Investor Behavior: Demographics, the Flow of Funds, and Capital Flow Analysis

Lesson: 11 | 12 | 13 | 14 | 15 | 16 | 17 | 18 | 19 | 20

Lesson sections: 12 | 12a| 12b | 12c | 12D

Capital Flow Analysis: Investor Behavior and Demographics Demographics and Capital Flow Analysis

The Role of Demographics

Markets are driven by people. As the composition of the population changes, so do markets.

Orthodox economists sometimes assume the behavior follows a constant pattern of rationality.

Behavior of market players will accompany shifts in society.

However, for purposes of Capital Flow Analysis it is better to assume that changes in the behavior of market players will accompany shifts in society.

There have been many changes in American culture that have led to new paradigms for capital markets.

The stock market of 1929 is not the same as the market of 1990.

Fluctuations in the S&P index during the 1920s tells us little about the market of the 1990s, unless we consider demographic patterns and social change effecting the players.

Elements of American demographics and society that are relevant to Capital Flow Analysis include savings patterns, the rich-poor gap, occupational change, aging, immigration, and cultural shifts.

Patterns of Saving

The personal savings rate in the U.S. declined from 12% in 1977 to about 2.5% in 2000.

Rising stock prices and easy credit created an illusion of financial well-being.

One reason for this was that blind faith was placed in the Common Stock Legend, reinforced by the pumping up of stock prices by corporate buybacks, creating an illusion of financial well-being.

Another reason was the severance of the dollar from gold in 1973, which spurred a growing trade deficit and an era of easy credit that self-indulgent Baby Boomers could not resist.

This change in behavior, combined with the growth of the derivative market and hedge funds, led to greater volatility in securities prices.

Over the half-century, investment habits changed.

As investors became more willing to trust others to manage their money, control of savings has been taken over by portfolio managers.

The nature of mutual funds is such that it is the investor that makes the basic decision as to asset allocation (e.g., stocks or bonds) and the fund manager that allocates money within that asset class.

When investors are blindly allocating assets based on the Common Stock Legend, the stage is set for an over-priced equity market.

Investor Behavior of Capital Flow Analysis: Demographics  Patterns of Saving: Lesson 12A >

Rich and Poor

The Democrat Party rightly points out that the economic well-being of the average American has declined in recent decades.

Democrats do not, however, concede that it was their policies and leaders that have been largely responsible for growing inequalities.

The economic well-being of the average American has declined in recent decades.

The rise of Workers' Capitalism and Big Government that began with Franklin Delano Roosevelt and was further institutionalized by Lyndon Baines Johnson, has now become the foundation of American society.

Deindustrialization, the evolution of a nation of employees, and an income tax that discourages entrepreneurial activity are some of the causes of the widening gap between rich and poor.

Because the income tax is regressive, taxing income rather than wealth, the gap between rich and poor in the United States is widening.

Because an increasing large segment of the electorate is either on the government payroll, or exempt from income taxes, or otherwise beneficiaries of tax money, the Snare of Democracy continues to discourage entrepreneurs, drying up the supply of equities and widening the gap between rich and poor.

Eventually — although perhaps not for years — this trend must have political consequences, unless countervailing forces intervene.

Investment Tutorial: Capital Flow Analysis: Investor Behavior  Rich and Poor : Lesson 12b >

Changing Occupations

People behave according to their role in life. In other words, 'we are what we do'.

Since the United States was founded, the population has gone through three major occupational changes:

In 1860, two-thirds of Americans were self-employed.

  1. a land of self-employed farmers;
  2. a country of industrial workers; and
  3. a nation of service employees.

In 1860, about two-thirds of Americans were self-employed, mostly on family farms. By 1948, self-employment had fallen to 18.5%.

By 1994, only 8.7% of Americans were their own boss.

By 1994, only 8.7% of Americans were their own boss.

Whereas the United States was founded as a nation of proprietors (owning property was a qualification for voting), after two hundred years, America had become a nation of employees.

