Investors interested in Chinese stocks view China’s demographic development with understandable concern. Some demographers see China’s population shrinking 48% between now and 2100that would presumably have a devastating impact on the country’s economy. To avoid this looming crisis, China recently announced that married couples can now have up to three children.
The country’s previous policy has been to allow families up to two children. Previously, families were only allowed to have one child. But since the adoption of the two-child policy in 2015 The birth rate in China has continued to decline.
While the picture certainly looks bleak, investors can safely ignore it. Demographic trends affect stocks, but they do so for many decades into the future. Additionally, trends that may be bearish for the stock market at one point in the future may actually be bullish at another.
Consider the demographic indicator which, according to Alejandra Grindal, chief international economist at Ned Davis Research, “is effective in identifying secular trends in the equity markets.” This is the so-called MY ratio, which reflects the ratio of the number of 35 to 49 year olds (“middle age”) to 20 to 34 year olds (“young”).
This means that it will take 20 years for an increase in births this year or next to affect the MY ratio and thus the stock market.
In addition, the impact of a surge in births this year through 14 years later will be bearish. This is because the higher birth rate increases the denominator of the ratio, which in turn decreases the overall value of that ratio. Not until the mid-2050s will any increase in births that year increase the numerator of the MY ratio and its total value compared to other values.
How shortsighted is the stock market?
This would not be so irrelevant today if the stock market took the long-term future into account. However, researchers have found that all in all, investors don’t seem more than four to eight years into the future. That is nowhere near enough for the stock market to react immediately to changes in birth rates.
This investor’s myopia has been fascinating Study published in the American Economic Review by Joshua Pollet of the University of Illinois at Urbana-Champaign and Stefano DellaVigna of the University of California at Berkeley. The professors focused on companies whose profitability is ultimately heavily influenced by demographic change. They found that these effects would not show up in stock prices for four to eight years, even though they were evident many years earlier. The professors concluded that investors “are short-sighted and neglect information beyond four to eight years”.
Using their research as a template, a rising Chinese birthrate in the next few years would not have a bullish impact on Chinese stocks until four to eight years ago. That is 2048 at the earliest.
The clock is ticking on the Chinese stock exchange. As you can see from the graph below, courtesy of Grindal of Ned Davis Research, the country’s MY ratio peaks in 2031 and then begins to decline for a few decades. If investors expect this tipping point four to eight years in advance, the demographic tailwind in China’s stock market could turn into headwinds in the next few years. There is little the Chinese government can do about that.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert ratings track investment newsletters that pay a flat fee for testing. He can be reached at [email protected]