The Demographic Wave

The following animation (from Calculated Risk, using Census Bureau data), which updates every second, shows the wave of demographic changes from 1900-2060.

PopDist

The additional numbers of older Americans (and thus retirees and, by implication, the need for better retirement saving and planning) going forward — as the Baby Boomer generation retires — should be obvious.

What Will 2030 Look Like?

The National Intelligence Council is composed of the 17 U.S. government intelligence agencies.  The Council’s Global Trends Report has, since 1997, worked with a variety of experts both in and out of government service to examine factors such as globalization, demography and the environment to produce a forward-looking document to aid policymakers in their long-term planning on key issues of worldwide importance. 

“We are at a critical juncture in human history, which could lead to widely contrasting futures,” wrote Christopher Kojm, the Council’s Chair, in his introduction to the current Report, published just this week.

The Report is intended to stimulate thinking about the rapid and vast geopolitical changes characterizing the world today and possible global trajectories over the next 15 years. Significantly, it does not seek to predict the future – we have a dreadful track record in the regard – but instead it seeks to provide a framework for thinking about possible futures and their implications.

The Report argues that the breadth of global change we are facing today is comparable to that during and surrounding the French Revolution and the rise of the Industrial Age in the late 18th century, but it is being realized at a much faster rate. While it took Britain more than 150 years to double its per capita income, India and China are set to undergo the same level of growth in a tenth of the time, with 100 times more people.

I encourage all investors to read it carefully.  Despite the vital importance of the “long cycle,” it isn’t likely to change your current portfolio outlook, but it will provide a helpful backdrop to your overall thinking and to your longer-term outlook and analysis.

Among the Report’s conclusions is that there are certain “megatrends” that are relative certainties and that we should prepare to deal with them.  These include the following (and note that all have investment implications, some of them potentially enormous).

  • For the first time in history, a majority of the world’s population will no longer live in poverty by 2030, leading to a healthier global population and a major expansion of the middle classes in most countries.
  • Life expectancies will continue to expand rapidly.  “Aging” countries (such as those in the West – particularly Europe – and Japan) face the possibility of a significant decline in economic growth.
  • Asia is set to surpass North America and Europe in global economic power, but there will not be any hegemonic power.
  • Demand for resources will increase owing to global population growth from 7.1 billion people today to about 8 billion by 2030.
  • Demand for food is likely to rise by 35 percent and energy by 50 percent over the next 15-20 years.
  • Nearly half of the world’s population will live in areas with severe water stress by 2030.  Fragile states are most at risk, but China and India are vulnerable to volatility of key resources.

These megatrends will inevitably lead to a variety of vexing and potentially “game-changing” questions.  Each has profound political, economic, market and human implications.

  1. Will divergences and increased economic volatility result in more global breakdown or will the development of multiple growth centers lead to increased resiliency?  For much of the West, the challenges involve sustaining growth in the face of rapidly aging populations. For China and India, the main challenge will be to avoid “middle income traps.” In general, the global economy will be increasingly crisis-prone and won’t return to pre-2008 growth levels for “at least” the next decade.
  2. Will current governments and international institutions be able to adapt fast enough to harness and channel change instead of being overwhelmed by it?  While this sounds generally like the investment challenge we face daily, there are a variety of major global issues in this regard.  Potentially (more) serious government deficits driven by rapid political and social changes are likely to exist. Countries moving from autocracy to democracy are often unstable and about 50 emerging market countries fall into this major risk group.  All of them could – at least potentially – grow out of their governance incongruities by 2030 if economic advances continue.
  3. Will rapid changes and shifts in power lead to conflicts?  The general answer is surely duh, with uncertainty only as to the number, extent and nature of the conflicts.  Limited natural resources—such as water and arable land—in many of the same countries that will have disproportionate levels of young men—particularly in Sub-Saharan Africa, South Asia, and parts of the Middle East—increase the risk of intrastate conflict.  It is particularly troubling to note that any future wars in (at least) Asia and the Middle East may well include a nuclear element. Many of these conflicts, once begun, would not be easily containable and would (obviously) have global impacts.
  4. Will regional instability, especially in the Middle East and South Asia, spill over and create global insecurity?  See the commentary re #3 above.  Wash; rinse; repeat.
  5. Will technological breakthroughs occur in time to solve the problems caused by rapid urbanization, strains on natural resources, and climate change?  The report identifies 16 key “disruptive” technologies with potential global significance out to 2030. They are generally grouped around potential energy breakthroughs, food- and water-related innovations, big data and the forecasting of human behavior, and the enhancement of human mental and physical capabilities, including anti-aging.
  6. Will the United States, as the leading actor on the world stage today, be able to reinvent the international system, carving out potential new roles in an expanded world order?  The Report anticipates that the U.S. will likely remain primus inter pares (first among equals) among the other great powers in 2030 because of the multifaceted nature of its power and legacies of its leadership.  But it also expects that the “unipolar moment” is over. Overall, power will likely shift to networks and coalitions in a multipolar world. The United States’ (and the West’s) relative decline is seen as inevitable but its future role in the international system is much harder to project. China is deemed unlikely to replace the U.S. as international leader by 2030.  Non-state actors and even individuals, empowered by new media and technology, will be an increasing threat.  A reinvigorated U.S. economy – spurred perhaps by U.S. energy independence – could increase the prospects that the growing global and regional challenges would be addressed. However, if the U.S. fails to rebound, a dangerous global power vacuum would be created.

