23, 2012 6:01 pm
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The population conundrum
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By Norma Cohen, Demography Correspondent
They were the decades that gave us Gordon Gekko and the Big Bang. The 1980s and 1990s were the boom years for stock-market investors, with globalisation, deregulation and rising productivity driving double-digit market returns.
Yet, just as the financial crisis has unravelled previous assumptions about free market economics, an FT analysis shows that perhaps the most significant driver of those equity returns was something else entirely: demography.
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The 1982-1999 bull market was driven by the post-war baby boom, which resulted in a bulge in the numbers of working-age adults and the core savings group.
That has ominous implications. Facing current trends in birth rates and rising life expectancy, a growing body of economic research suggests that the rates of stockmarket growth enjoyed by investors during the 1980s and 1990s are gone for at least a generation - and possibly forever.
But another factor was at work, too: demography. The 1982-1999 bull market was driven by the post-war baby boom, which resulted in a bulge in the numbers of working-age adults. Those adults are now retiring, having spent too much time working and not enough time procreating.
Falling birth rates and rising life expectancy have left the industrialised world with a demographic profile very different from that of the 1950s. There is a growing body of evidence to suggest that sharply ageing populations will weigh on both economic growth and asset values for years, if not decades to come.
A growing body of economic research suggests that the rates of stockmarket growth enjoyed by investors during the 1980s and 1990s are gone for at least a generation, and possibly forever.
Such high returns were frequently attributed at the time to factors such as globalisation, deregulation, rising productivity through the widespread use of technology and the taming of inflation. All were important. But there was another far more significant factor at work: demography.
Demography is also the key to understanding why such times may never return. In the last four decades of the 20th century, there was an unprecedented rise in life expectancies and a concurrent drop in birth rates. This has left the industrialised world with a demographic profile very different from that of the 1950s. There is a growing body of evidence to suggest that sharply ageing populations will weigh on both economic growth and asset values for years, if not decades to come.
Populations in most of the major industrialised nations are ageing rapidly, which means the numbers of those saving for retirement – generally the ones investing in equities – are a diminishing percentage of investors as the baby boom generation grows old. As those boomers – people born in the years immediately after the end of the second world war – grow older, their investment preferences tend to favour safer assets such as bonds. This demographic pressure follows a regulatory drive to push banks and insurance companies into “safer” assets and is driving yields on those assets ever lower, the research suggests.
The shift from a predominance of younger workers to a growing number of older and much longer-lived adults is confronting policymakers with increasingly unpalatable choices about how to pay for pensions and healthcare in economies where workers simply cannot provide enough tax revenue to maintain decent standards for those too old to work.
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The figures are stark. The percentage of the UK population that is 65 and older rose from 15 per cent in 1985 to 17 per cent in 2010, and would have been much larger had it not been for a surge of working-age migrants over the past decade. Even allowing for that, by 2035 those over the age of 65 will be nearly a quarter of the total UK population.
Nor can the asset markets save us from the inevitability of more old folk. The double-digit rates of return that today’s baby boomers have come to think of as “normal” may already be beyond reach of those who will come after them. This trend has enormous implications for the millions about to begin pension saving for the first time through auto-enrolment.
Purple patch
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“The 1980s and the 1990s have to be regarded as an anomaly,” said Michael Gavin, managing director and economist at Barclays Capital. Gavin works on the bank’s annual Equity-Gilt study, which highlights the role that rapidly shifting populations have on investment markets. “It is very hard to see how you get a replay.”
Data from the 2010 edition of the Equity-Gilt study, and updated to 2012, shows a clear correlation between the percentage of the UK population aged 35 to 54 – considered a prime age group for pension savings – as a percentage of the total population and that of price/earnings (p/e) ratios of UK equities.
The p/e ratio measures what investors are prepared to pay for companies’ past or future earnings, and so acts as a proxy for supply and demand. A higher p/e suggests demand is greater than supply, pushing prices – the numerator in the ratio – higher.
In 1982, as the last great equity bull market was beginning, this age group accounted for 22 per cent of the population and the cyclically adjusted p/e ratio – which attempts to smooth out the effects of the economic cycle – averaged 8.5 times.
By 1999, the p/e ratio had soared to a record 44.2 times earnings. The conventional explanation for this is that the boom in technology and media shares massively distorted the market, enough to overpower the smoothing effect of the cyclical adjustment.
But there is an alternative explanation: the proportion of 35-54 year-olds had soared to 29 per cent of the UK population. It continued to rise marginally for a few years, while p/e ratios subsided.
Come 2012, the 35 to 54 age group had eased back to 27 per cent of the population, and p/e ratios fell back to 21.4 times earnings. This core savings age group is set to fall back to 25 per cent of the population by 2018, a smaller percentage than it has been at any time since 1989 – and their real incomes are being relentlessly squeezed by stagnant growth and above-target inflation.
An international issue
Nor are Britain’s stock markets likely to be unique in this respect, economists say. Indeed, much of the research about the link between stock price performance and demography has focused on the US, a nation with similar population trends to those of the UK.
A study in 2011 from the Federal Reserve Board of San Francisco, entitled “Boomer Retirement: Headwinds for US Equity Markets?,” studied US stock market performance from 1954 to 2004, a period long enough to be statistically robust. In particular, it looked at the ratio of those in their peak “saving for retirement” years to the number of those who are around retirement age.
