How Will Changing Demographics Impact Global Markets?
The Ratio Between Workers and Non-Workers
Demographic trends have a big impact on the global economy. Young populations can experience a demographic dividend stemming from an influx of new workers into the workforce, while aging populations may be a demographic time-bomb that threatens a country’s economic growth and the sustainability of social programs. Most investors are aware of these demographic risks, but they aren’t always as black and white as they seem.
Decline in Working Age Population
Economic growth is driven by a combination of labor and technology. Workers are needed to provide products and services, while technology can help increase the efficiency of producing those products and services. For example, industrial production is driven, in part, by the volume of products produced and sold in factories. Technology has helped reduce the number of workers needed, but workers are still required to run the operation.
Technology has amplified the efficiency of each worker, but there is little doubt that there will be fewer workers over the coming decades. Fertility rates have fallen across the developed world and there are no signs of a change in trend. The percentage of workers supporting the overall population is expected to fall from around 65 percent in 2010 to nearly 50 percent by 2060, which could have a negative impact on economic growth.
These demographic trends could threaten the sustainability of social programs. For example, in the United States, the Social Security Administration estimates that the trust fund will be exhausted by the year 2040. The only way to keep the system solvent would be to reduce retirement benefits or increase Social Security taxes.
Both of these options would be politically difficult to implement, which is why politicians have largely avoided addressing the issue.
How It Could Impact the Market
The decline in the working age population has many economists worried about a looming disaster for growth and sustainability. In Japan, the ratio of workers to non-workers fell about 25 years ago and contributed to what’s became known as the Lost Decade. The country’s economic growth has stalled, inflation has been near zero, and the burden of social programs has led to the highest debt-to-gross domestic product ratio in the developed world.
On the other hand, some economists believe that real interest rates may actually rise as the ratio of workers to non-workers shrinks. They argue that, as labor becomes scarcer, companies will increase their investment in technologies that enhance productivity and tighter excess capacity will lead to higher inflation. While inflation is generally negative for retirees on fixed incomes, new technologies could simultaneously reduce their costs.
Many new technologies are difficult to see coming in advance. For example, the rise of personal computers in the 1990s and the Internet in the 2000s revolutionized the global economy in ways that few could predict.
The development of artificial intelligence or other technologies could do the same in the late 2000s, reducing the labor needed to achieve economic growth and resolving some of these demographic problems.
Preparing Your Portfolio
There are many different ways that investors can position their portfolio to mitigate these problems over the coming decades, but the most important starting point is diversification. By maintaining a diversified portfolio, whether by sector or country, you can mitigate the risk of any single country’s demographic issues affecting the entire portfolio. The inclusion of frontier and emerging markets can also offset slower growth in developed countries.
There are also several specific implications of an aging population:
- Inflation: Faster inflation could benefit international stocks relative to domestic stocks since most international earnings are driven by the financial sector, which is very sensitive to inflation, while domestic earnings are driven by the technology sector, which is less sensitive to inflation. The opposite is true for deflation.
- Capex: Greater business spending on productivity improvements could translate to opportunities in the technology sector, while stronger wages could improve consumer discretionary companies. The opposite is true if wages are depressed.
- Interest Rates: Higher interest rates could hurt the performance of the utilities and telecom sectors that tend to be sensitive to bond yields. The opposite is true if interest rates move lower, where utilities and telecom sectors could see higher valuations.
Demographic changes have a big impact on the global economy over the long-term, but they aren’t always very predictable. Fortunately, there are some steps that investors can take to ensure that their portfolio is insulated from some of these effects.