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Generational Regimes

February 28, 2010

Buttonwood from the Economist recently published an interesting article describing the essence of generational regimes, summarizing results from the Barclay Capital 2010 Equity Gilt Study (27 Feb print edition, p. 82). Although seemingly irrelevant for short-term trading, understanding generational regimes is crucial for two reasons:

  • Regime self-similarity: generational regimes illustrate that finance is broadly self-similar across all investment horizons, from intra-day to inter-generational
  • Context: generational regimes are to trading what cosmic background radiation is to astrophysics, providing long-term fabric on which all short-term oscillations overlay

Generational regimes are another root cause why Naïve Backtesting is Bogus, as assuming stationarity and ergodicity across generational regimes is economically nonsensical. Yet, despite this fact, methodologies for adjusting quantitative backtesting for generational regimes remain an interesting open research question.

The key quote on generational regimes pertains to market tops:

In real (inflation-adjusted) terms, Wall Street reached peaks in 1928, 1968, and 1999. The patterns suggest that each generation discovers a passion for equity investment that is followed by disappointment.

With explanation that appeals to behaviorial finance:

It was the belief in ever-rising share prices that pushed stockmarket valuations to absurd levels and thus ensured subsequent underperformance.

And, generational demography:

Demograpghy may be to blame. The key “saving age” is the cohort 35 – 54 year-olds. As they prepare for retirement, they pile into the asset class du jour.

For readers interested in learning more about generational regimes, the Equity Gilt Study is interesting reading. For those seeking to understand generational dynamics and its macroeconomic implications, The Coming Generational Storm: What You Need to Know about America’s Economic Future, by Kotlikoff and Burns, is a well-researched introduction (ignoring the overreaching marketing hype title).

Despite being published nearly five years ago, Quantivity anticipates this meme will prove as prescient over the next decade as it has over the past five.

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