Demographics, Debt And Asset Prices

Over the next two decades, China’s working age population, 15- to 64-year-olds, is likely to shrink at 0.6%, exactly the same rate as the eurozone’s. “China is on course to replace Japan as the world’s largest nursing home,” observes economist and market strategist Ed Yardeni. America’s demographic picture is superior, since its fertility rate virtually equals its population replacement rate.

Still, the implications for the global economy are far-reaching. As longevity makes demographic profiles everywhere more geriatric, it puts pressure on governments “to borrow more and accumulate more debt to provide retirement support programs” for their rapidly expanding base of senior citizens, Yardeni says That can exert deleterious effects on traditional economic policy instruments like debt-financed government spending and tax cuts. In the 20th century, both were seen as stimulative for the economy. “That no longer seems to be the case,” Yardeni concludes.

At some point as people age out of the workforce, deteriorating demographics inevitably should collide with increased demand for spending on services for those same individuals. Tax revenues, unfortunately, are likely to be curtailed, Sheets projects. As younger workers watch government services “increasingly being skewed to the old,” upcoming generations might become a force for austerity.

What can prevent a clash of generations? Keeping older citizens in the workforce is one option. The Bureau of Labor Statistics expects the 65- to 74-year-old age group to be the fastest-growing in the next decade.

The longer people work, the less pressure they face to liquidate their lifetime wealth, easing downward pressure on asset prices. Sheets says extended career longevity is already occurring in the U.S. and Japan, though not in Europe.

When it comes to asset prices, older investors tend to become more risk-averse. Theoretically, this should contribute to lower yields.

Miniscule interest rates can also keep equity prices elevated, even if corporate profit growth is muted. Sheets contrasts the earnings yield on stocks (the price-to-earnings ratio reversed) with bond yields. If the S&P 500 is selling at 19 times, it translates into an earnings yield of about 5.2%. Since equities are a long-duration asset, the 10-year Treasury is the appropriate comparison. The difference between 5.2% and 1.7%, or 3.5%, is a proxy for the equity risk premium.

Whether that justifies today’s stock prices is anyone’s guess. What is clear is that smart minds don’t believe the recent drop in Treasury yields is an aberration. Rosenberg believes yields on the 10-year bond could fall below 1.0% “before all is said and done.” Tipp, the 2017 Morningstar bond fund manager of the year, believes they will fluctuate around 1.5%. That could make dividend-paying equities a reasonable alternative.           

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