Sunday, August 15, 2010

The MY Ratio


MY ratio which stands for the middle-aged to young ratio or simply Middle-Young.

This ratio is key because in these two different stages of life, people have very different priorities which, aggregated as a great galloping herd, has an inevitable effect on the pattern of savings, spending and investing that happens in a given society.

When you are young, typically, your income is very small to non-existent. You are interested in spending primarily. Both as a means of entertainment and as a way to gain education in order to achieve your full earning potential later in life. So at this stage, the average young person has much higher expenses than income - which results in debt.

On the other hand, in middle age, the average person has reached their peak income potential. They do have expenses obviously but they are also mindful of their impending retirement and as a result, saving a portion of their annual income and investing it. The majority of this investment flows to the equity markets because that is where the best risk adjusted returns are.

So it would follow then that demographics and especially the MY ratio potentially not only describes the fluctuations in the stock market, it also may explain the expansion and contraction in the Price/Earnings ratio.

After all, when you have an abundance of middle-aged investors chasing after stocks, they will be ready to pay a higher and higher price for them. And inversely, when you have few middle-aged investors there will be few competitive bidders for equities, allowing stocks to become extremely ‘cheap’.

My Notes:

For India, the Y is much more than the M since we have a young population, so the MY ratio will be low. Does this mean that PE Ratios in India are unlikely to see big expansions since the young may not be prepared to pay higher and higher prices for stocks. Most of the stock market gains may come from a growing economy rather than higher valuations. I would think this is good news for investors.

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