Mark Speigel, an economist at the San Francisco Fed and co-author of the report, said the research focused on savers aged 40-49 because workers younger than that are assumed to be saving for housing, not retirement, and will not be investing for the long term. What the research showed, he said, is that although it is too early to prove that an ageing population causes weaker stock markets, there is clear evidence of a strong correlation. “It is a pattern in the data that seems to have held up for quite a long time,” he said.
“This evidence suggests that US equity values are closely related to the age distribution of the population,” the paper concluded. Moreover, Speigel and his colleague Zheng Liu went on to project how the domestic stock market might perform through until 2024, given what is known now about how the nation’s population will age. The findings don’t make palatable reading; even the p/e ratios seen in 2010 are too generous, the study concluded.
An FT analysis of UK census data that replicated the methodology of the San Francisco Fed research found a similar pattern. Although the percentage of those aged 40 to 49 continued to grow relative to those between 60 and 69 in the early years of the 21st century, by 2007 that trend had reversed. So, too, did p/e ratios on UK equities.
The decline in the UK stock market might have been more precipitous but for two factors: monetary easing by central banks, and inflows from foreign investors snapping up stocks. Foreign investors owned 30.7 per cent of the UK stock market as early as 1998, and over 41 per cent by 2008, according to the Office of National Statistics. Prior to the liberalisation of UK markets in 1986, UK shares were predominantly owned by UK individuals. In the US, foreigners own only 11 per cent of the market.
It would be unwise to count on such support in future, because populations are ageing in much of the rest of the industrialised world too. While those over 65 accounted for 12 per cent of the industrialised world’s population in 1982, that has risen to 16 per cent today and is projected to reach 25 per cent by 2042. The working age population within the European Union is expected to decline by 2060 to 56 per cent of the population, from 67 per cent today.
False hope
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Some look east for salvation, towards the massive pools of surplus saving in Asia, particularly China. But China’s population over 65 is projected to rise from 8 per cent of its population today to about level with that of the rest of the industrialised world by 2042, partly because of the one-child policy that has been in place since the early 1980s. Its working age population is set to peak in 2020 and begin to fall quickly thereafter.
Russ Koesterich, chief strategist at iShares and author of a recent report on demographic change and stock markets, noted that although there may be many other factors that affect stock prices, there is by now a compelling body of evidence that suggests demography is a key driver. “The burden of evidence seems to be fairly clear,” he said. “The mechanisms by which demographics affect growth are fairly common sense. The great bull market in equities has been over for some time.”
Research from iShares found that as US workforce participation rates peaked at the end of the 1990s at over 67 per cent, just as stock market prices peaked. Moreover, as the ratio of those aged 15 and under in the US population declined relative to the number of those aged 65 and over – a ratio which fell steadily between 1981 and 2011, yields on US 10-year Treasuries fell, too.
The reasons why stock prices and bond yields fall as the proportion of older adults in a population rises probably has to do with the relative appetite for risk at different ages, economist say. Indeed, in the UK, the most common “lifestyle” fund for pension savings – and the default investment choice for most employees saving via workplace pension schemes – involves a gradual shift away from equities into bonds as the individual approaches retirement age. Upon retirement, savers buy annuities and insurers who sell these policies buy bonds to make sure they can deliver promised cash payments. That suggests that even if the Bank of England reverses its current easy monetary policy, there will be a natural brake on rates.
In considering the predicament of Japan, Shiri paid tribute to the foresight of Swedish economist and Nobel laureate Gunnar Myrdal, who saw that falling fertility rates posed a threat to economic growth as long ago as the 1930s.
If higher rates of investment return are not going to rescue our retirement systems, what will? Most of the solutions being considered by western governments - later retirement ages, greater compulsion to save, higher taxes - are politically tricky, and will not in any case fully fix the system. The same goes for allowing greater levels of immigration.
Some economists believe that enduring solutions need to be “cradle-to-grave”. They favour policies that maximise each nation’s human capital, as well as relying on longer working lives and higher savings rates, and point to the Swedish social model which encourages women to both have children and pursue careers. In a part of the world with limited immigration and a small population, social policy has acted as a bulwark against the worst effects of demographic drift.
Land of the rising age profile
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If one wanted to look at asset values in the industrialised economy most representative of population ageing, that would be Japan. It has sharply declining fertility rates, net immigration of virtually zero and the longest-lived population of any large economy. Its stock market peaked in the late 1980s – at about the time the size of its working age population did – and has atrophied ever since.
In a recent speech, Sayuri Shiri, a member of the Bank of Japan’s Policy Board, spelt out the challenges of managing an economy with both a shrinking workforce and a shrinking population. Already, those over 65 are nearly a quarter of the population.
Shiri noted that stock prices are not the only affected asset class, pointing out that the bursting of Japan’s real-estate bubble also coincided with the peak in the working age population. Citing earlier economic research that suggests risk premiums rise as a population ages – investors are prepared to pay less when they are asked to take more risk – he pointed to the excessive cash holdings of Japanese savers.
“Despite nearly zero-interest rates, the share of deposits (and cash) accounts for about half of total assets,” which, in Japan, amount to about $19tn. “As they become older, they (households) may gradually shift their financial asset allocation toward life insurance and securities, setting aside housing investment.”
As they age even further, he noted, households with financial resources tilt even more heavily towards “safe” assets, such as deposits and bonds. “This makes sense since elderly people are more concerned about the the stability of the valuation of their financial assets and thus tend to be more risk-averse than younger people,” he said.
Copyright The Financial Times Limited 2012.
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