Investors Don't Take Advantage of the Picture
by Joshua Pollet, assistant
professor of finance, and co-author Stefano Della Vigna, assistant
professor of economics at the University of California at Berkeley,
was the focus of a New York Times article by Mark Hulbert
on June 19.
Hulbert reported on Pollet and Della Vigna's recently released
National Bureau of Economic Research (NBER) working paper "Attention,
Demographics, and the Stock Market." More than 60 years
of data from the Bureau of Labor Statistics from two dozen age-sensitive
industries such as toy manufacturers and nursing homes was analyzed.
Demand changes from populations are predictable once a specific
cohort is born. Even so, few investors look at such predictable
events like an increased demand for nursing home care for baby boomers
and use that information when making investments.
The authors devised a test of underreaction to information based
on demographic variables and looked at whether investors respond
appropriately to predictable demographic changes.
"One unusual feature characterizes demographic changesthey
are forecastable years in advance. Current cohort sizes, in combination
with mortality and fertility tables, generate accurate forecasts
of future cohort sizes even at long horizons. Different goods
have distinctive age profiles of consumption, and therefore forecastable
changes in the age distribution produce forecastable shifts in
demand for various goods. These shifts in demand induce predictable
changes in profitability for industries that are not perfectly
competitive. Consequently, the timing of the stock market reaction
to these predictable demand shifts is a test of investor attention
to determinants of profitability."
The authors found that demand forecasts predict profitability by
industry. But forecasted demand changes over shorter horizons do
not predict stock returns. Investors, it appears, are not paying
attention to clear and predictable changes over the long term.
The working paper is available online as a PDF
document. The New York Times article by Hulbert is available
at a fee.