Long-term demographic trends are of little concern if you are a short-term-focused investor. But demography becomes quite important if you’re a decade or more from retirement and trying to devise an appropriate financial planning strategy for your nonworking years.

Researchers have found that the ratio of a country’s middle-aged population to its elderly is highly correlated with the long-term cycles of its stock market.

This ratio — known among demographers as the “M/O ratio” or “middle-old ratio” — is plotted in the chart below. It is calculated by dividing the number of those 40-49 by the number of those 60-69. (The M/O ratio data in the chart are from Alejandra Grindal, chief economist at Ned Davis Research.)

There is a distinct connection between the long-term trend shifts in the M/O ratio and the S&P 500 For example, the ratio hit a peak in 2000, coinciding with the end of the go-go years of the 1990s and the top of the internet bubble. The ratio then declined for more than a decade — a period coinciding with the global financial crisis and the 2008-09 bear market. The ratio has been in an uptrend since the mid-2010s.

The correlation is not perfect. The M/O ratio didn’t hit bottom until several years after the financial crisis, for example, by which point the stock market had already embarked on a new bull market. Furthermore, the ratio is of no help in predicting shorter-term bear markets, such as the one in 2022.

Nevertheless, the M/O ratio’s correlation with longer-term cycles is impressive, according to John Geanakoplos, an economics professor at Yale University and co-author of perhaps the topic’s seminal academic paper, published in 2002. He found evidence that demography provides “a single explanation” for the alternating 20-year periods of boom and bust since World War II.

Notice that the focus of Geanakoplos’ research is on the relative sizes of different population cohorts rather than the size of a country’s entire population. That’s important because many on Wall Street focus on overall population when making doomsday predictions about the future of the world.

Stocks for the very long term

The chart also shows the path the M/O ratio will take through 2050, rising until the mid-2030s (though never getting to the level it did at the top of the internet bubble) and then declining through 2050.

When interpreting this, Geanakoplos says it’s important to focus on both the ratio’s trend as well as its absolute level. He said in an email that the data suggest “the demography effect [will be] slightly smaller going forward, but [with] stock market growth slowing in the early [20]30s.”

You should plan accordingly in your retirement portfolio. Since the demographic projections aren’t precise, this analysis suggests that over the coming decade, you would want to start reducing your equity exposure level to even lower levels than is suggested by the traditional glide path employed by target-date funds and financial planners.

By the time you reach 65, for example, the glide path employed by Vanguard’s target-date funds suggests that you should dedicate 30% of your retirement portfolio to U.S. equities. The dictates of demography would have you even less exposed to stocks at that time.

The Vanguard glide path also calls for a 65-year-old investor to allocate an additional 20% to non-U.S. equities. Whether you maintain that allocation depends on the country and region of the world. The average non-U.S. country is also projected to have a lower M/O ratio in 25 years, according to the World Bank, though the decline between now and 2050 will be less than in the U.S.

Many emerging market countries in Africa and Asia will have higher M/O ratios in 25 years, according to the World Bank’s projections. So if you follow the demographic projections, you would want to shift some funds from U.S. equities and overweight emerging markets.