The Barclays Equity Gilts Studypublished in the Financial Times on Feb. 10, 2010 suggests these bubbles were driven by shifts in the demand for equities and other assets and these, in turn, were driven largely by demographics.

Equities only became mass-market savings vehicles in the 1950s, as investment management companies started marketing their services.  This process accelerated sharply in the early 1980s, which is exactly when baby boomers began entering their ages of peak productivity and savings.  The introduction of 401K pension plans in the U.S. further incentivized individuals to start playing in stock markets.  As of 1980 the world had survived without a true bubble since the Great Crash of 1929.  Economic growth continued to be unusually stable until 2000 and the bubbles of the past decade.

As baby boomers aged and the long bull market made them more confident, they ‘over-invested’ in assets around the world. The process was already apparent when Alan Greenspan made his famous speech about the risks of “irrational exuberance” in 1996, and become obvious with the Asia crisis of the following year, and then the great Internet bubble that finally burst in 2000.  The size of the pool of capital available to pour into Asian or Internet stocks was disproportionate to the availability of investment opportunities.  No one told the boomers this, since the investment industry is paid according to the amount of assets it manages.

Barclays compared cyclical price/earnings ratios on stocks since 1950 with the ratio of 35-54 year-olds in the population.  Stock valuations became most extended just as baby boomers were saving and producing most.

The Barclays study suggests boomers were a major force in creating the later credit crisis. Mistakes both in U.S. monetary policy and in regulating mortgage lending were serious contributory factors to the credit crisis.  However, the study contends that underlying demographic factors were a more potent underlying force.  Baby boomers, faced with the crash in equities and with their retirements imminent, they would only have been expected to put money into bonds and other debt products, thereby helping to push interest rates.  That’s exactly what boomers did.

This drove a strong acceleration in the global appetite to put savings into debt financial instruments, which is the same thing as a surge in the global appetite to lend.

The implications here for the future are not good.  The proportion of 35-54 year-olds in society will keep declining for another decade, while the growth in the retired population will be very sharp.

This means equity valuations should keep coming down.  The demographic shift that drove the equity bull market for 20 years can be expected to drive a bear market for another 20 years.  This would suggest that this bear market has another 10 years to run.

Granted, equity valuations have already come down a lot.  And if companies keep producing decent profit growth, equities can still perform.  This should make markets more efficient.  With the pool of willing capital contracting, we should at least be less susceptible to investment bubbles.

So, what’s an investor to do?  Buy property!!??

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