From these building blocks and issues, the Report posits potential  futures including a best-case scenario of increased cooperation between the U.S., China and Europe as economic and security interests increasingly align, a worst case scenario of conflict and fragmentation in a stalled global economy where political, social and economic inequalities work against integration and stability, and a scenario involving a “nonstate world,” where the nation-state does not disappear, but countries increasingly organize and orchestrate “hybrid” coalitions of state and nonstate actors which shift depending on the issue.

There is no earth-shaking news here.  But it is helpful to take a step back and look at the bigger picture once in a while.  Because change is so often incremental, it is easy to underestimate how quickly it can happen and how much impact it can have in the aggregate.  In the markets as in life, caveat emptor.

Demography as Destiny

Josh Brown had an interesting post yesterday based upon a report from Tobias Levkovich of Citi (Bloomberg story here) focusing on the anticipated boom in 35- to 39-year-olds — those in their key “savings years.” This age group is said to be poised to increase for the next 17 years. Saving and investing by these echo boomers “would generate a new set of equity fund inflows,” Levkovich claims. Levkovich expects the S&P 500 to rise to 1,615 in 2013, about 50 points higher than the index’s October 2007 record and about 12 percent above current levels. Besides demographics, he argues that expansion in U.S. manufacturing, energy, mobile technology and housing and efforts to curb federal budget deficits will combine to drive stocks higher.  He also sees valuations as attractive.

Obviously, Levkovich is generally paid to be bullish, so his forecast needs to be considered in that light.  But still, I hope he’s right.  However, I’m not sold on the growing strength of the economy, anything other than ongoing governmental dysfunction (see here and here, for example) or attractive valuations — even though I could easily be wrong.  I’m also skeptical of his view of the demographics.

The ongoing demography as destiny argument is a fascinating one. A useful paper called Demography and the Long-Run Predictability of the Stock Market back in 2002 argued that P/E ratios are correlated to the ratio of middle-aged people to young adults (the “MY ratio”). When MY rises, the market P/E will tend to rise and when it falls, P/Es tend to fall.  This study claimed that we should see a continued fall in P/E ratios from then (2002) through and until a long-term bottom in stock prices forming about 2018.  So by that measure, Levkovich is about five years early.  It may be hard to imagine a Wall Street analyst being too bullish too soon, but there you go.

On the other hand, a report on Boomer retirement and demand for stocks by researchers from the Federal Reserve Bank of San Francisco got a fair amount of play about a year ago and came to a different conclusion. The full report is available here. They see a strong relationship between the age distribution of the U.S. population and stock market performance too. But they see the aging of the baby boom generation as the key demographic. As Boomers reach retirement age, they are seen as likely to shift from buying stocks to selling their equity holdings to finance retirement. They report that their statistical models suggest that this shift could be a factor holding down equity valuations over the next two decades. 

A helpful discussion of the methodological differences between the papers cited above by Cam Hui is available here.  Hui’s analysis also carefully notes that the differences between the respective findings are not all that great.  The San Francisco Fed researchers concluded that stock prices will bottom in 2021, instead of 2018 as implied by the other paper cited above.   That’s not much more than a rounding error for this types of analysis.

