Saturday, February 05, 2011

Predictable Trends and Capitalist Investment

There are no "$20 dollar bills on the ground"?  If we anticipate that the Baby Boomers are a large aging cohort, does capitalism get ready to innovate to provide products they will demand to help them achieve their daily goals?  This newspaper article says "yes".  Anticipating increased demand for a variety of products to help seniors, firms are paying the fixed costs today to develop these products in order to meet future rising demand.
Stephano DellaVigna and Joshua Pollet have written an important paper related to this topic.

Attention, Demographics and the Stock Market

Their Abstract

"Do investors pay enough attention to long-term fundamentals? We consider the case of

demographic information. Cohort size fluctuations produce forecastable demand changes

for age-sensitive sectors, such as toys, bicycles, beer, life insurance, and nursing homes.

These demand changes are predictable once a specific cohort is born. We use lagged consumption

and demographic data to forecast future consumption demand growth induced

by changes in age structure. We find that demand forecasts predict profitability by industry.

Moreover, forecasted demand changes 5 to 10 years in the future predict annual

industry stock returns. One additional percentage point of annualized demand growth due

to demographics predicts a 5 to 10 percentage point increase in annual abnormal industry

stock returns. However, forecasted demand changes over shorter horizons do not predict

stock returns. The predictability results are more substantial for industries with higher

barriers to entry and with more pronounced age patterns in consumption. A trading strategy

exploiting demographic information earns an annualized risk-adjusted return of 5 to 7

percent. We present a model of underreaction to information about the distant future that

is consistent with the findings."
Why do I blog about this?  Capitalism is more likely to help us to adapt to climate change if firms are forward looking in anticipating future needs and desires (such as energy efficient appliances and innovations that economize on water consumption). 

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