How Demographics Determine Supply and Demand of Shares

God intervened in the US political system again yesterday.

The Republican Party’s second in command in Congress lost his primary. His primary what? His primary to represent the Republican Party in his electorate at the next election.

This is sort of like having Julia Gillard lose her pre-selection to represent the Labor Party in 2009.

So where does God come in? Well, nobody expected the Tea Party’s Brat (that’s his surname) to win. But Brat had an ace up his sleeve. You see, the media is reporting he has an economics degree. But his actual undergraduate qualification is in divinity. No doubt he made a deal.

Our understanding of divinity comes from crystal ball gazing in the movie Harry Potter. But we can’t give Brat too much of a hard time. His study of the religious discussion of usury just might feature in our own postgraduate thesis. Brat also believes that religion and economic growth are somehow related. Nothing wrong with that until you combine it with Keynesian ideas of stimulus…yikes.

The political establishment isn’t interpreting Brat’s victory as a sign from above. They’re worried about the below. Could more grassroots Tea Party challengers steal Republican posts? Could they meddle with debt limit and budget negotiations? Could they make the Republican Party too extreme to appeal to swing voters?

The Tea Party used to be more grass smoking than grassroots. Presidential hopeful Ron Paul’s annual tax day protest was a libertarian event. Now the movement is very different things to different people. But they tend to be disruptive, which isn’t good for an economy on life support. Add a Tea Party comeback to European protest parties on the move and you begin to have a problem. A ruling elite without the façade of political backing is dangerous.

But politics and the stock market were yesterday’s topic. Today is about demographics and paperwork. Which would you like first?

Still reading? OK, it turns out we may have been wrong about our demographic theory. And just as the hate mail began turning supportive too.

If you remember, our theory is that the price of shares (and everything else) is determined by supply and demand. Others argue it’s determined by things like earnings, dividends and charts.

But they’re wrong. Demographics determine the supply and demand of shares. You buy shares in middle age and sell them in retirement. At least that’s the tendency of a generation as a whole.

Looking at demographics tells you the ratio of buyers to sellers, which predicts prices. Right now the biggest wave of buyers ever, the baby boomers, are turning into sellers. And there aren’t enough future buyers to support all the baby boomers selling. Prices will fall.

But it turns out there are other influential factors. Not just financial crises, economic policy (which causes financial crises) and the economy. There are factors which affect the supply and demand for shares as directly as demographics do. The amount of shares, for example.

Our American sister company’s investment director, Paul Mampilly, pointed out how this has played out in the US:

At the end of 2013, there were 5,008 stocks traded on U.S. exchanges. But here’s the kicker — according to the World Federation of Exchanges, this number is down by 44% from a peak of 8,884 in 1997.

And since 2010, the total number of shares available has shrunk almost 10%, according to S&P. Companies are buying back their own shares at a remarkable rate, limiting their supply. In 2013 S&P500 companies alone bought back almost half a trillion dollars’ worth of their own shares.

Less shares means less supply. And less supply means higher prices. Paul continues:

This is how bad things are: The Wilshire 5000 index, which is the broadest, most inclusive U.S. stock index, cannot find 5000 stocks to invest in. The Wilshire 5000 has only 3,776 stocks in it. The number of stocks in the Wilshire 5000 stock index peaked at 7,459 stocks in 1997.

It’s been dubbed the Great Stock Shortage.

As anyone who isn’t a socialist will tell you, less supply means higher prices. We’re sick of explaining this basic thesis, so here’s more from Paul Mampilly:

‘Hard to believe, but the stock market is driven by something that no one is talking about. In a way, it’s too simple — and too obvious.

Too few stocks. And too much demand compared with supply. This is Market Economics 101. If there’s more demand than supply, prices go up. Until supply increases.

‘It’s hard to believe after an equity rally that’s been going nonstop for the last five straight years, but the data back it up.

It’s great to see that the stock market can be as simple as supply and demand.

So how does all this invalidate our theory? Well it actually proves it. We specifically mentioned the amount of shares on issue as a factor in the supply of shares. But we had no idea it has been so influential.

We couldn’t find stats for the number of shares on the ASX, but the amount of listed companies has been flat since the financial crisis, after rising steadily in the years before. Meanwhile, Australia’s ratio of buyers to sellers topped out in about 2008.

There are far too many other factors affecting the supply and demand of shares to make a specific analysis of the number of shares terribly helpful anyway. We came up with about 10 off the top of our head at the World War D conference, which you can view here.

In the end, it’s the ratio of buyers and sellers that wins out because it’s so dominant. To find out just what Australia’s ratio looks like going forward, what that means for the stock market, and what to do about it, click here.

We’ve run out of room to discuss Chinese paperwork. The rehypothecation scandal gets more intriguing by the day anyway. So, as we said yesterday, let’s tackle it tomorrow.

Nick Hubble
for Markets and Money

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Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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