Putting demographics into decision-making
Paris - A forecast calling for a bull market in Japanese equities until 2016, the end to a devastating bear market in the United States in 2015, ideal investment conditions in Brazil until 2024 and India through 2042, an imminent Singapore disaster this year - all might be thought of as preposterous or sensationalistic.
But two demographic metrics that have nailed the macro moves in Japan and the United States for the past 50 years suggest we should not dismiss such possibilities.
Forecasts usually fail because they try to guess the future path of markets by building fundamental stories and technical models whose inputs are historic prices, correlations and a steady stream of the latest economic numbers. Those are all symptoms of the past, not predictors of the future. Fortunately one very specific historical event, usually the result of unchecked passion, helps us predict the future - babies.
The economic fate of a nation derives largely from its population dynamics. The number of people in a specific age group (or demographic), and the relationship of one demographic to another has an overwhelming influence on whether stock markets, housing prices or long-term interest rates will rise or fall.
We like to think of ourselves as individuals, original and free-thinking, yet we are simply members of a crowd and act in predictable ways as we progress through life. People broadly fit into four demographic categories: Moochers are aged zero to 19 and the moocher balance sheet is perpetually funded by parents. Spenders occupy the years from graduation until 34 and have very little cash for stock market investments. Investors, aged 35 to 49, use their rising income to buy equities and invest for the future. The bond buyers, age 50 onwards, are more focused on preserving their wealth for retirement. Bonds become more attractive than stocks.
Begin with a war, a famine or a repressive regime. These devastating circumstances leave a dearth of babies and increase the pent-up demand for future babies. It's a classic inventory drawdown, which leads to increased future production.
The next batch of ingredients involves any combination of peace, bountiful harvests, benevolent regimes and improved sanitation. All lead to high fertility rates and a baby boom.
A baby boom, followed by a rapid decrease in fertility sets the stage for a stock market boom approximately 35 years into the future.
In 1955 there were just 14 million Japanese in the investor demographic, and for every 100 spenders there were a mere 65 investors. By 1983 the investor demographic had caught up with the spending demographic and the Nikkei began rising by an average of 60 percent per year. This important ratio peaked at 117 investors for every 100 spenders in 1989. That year also marked the all-time high of the investor demographic at 28.8 million people - double the level 33 years earlier - and, of course, the top of the stock market.
In 1990, Japan accounted for 60 percent of the world's stock market capitalization. Minoru Isutani bought the Pebble Beach Golf Links for $850 million. If you had objectively looked at the prospects for the stock market over the next 13 years (as defined by our two metrics) you would have seen 4.6 million fewer investors and an investor/spender ratio that had dropped from 117 percent to 89 percent. Not surprisingly, 13 years of a falling stock market coincided with 13 years of deteriorating demographics.
A coincident decline in the investor/spender ratio and the number of investors is toxic for equities.
Over the next three years, the Japanese Investor/spender ratio will rise to 138 percent, significantly higher than the 2003 low of 89 percent, and another 2 million cash-rich salary men will join the investor demographic - the result of an echo baby boom from 1967 to 1974. There should be some respite from the sombre mood of two lost decades.
In the United States, both of these metrics have been deteriorating since 2000, but will slowly begin to improve in 2016. By 2020 the stock market should accelerate rapidly and remain a good place to invest until 2028. As with Japan, the 2020 US equity surge will be a function of an echo baby boom.
One final Japanese enigma has been the government's ability to borrow 10-year money at less than 2 percent since 1999, despite racking up one of the highest global debt-to-GDP ratios. Economists instruct us that a critical factor in maintaining a high debt/low interest rate regime is the ability to domestically finance the debt. The ratio that best forecasts the ability to service debt is the bond buyeriInvestor ratio (the number of bond buyers aged over 50 relative to the 35 to 49 investor category).
A bond-buyer-to-investor ratio of 120 percent appears to usher in an era of easily serviceable debt, and a relative preference for bonds over equities. Japan crossed this hurdle in 1990 when 10-year interest rates were 8 percent. The US bond buyer/investor ratio reached 120 percent for the first time in 2007 (5 percent 10-year yields) and will surpass 150 percent in 2013. For a bit of emerging market perspective, Indians will not demand a liquid government bond market until 2036, Brazilians will favor domestic government bonds over equities in 2026, but China will be in desperate need of safe income-generating retirement investments in just seven years.
Financial forecasting is all about estimating future demand and supply for assets or liabilities. By looking at the future size of the investor demographic and by using the investor/spender ratio to estimate the demand/supply for stocks, we can make investment decisions based on objective parameters.
China Daily
(China Daily 03/07/2011 page14)
