Saturday, February 18, 2017

Demographic trends are a long-term challenge for markets


Capital markets have experienced a shift in sentiment over the course of the past couple of months. Fears over secular stagnation and deflation have dissipated and investors have been willing to embrace risk assets again. Many economists have revised upwards their estimates of global economic growth, starting first with the US where the fiscal reigns are expected to be loosened in order to meet some of President Donald Trump’s election promises to voters. While there is clear short-term momentum in economies like the US and UK, where unemployment rates are low and consumption is robust, there remain secular themes that investors should be aware of when they formulate long-term investment decisions. One of these themes is a shift in the focus of economic policy, driven by demographics. Unlike economic variables, demographic trends are predictable and greatly impact on all of us. The global economy has now passed an important tipping point. For the first time in recorded history, children under the age of five no longer outnumber those aged 65 and above. We have arrived at “peak child”. The United Nations has estimated that the global population will continue to age and, by 2050, more than 15 per cent of the global population will be aged over 65. Economists often point to the challenges that Japan faces as the population ages; by 2050, most of the G7 will have a similar demographic profile as Japan does today, as will China, Brazil and Russia. Longevity risk — the risk that people live longer than expected — could put huge pressure on our current retirement systems. Research from Bank of America Merrill Lynch suggests that age-related spending accounts for 40 per cent of government spending in developed markets and as high as 55 per cent for the US. In order to meet the challenges presented by an ageing society, we will need to work longer and think about policies and initiatives that incentivise people to work past the traditional retirement age. If these issues aren’t addressed, increasing old-age dependency ratios could have wide-ranging impacts on government finances, productivity rates and inequality. In a world where immigration policy reform is increasingly dominating political agendas, policymakers should recognise that gross domestic product largely reflects a demographic profile where more workers enter the workforce, who (if everything goes to plan) will then produce, earn and consume more than the previous quarter. Naturally, as the workforce shrinks due to ageing, the reverse will be true. However, it does not necessarily mean that an economy is underperforming if the trend rate of growth is falling to reflect a smaller workforce. The changing demographic trend that the developed and parts of the emerging world are now experiencing will increasingly act as a headwind to global GDP. China in particular, which has driven global growth post-crisis, will probably slow markedly in coming years from historic growth rates. In the future, it will be important for policymakers to look beyond GDP as a measure of economic success, in favour of alternative measures which look at economic wellbeing. While it is easy to focus on near-term tactical shifts in markets, it is increasingly important to focus on long-term secular trends that are reshaping the economies that we live in. Higher rates of GDP are not necessarily the answer to face the challenge of an ageing population. Individuals, companies and governments will have to adapt to these challenges, and we may find that in the future we see a greater focus on intergenerational fairness and living standards than has historically been the case. Of course, the effects of ageing will have far-reaching impacts on financial markets. Ageing societies will usher in an era of saving, which should provide a tailwind for companies that help people plan, invest and save for retirement. Fixed income and dividend-paying equities will probably benefit in this environment given both asset classes provide a regular income for retirees to use. Additionally, the structural demand for longer-dated bonds from insurers and pension funds may limit the extent to which bond yields can rise in the future.

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