On the other hand (although, like Tevye in Fiddler on the Roof, there is no other hand), a Congressional Budget Office background paper published in 2009 comes to a different conclusion from that offered by the San Francisco Fed researchers.   The CBO paper argues that Boomers won’t sell assets very rapidly to finance retirement on account of several factors.

  1. Boomers will be careful — they are concerned that they might live longer than expected or might face higher than anticipated medical costs.
  2. Boomers desire to transfer assets to the next generation, which should also blunt asset sales.
  3. Since the wealthiest one percent of Americans own about one-third of the nation’s financial assets and, for the most part, the very wealthy don’t sell assets to finance retirement, this asset concentration will help to keep demand steady.
  4. Many Boomers may work longer than they otherwise would have due to losses of retirement assets due to the 2008-09 financial crisis (but the empirical evidence on this point is inconclusive and the impact might be small).

Wharton’s Jeremy Siegel, author of Stocks for the Long Run, says (unsurprisingly) that growth in developing countries should generate enough demand to absorb a baby-boomer selloff and “keep stock prices high.”

The CBO conclusion may be the key one in this context.

Although the retirement of the baby boomers is not likely to cause a large decline in aggregate demand for assets, several economic studies suggest that the retirement and aging of baby boomers could cause a temporary decrease in asset prices. … Empirical evidence, however, has not revealed much connection between demographic trends and the changes observed in financial markets.

Demographics surely matter. Correlations are important (even if distinctly different from causation). But so do lots of other things — like (duh) the strength of the economy or lack thereof and market valuations.  The market did not tank in 2000 on account of demographics and demographics isn’t controlling the nature and extent of this secular bear market even if and as it is a noteworthy factor.  Demographic trends are interesting, useful and important for the markets.  But there is no evidence that demographics is destiny.

More on the Retirement Crisis

A common recommendation for aging Boomers trying to manage the “retirement crisis” of difficult markets, inadequate savings, expanding life expectancies, fewer pensions and generally poor retirement prospects is to work longer and to delay taking Social Security benefits.  Unfortunately, as The Wall Street Journal reports today, doing so may be much easier said than done.

More than four million Americans aged 55 to 64 can’t find full-time work and that number has nearly doubled in five years, according to recent U.S. Department of Labor figures. This group without full-time work now accounts for more than one in six older Americans seeking positions.

Older people also have more trouble finding new jobs. Among unemployed workers older than 55, more than half have been looking for more than two years, compared with 31% of younger workers. Among older workers who found a new job, 72% took a pay cut, often a big one.

This “news” isn’t really new, but it’s awful nonetheless — especially because it offers no easy solution.

Open Questions re the Longevity Crisis

I wrote earlier today about yesterday’s new report from the Census Bureau about the explosive growth seen in the number of people aged 90 and above in the United States.  There has been a fair amount of conjecture over the past several months about what demographic change will mean for the markets, but there is nothing like consensus on the subject. 

According to researchers from the Federal Reserve Bank of San Francisco, historical data indicate a strong relationship between the age distribution of the U.S. population and stock market performance. Obviously, the aging of the baby boom generation is a key demographic trend. As they reach retirement age, they may shift from buying stocks to selling their equity holdings to finance retirement. Statistical models described in the report suggest that this shift could be a factor holding down equity valuations over the next two decades. Rob Arnott describes the “3-D” risks (debt, deficits and demographics) very well here

On the other hand, Wharton’s Jeremy Siegel, author of Stocks for the Long Run, says that growth in developing countries should generate enough demand to absorb a baby-boomer selloff and “keep stock prices high.”  A Congressional Budget Office background paper published in 2009 supports Siegel’s view, arguing that Boomers won’t sell assets very rapidly to finance retirement on account of several factors.

  1. Boomers will be careful — they are concerned that they might live longer than expected or might face higher than anticipated medical costs.
  2. Boomers desire to transfer assets to the next generation, which should also blunt asset sales.
  3. Since the wealthiest one percent of Americans own about one-third of the nation’s financial assets and, for the most part, the very wealthy don’t sell assets to finance retirement, this asset concentration will help to keep demand steady.
  4. Many Boomers may work longer than they otherwise would have due to losses of retirement assets due to the 2008-09 financial crisis (but the empirical evidence on this point is inconclusive and the impact might be small).