Most large corporations are no longer run by owners, but rather by hired-hands with short-term goals.

This change in society has influenced the ethics and attitudes of major players in the capital market.

The long-term fall in entrepreneurial activity has had a negative effect on the supply of equities.

Investment Theory: Demographics and Capital Flow Analysis  Changing Occupations : Lesson 12c >

Old and Young

A common reason for saving is to accumulate funds to pay the living expenses of old age.

Expectations as to how long people live are fundamental to Capital Flow Analysis.

Expectations of longevity are fundamental to Capital Flow Analysis.

The longer we live, the more we need to save for retirement.

However (except in the minds of optimists and economists that believe in the Invisible Hand), there is no assurance that there will be sufficient and adequate investment vehicles to convey savings over fifteen to twenty years.

The balance between old and young and incentives for inter-generational transfers set prices in securities markets.

The demographics behind inter-generational transfers are complex, dependent upon medical science, the birth rate, and immigration patterns.

Furthermore, there is a possibility that sometime during the 21st century world population will stop growing, ending the Great Age of progress that began three hundred years ago.

Since there is a strong correlation between corporate profits (for the whole economy) and population growth, the demographic outlook is important in Capital Flow Analysis.

Capital Flow Analysis of Federal Reserve Flow of Funds Accounts  Old and Young : Lesson 12d >

A Nation of Immigrants

The assets traded in capital markets become more valuable as more people are involved.

The great economic boom in America during the 19th and early 20th century was spurred by extraordinary population growth fed by massive immigration from Europe.

In the 21st century, it is immigration that offers a solution to the economic stagnation that we would ordinarily expect to see with an aging population.

During the 19th century and before, most immigration to America was from the Protestant countries in Europe.

By the 20th century, the tide had shifted in favor of Catholic and Jewish immigrants, also from Europe. By the 21st century, U.S. immigration patterns had again shifted, this time to Catholics from Mexico, Central, and South America.

In contrast, populations left Europe during the 18th and 19th century, but immigration into Europe now comes from the Muslim countries of North Africa and the Mid East.

In the U.S. it is likely that immigration from Latin America will continue to counterbalance the aging population.

In view of long-term expectations for the War on Terror, changing composition of European populations may break down traditional alliances.

In Europe and North America, immigration ameliorates the negative effects of an aging population. Japan, on the other hand, is a crowded island with a xenophobic culture that discourages immigration.

In Japan, the effects of an aging population are not counterbalanced by immigration.

In the United States, the economic advantages of immigration are so great that, despite political opposition, it is likely that immigration from Latin America will continue to counterbalance the aging population.

On the other hand, the political leanings and culture of Latin immigrants will undoubtedly influence the American capital market.

Shifting Cultures

Demographic changes, generally, are slow and don't make the daily news.

The challenge in Capital Flow Analysis is to be aware of changes that will effect securities markets.

Entrepreneurial immigrants tend to go into business for themselves.

For example, entrepreneurial immigrants tend to go into business for themselves and, eventually, this may result in an increase in the supply of equities.

Some studies show that Mexican immigrants are more entrepreneurial than immigrants from other nations.

However, Mexicans (unlike Cubans) tend to vote the Democrat Party, which favors high taxes and big government — policies that diminish the supply of equities.

This suggests how difficult it is to interpret the effect of changes in demographic composition on a market.


Before proceeding, check your progress:


Between 1977 and 2000, the personal savings rate in the United States declined because of many factors, including:
Choice 1Easier credit due to the trade deficit.
Choice 2The 'wealth effect' of rising stock prices.
Choice 3Increased self-indulgence of Baby Boomers.
Choice 4Increased poverty among Americans.
The U.S. income tax is regressive because:
Choice 1The rich pay more taxes than the poor.
Choice 2The tax is on income, not wealth.
Choice 3The tax is not levied at a flat rate.
Choice 4Tax payers must prove innocence.
The United States is considered a capitalist country because:
Choice 2 Most Americans are self-employed.
Choice 3 Most Americans are entrepreneurs.
Choice 1 Most businesses are in the private sector.
Choice 4 There are more capitalists than workers.

