Do Demographic Trends Affect Stock Valuations

The Economist's Buttonwood column makes an interesting claim:

Tim Bond of Barclays Capital argues that [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.

The bad news is that the demographic maths imply that equity valuations will continue to fall until the middle of this decade. The news is even worse for government bonds. A similar model suggests that yields in both America and Britain are heading for 10% by 2020.

I'm puzzling over this because I just finished teaching valuation in Corporate Finance. In a semi-strong efficient market, asset valuations reflect all publicly available information. Accordingly, valuations should be affected only new information. In turn, this means that only a demographic shock should affect valuation. Since the number of 35-54 year olds is known, where's the shock?

I suppose we could come at it from a portfolio theory perspective. Changes in demand for particular asset classes might be characterized as a nondiversifiable systematic risk. If so, however, shouldn't the decline in demand be a risk for which the remaining investors need to be compensated, raising returns?

In puzzling about all this, I found a very interesting paper by a couple of Italian economists, which reports that:

A lively debate on the financial effects of ageing is ongoing among both academics and practitioners and has originated a vast literature constituted by both theoretical and empirical contributions. ... [A] particular strand of the empirical literature has focussed on the effects that ageing may have on financial asset returns and portfolio allocations ....

These works are far from being homogeneous with regards to both the methodology used and the results obtained. ... As for the results, while some authors report significant effects of ageing on financial markets (e.g Yoo, 1994), others find evidence of only a weak, if any, relationship between demographic and financial variables (e.g. Poterba 2001, 2004).

I am reminded, of course, of Harry Truman's quixotic search for the proverbial one-handed economist. And I remain puzzled as to how one fits macro factors like demographics into asset pricing models.