Will Demographic Changes Affect Your Investments

Will Demographic Changes Affect Your Investments?

• The World is aging.
• Some countries faster than others.
• Countries with rapidly aging populations tend to have:

•       Fewer people working
•       A smaller number of workers supporting each retiree’s government pension
•       Greater demand for bonds

Fewer People Working

Economies get bigger when they add people or get more from the existing workforce. 

In the U.S. less of both is happening.

The Bureau of Labor Statistics projects the labor force will grow an average of .5% per year down from 1.2% growth during 1994 to 2004.  That smaller workforce is also less productive:

                                                U.S. Productivity Change 1990-2016

Source: Bureau of Labor Statistics

A slow growing workforce, all else equal, retards GDP growth. 

This has been the situation in Japan for the past twenty years.  Slow GDP growth then curtails profit growth that ultimately forces the stock market down.  Today, the Japanese stock market is half its 1990 value: 34,992 in Feb 1990 vs. 16,966 today.

 

Japanese Nikkei 225 Index: 1985-2016

Source: Trading Economics

Did Demographic Change in Japan Contribute to their Stock Market Decline?

The chart below shows that in 2015 Japan’s demographic makeup hindered its GDP growth by -5%.  That is a big drag on GDP and, therefore, corporate profits.  In the absence of corporate profit growth, a stock market will decline or remain stagnant.

 

Source: Research Affiliates, LLC

Is the U.S. Going Down a Similar Demographic Road as Japan?

In 2015 demographics impeded U.S. GDP growth by -1.5%.

If economic growth is sluggish business investment is curtailed as there are reduced opportunities for profitable investments.  This is now happening in the U.S. as business investment has fallen for three consecutive quarters.  This too curtails GDP growth.  For example, during the second quarter of 2016 consumption increased +5.5%, but lower business investment reduced overall GDP growth to +1.2%.

Lower business investment erodes future growth by hurting productivity.  For the past ten years output per hour worked has grown by only 1.3%, down from 3% per year during the previous ten years.

Lower growth also stymies innovation.  The number of startups per 100,000 people halved from 160 in 1977 to 80 in 2013, according to data from the Kauffman Foundation.  Furthermore, the new startups such as Facebook, Twitter and Uber have had a more muted (could we say negative) effect on productivity growth as did the introduction of the microprocessor and the PC, the telephone or air conditioning. 

U.S. vs. Japanese Demographics

Source: Research Affiliates, LLC

The demographic makeup of Japan in 2010 (color bars) is similar to the projected demographics for the U.S. in 2031 (gray bars):

•       In 2010 23% of Japan’s population was over 65
•       In 2010 13% of the U.S. population was over 65

•   In 2031 21% of the U.S. population is projected to be over 65

Compare the U.S. projection of an aging population to that of a country like Indonesia which is projected to have only 13% of its population older than 65 by 2035 

 Indonesia Demographics

 

            Source: Research Affiliates, LLC

Indonesia can, therefore, be expected to have a more robust economy, more workers supporting each retiree and less pressure to either raise taxes or the retirement age.

Based on projected demographic changes would you invest in the U.S. or Indonesia?

Demographics Effect on Public Pensions 

The U.S. social security system is a “pay as you go” system meaning it depends on current workers’ taxes to fund the payouts to retirees.  Back in 1950 there were about 8 workers to fund each retiree, today that number is about 4, it is projected to be about 3 by 2030. 

A dwindling pool of workers puts pressure on the finances of a pay as you go system.  Therefore, to shore things up either: 

•       Taxes must be raised from the existing workers
•       Extend the retirement age of workers

To maintain the current ratio of 4 workers for each retiree, all else equal, by 2040 the retirement age in the U.S. would have to be increased to 71 as shown below.

Alternatively, if the social security wage base of $118,500 (amount of wages subject to social security taxes) were increased then the retirement age would not have to increase as much.

U.S. Projected Retirement Age to Stabilize Social Security

 

Source: Research Affiliates, LLC

Greater Demand for Bonds

Demographic changes affect the demand for bonds in two ways:

•       An older population has greater demand for income and buys more bonds
•       An economy beset by slow growth and low inflation is a more favorable environment for bond rather than stock investments

We are already seeing this. 

The global bond market now totals approximately $35 trillion.  Today about 40% of global bonds offer negative yields – yet the buying goes on. 

As people buy more bonds their prices are pushed up and yields pushed down.  This results in low bond returns and a misallocation of funds to stocks. 

This chart shows the expected future returns from bonds, adjusted for inflation, to be less than 1%.

 

 

                                    Source: Research Affiliates, LLC