We heard an interesting presentation this week about the impact of global demographic shifts, by Dean Stewart, an executive at Macquarie. In a nutshell, ageing populations in the developed world and China will affect global investment trends as more people retire to spend their savings in a slower growth world. Though this is not news, Dean’s view on how it may impact markets is interesting. In particular, he expects an ageing population to lead to inflation – more on this later.
Demographic change is behind the prolonged Japanese recession, European recession, post GFC consumer debt repayment, successively lower cash rate cycles for diminishing stimulatory effect, disinflation, asset price inflation and the timing of all these. So, investors could benefit from understanding all this. Even in the next 5 years, demographics will begin to influence investment market behaviour. So, what do demographics tell us about what’s in store?
As we age, our buying behaviour changes, creating investment opportunity or leaving disappointment in its wake. The post ‘46 baby boom children effect is now flattening out into an older, smoother population profile. Global population growth is also slowing – women now have 2.5 children compared with 6 in the 20th Century. Countries with shrinking workforces have experienced economic hardship. Japan’s population began shrinking in the 1990s and China’s and Europe’s will soon begin to shrink. The US and Australia will still grow but more slowly. The graph below shows China’s labour force should soon start shrinking, which has implications for Australia’s exports there. The US and Australia follow a similar path to the ‘world’ orange line – immigration helps us.
Source: United Nations, November 2014.
Demographics suggest Europe and China will soon face tougher economic change than even Japan experienced when its population started shrinking in the 1990s. Less people in the workforce will affect production while reducing unemployment. As we tend to consume most around ages 35-60, the ageing profile means we can expect slower production and consumption ahead. The mix of these may also change – more on that below.
Dean believes an ageing population may lead to inflation… it does seem perverse that in a world of slow economic growth we could still expect inflation. But a shrinking workforce slows productive capacity (supply) and if this change occurs faster than a declining consumption (demand) as expected, then the laws of supply/demand may trigger inflationary pressures. Retiring baby boomers will no longer produce goods or services, so the supply side stops almost completely for that age group. But of course their consumption will continue – hence the changing mix.
The above graph shows the typical production and consumption patterns against age. The gap between the two graphs to retirement age is savings and after that it’s reversed as savings are drawn down.
As a larger proportion of people leave the workforce, they’ll need to start selling down their assets to fund their needs – an extra downforce on property and share prices. This is compounded by reversing the wave of money that has till now been flowing into superannuation as baby boomers approach retirement. Once retired, they’ll start drawing on this money in greater numbers – a change in direction we may soon begin to see. Demand for new housing will slow and we could expect movement from family sized to retiree-sized houses.
Some things may influence these demographic predictions. An obvious one is people delaying their retirement with improved health and more light-labour jobs. Another is technological change, though this has been with us for many decades now.
For equities (shares), labour intensive activity will be disrupted. Innovation, automation and telecoms should prosper and infrastructure too when inflation picks up again. While healthcare for the ageing may boom, slower population growth means total healthcare spending has already peaked and will decline.
For bonds, sustained low interest rates with volatile patches can be expected – but when inflation returns, bonds won’t keep up – so ‘real’ interest rates may become negative. In 5-10 years, housing investment is likely to begin being depressed by the demographic slowdown.
The emerging economies, particularly Latin America and India, will have younger populations and should experience upside from these demographic changes with growing productive capacity (supply). Wealth will transfer somewhat from the old, richer economies to the poorer, developing ones with the use of cheaper labour off shore.
So, what’s an investor to do?
We believe a continued focus on quality companies in long-term growth sectors and regions will be critical. The ‘index’ (broader market) may grow slowly but there will be growth sectors and regions. It’s important to not lose sight of the bigger picture (simple but not easy) – more than ever it’s important to be clear about your investment time-frame and objectives, and then seek to invest dispassionately, with rigor and discipline.
Source: Demographic Impacts Today – Dean Stewart, Executive Director, Macquarie Investment Management, April 2015