Investment Tutorials: Themes of Capital Flow Analysis  The Asset-Lite Movement : continued >

Lesson: 11 | 12 | 13 | 14 | 15 | 16 | 17 | 18 | 19 | 20

Lesson sections: 12 | 12a| 12b | 12c | 12D

Suggested Reading in Investment Theory of Capital Flow Analysis (Demographics)
'History Matters: Essays on Economic Growth, Technology, and Demographic Change', Hardcover, Timothy Guinnane, William Andrew Sundstrom, Warren C. Whatley

An erudite collection of papers edited by an eminent economic historian

'American Incomes: Demographics of Who Has Money', e-doc, New Strategist Publications, Inc.

Research and analysis on America's rich and poor, with ample tabular data.

'White Collar: The American Middle Class', Paperback, C. Wright Mills, Russell Jacoby

This classic describes the American middle-class in the 1950s, serving as a useful benchmark against changes in the 1990s.

'The Empty Cradle: How Falling Birthrates Threaten World Prosperity and What To Do About It', Hardcover, Phillip Longman

A controversial argument that reduced fertility and global aging threaten world prosperity, jeopardize national economies, and will change our way of life for decades to come.

'Demographic Change and the Family in Japan's Aging Society', Paperback, John W. Traphagan, John Knight

Demographic trends in contemporary Japan's rapidly aging society

'The Immigration Debate: Studies on the Economic, Demographic, and Fiscal Effects of Immigration', Paperback, James P. Smith, National Research Council, Barry Edmonston An analysis of the gains and losses from immigration.
'Walls and Mirrors: Mexican Americans, Mexican Immigrants, and the Politics of Ethnicity', Paperback, David G. Gutierrez

Why immigration policy exists in its present form, and why racial tensions still persist within the southwest.

'Slouching Towards Gomorrah: Modern Liberalism and American Decline', Paperback, Robert H. Bork

A must-read for those interested in the state of American morality.

'Demographic Methods and Concepts', Paperback, Donald T. Rowland

Commonly needed techniques for working with population statistics, irrespective of the reader's mathematical background

'Americans and Their Homes: Demographics of Home ownership', Hardcover, Cheryl Russell

Home ownership is the principal long-term investment of the American people.

'The Demographic Dividend: A New Perspective on the Economic Consequences of Population Change', e-book, David Bloom, David Canning, Jaypee Sevilla

How population growth effects national economies.

'The Rise of Big Government in the United States', Hardcover, John F. Walker, Harold G. Vatter

Public expectations and budget dynamics will mandate large government for the foreseeable future.

External Links on Investment Theory of Capital Flow Analysis and Demographics.
Personal Savings Rate : 'What's Behind The Low U.S. Personal Savings Rate?', Federal Reserve Bank of San Francisco Economic Letter, March 29, 2020. [Return]
Severance Of The Dollar From Gold : 'The Monetary Breakdown of the West', Ludwig von Mises Institute. [Return]
Derivative Market : 'Modern Banking and the OTC Derivatives Market', International Monetary Fund. [Return]
Hedge Funds : 'Facts About Hedge Funds', The Hedge Fund Association. [Return]
Volatility : 'Volatility and the Greeks', The Options Industry Council. [Return]
Big Government : 'Republicans Become the Party of Big Government', The Cato Institute, February 2, 2020. [Return]
Franklin Delano Roosevelt : White House biography and links. [Return]
Lyndon Baines Johnson : LBJ Library and Museum. [Return]
Self-Employment : 'Measuring Self-Employment in the U.S.', Bureau of Labor Statistics. [Return]
Invisible Hand : 'Adam Smith and the Invisible Hand', Helen Joyce, Plus Magazine. [Return]
Immigration : Modern History Sourcebook: U.S. Immigration. [Return]

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