The Scariest Chart of Your Children’s Retirement

How many dependents could your children support?

The correct answer is ‘not enough’.

One chart set to appear in your inbox next week spells disaster for your children’s retirement. It literally made us drop an apple into our coffee when it first appeared on our spreadsheet.

Source: Nick’s Desk

Pictures may tell a thousand words, but to understand what gave us such a fright, you need to understand the Life Cycle Hypothesis first.

When people are young, they cost their parents money. They reach adulthood and go into debt to start their life, often getting a mortgage to buy a home. Paying off the mortgage and seeing their own children become financially independent are two key moments when income for saving and investing suddenly become available. Both take place around say 45.

So the period between 45 and 65 is the period of maximum saving and investing — the period of a generation’s maximum demand for investment assets.

But after around 65, this changes abruptly. People go from demanding financial assets to supplying them. They suddenly begin to sell investments to pay for retirement instead.

So the key demographic relationship determining supply and demand for financial assets is the amount of selling by retirees above say 65 compared to the amount of buying by those in the stage of maximum accumulation — around 45 to 65.

Of course, supply and demand determine price. So the ratio of buyers to sellers can make prices move. Demographics, which determine demand and supply of investment assets according to the life cycle hypothesis, are predictable. That means they might actually predict investment prices.

The ratio of buyers to sellers based on the life cycle hypothesis is known as the M/O Ratio — the ratio of middle aged investment buyers (M) to the ratio of old investment sellers (O). When the ratio is rising, the number of middle aged buyers is growing relative to the older sellers. The demand outweighs supply and prices should rise. When the ratio falls, sellers outweigh buyers and the market falls.

Sure enough here’s what a chart of the ratio over time looks like next to the stock market over the same time frame.

click to enlarge

As expected, a falling M/O creates a bear market. A rising M/O generates a bull market.

So what does Australia’s future M/O Ratio look like? You’ll have to wait and see. But don’t eat an apple while you take a peek.

Read the rest of this article at The Daily Reckoning