The CBO conclusion:

“Although the retirement of the baby boomers is not likely to cause a large decline in aggregate demand for assets, several economic studies suggest that the retirement and aging of baby boomers could cause a temporary decrease in asset prices. … Empirical evidence, however, has not revealed much connection between demographic trends and the changes observed in financial markets.”

Moreover, some observers have questioned whether longevity will continue to increase in this country at historical rates on account of the <pun warning> expanding obesity problem. Life expectancy growth overall may mask wide local disparities, according to a recent study. Men in Holmes County, Mississippi, for example, have a life expectancy of 65.9 years, the same as men in Pakistan and 15.2 years behind men in Fairfax, Virginia. Gaps between America’s counties have widened since the early 1980s. Most alarming, 702 counties, or 30% of those studied, saw a statistically significant decline in life expectancy for women from 2000 to 2007; 251 counties saw a statistically significant decline for men.

Moreover, America’s advances on the national level have lagged behind those of other developed countries. A panel at the National Research Council recently reported that for American women, a rise in life expectancy of 3.3 years from 1980 to 2007 amounted to just 60% of the gains in other rich countries.  The question is why these trends have developed.  Some have suggested that obesity is capping life expectancies.  For example, this paper contends that obesity threatens progress in life expectancy. However, Australia has bulging waistlines much like America and its life expectancies continue to grow nicely. 

Since we know that U.S. lifespans have been limited by smoking and that tobacco use has been reduced dramatically, it is unclear whether these life expectancy disparities will continue going forward.  James Vaupel, director of Duke University’s Population Research Institute, is skeptical of the argument that obesity may reverse future progress in life expectancy. More worrying, he says, is that rising obesity will lead to higher levels of disability.

Accordingly, further study will be needed to ascertain what the markets will look like as the American population ages and even the extent to which longevity will continue to increase.  Open questions remain.

Boomer Retirement Redux: Headwinds for U.S. Equity Markets?

A report on Boomer retirement and demand for stocks by researchers from the Federal Reserve Bank of San Francisco got a fair amount of play recently. The full report is available here. I noted it here. The report showed that historical data indicate a strong relationship between the age distribution of the U.S. population and stock market performance. Obviously, a key demographic trend is the aging of the baby boom generation. As they reach retirement age, the authors argue that Boomers are likely to shift from buying stocks to selling their equity holdings to finance retirement. Their statistical models suggest that this shift could be a factor holding down equity valuations over the next two decades. 

This report isn’t the first such claim.  Analysts have speculated about how the retirement of the Boomer generation will affect demand for financial assets for years now. However, reporting on the piece neglected a Congressional Budget Office background paper published in 2009 which comes to a different conclusion.   The CBO paper argues that Boomers won’t sell assets very rapidly to finance retirement on account of several factors.

  1. Boomers will be careful — they are concerned that they might live longer than expected or might face higher than anticipated medical costs.
  2. Boomers desire to transfer assets to the next generation, which should also blunt asset sales.
  3. Since the wealthiest one percent of Americans own about one-third of the nation’s financial assets and, for the most part, the very wealthy don’t sell assets to finance retirement, this asset concentration will help to keep demand steady.
  4. Many Boomers may work longer than they otherwise would have due to losses of retirement assets due to the 2008-09 financial crisis (but the empirical evidence on this point is inconclusive and the impact might be small).

The CBO conclusion:

“Although the retirement of the baby boomers is not likely to cause a large decline in aggregate demand for assets, several economic studies suggest that the retirement and aging of baby boomers could cause a temporary decrease in asset prices. … Empirical evidence, however, has not revealed much connection between demographic trends and the changes observed in financial markets.”

Boomer Retirement: Headwinds for U.S. Equity Markets?

According to researchers from the Federal Reserve Bank of San Francisco, historical data indicate a strong relationship between the age distribution of the U.S. population and stock market performance. A key demographic trend is the aging of the baby boom generation. As they reach retirement age, they are likely to shift from buying stocks to selling their equity holdings to finance retirement. Statistical models suggest that this shift could be a factor holding down equity valuations over the next two decades.  On the other hand, Wharton’s Jeremy Siegel, author of Stocks for the Long Run, says that growth in developing countries should generate enough demand to absorb a baby-boomer selloff and “keep stock prices high.”

The full report is available here; some interesting analysis essentially supporting the report is here.  Further analysis is available here.