Spring 2020 Economic & Investment Outlook

For good reason, the eyes of the world  are focused on the global health crisis.  In many ways, whether work, school, or simple daily activities, life has come to a screeching halt.  As with any acute problem, other issues fade to the background as communities around the world deal with the immediate consequences.

COVID-19 is already having an unprecedented impact on both the economy and financial markets.  Each week, we seem to be breaking another record in terms of market volatility or never-before-seen economic data.  Like most others, we have focused much of our recent communication on analyzing the market impact of the virus, and helping clients navigate this challenging time.

Amid the many unknowns, I think we can confidently say that the current situation is temporary, and that global economies and financial markets will begin to recover as the virus fades and new medical treatments become available.  Let us not forget that in the simplest terms, the value of a stock is the present value of all future company earnings (or cash flows).  Through this lens, even if we lose an entire year of earnings, the discounted value of all future corporate earnings shouldn’t change that much.

Becoming too focused on what is happening today, and what might transpire over the coming months, can be counterproductive within the context of a long-term investment strategy.  Therefore, we are using the following pages to take a step back from current events, instead focusing on a trend that will impact our world for years (if not decades) to come – demography and global populations trends.

Is Demography Truly Destiny?

Have Population Trends Predetermined the Economic Winners and Losers of Tomorrow?


The phrase “demography is destiny” is often attributed to the 19th-century philosopher Auguste Comte, who took a particular interest in the macro effects of population trends.  Comte looked at demographic trends as supportive, noting how demography could impact progress in a rapidly industrializing world.  Today, as we analyze how demographics are likely to impact our future world, the conclusions are far less clear.  In many cases, demographic trends are likely to create challenges, and economic winners and losers may emerge simply based on these irreversible trends.

Throughout the history of humanity, the world population has generally trended higher, exponentially so during the past few centuries. Population decline has seldom been a concern as it relates to economic growth.

The most common measure of a country’s economy – Gross Domestic Product (GDP), or aggregate consumer spending, investment, government spending, and net exports – is highly dependent on population trends[1].  Unfavorable trends in the demographics of a country may have a profound impact on economic growth rates and economic health.

Consider the example of Japan which, a generation ago, appeared poised to dominate the global economy.  Bookstore shelves were crammed with volumes explaining, lauding, or warning about the growing power of “Japan, Inc.!”  What has transpired since has been anything but!  The Nikkei Index of Japanese stocks peaked at 38,915.87¥ in 1989 and since then has returned -38.7% cumulatively.  Similarly, the country’s GDP has declined from $6.20 trillion in 2011 to $4.97 trillion in 2018.[2] While many factors, economic and cultural, have contributed to the contraction of Japan’s economy, population trends may have been the primary driver, as an aging population and declining birth rates took their toll.

China – Another Victim of Demography?

It has been noted that increased affluence tends to negatively impact birth rates, but China, which is facing potentially the worst population crunch of all countries, compounded the issue with its 1979 one-child policy by which the Chinese government mandated couples could only have one child.  In 2013 these controls were relaxed, and in 2016 the government completely abolished the policy…but it may be too little, too late.  In 1979 the fertility rate in China was 2.7 (births per women) and decreased to 1.6 by 2013. The one-child policy also had a significant effect on the population growth rate as seen in the table below.

Population Annual Growth Rate (%)
 1979199020002018Change (1979 to 2018)
United States1.
European Union0.400.330.150.20-0.2

Source: World Bank

Fertility rates and population growth are only part of the story.  In countries with declining fertility rates, immigration can often supplement population growth.  The U.S. and Germany have compensated for their lower fertility rates with immigration, while Japan and China have net zero or even negative immigration.

RankCountryNet Migration Rate 2017
(Migrants/1,000 Population)
29United States3.9

Source: CIA World Factbook

In labor-intensive economies such as China, these population declines can have more significant effects. Data from the International Labour Organization shows China’s GDP per worker at $15,331USD, significantly behind that of the U.S. ($114,003), Germany ($93,548), and Japan ($93,851). While China’s GDP per worker is growing at a significant rate, the economy still needs a substantial contribution of workers (labor) to maintain their GDP growth.  More developed economies have increased efficiency and technology over developing markets and can be less sensitive to labor population changes.  At its simplest, economic growth is the product of two things – the amount of people working and the productivity of those workers.  In the absence of productivity-enhancing investment and technology, an economy will struggle to grow with a shrinking population of workers.

With China’s foreign-born population currently below one-tenth of 1%, and a general hostility toward immigration, it is unlikely this will ever be a viable source of population growth.  So, without recourse to external options, the population decline will continue.

Indeed, the segment of the population most integral to economic growth, the 15-64-year-old demographic, is predicted to drop by 20% by 2050.[3] By 2100 the overall Chinese population will have decreased by 374 million, a decrease larger than the current U.S. population.[4]

From 1979 to 2018 the Young Age-dependency ratio in China (population ages 0-14 divided by population 15-64) decreased by 60%.4   This demographic momentum indicates a significant shift toward an older median age and, accordingly, the U.N. projects that the percentage of the Chinese population over 65 will double, reaching 25% by 2050. This puts stress on a country like China where social programs are significant, and the retirement age is 60 for men and 55 for women: how will the national pension fund, when the working population is shrinking, be able to support the increasingly retired population?  One study indicates the complete draining of the state pension fund by 2035,[5] but officials have no clear plan to increase the retirement age, possibly for fear of political backlash.

Source: https://data.un.org/Data.aspx?q=total+population&d=PopDiv&f=variableID%3a12

China – Demography and Political Stability

The Communist Party’s leadership understands that slower economic growth could have a negative impact on political legitimacy: it’s easier to stay in power when the population is growing more prosperous every year.  After such rapid growth over the last few decades, it is reasonable to assume a significant reduction to that growth, or worse a decline, will not be well received. In President Xi Jingping’s January 2019 “meeting on instability,” the risks associated with a slowing economy were clearly recognized.  To that end, the Belt and Road Initiative[6] has been an attempt to create self-initiated export, import, and labor market expansion.  This is perhaps the most externally visible effort on the part of the Communist Party to shore up China’s economy.  Regardless of the success of such efforts, it seems reasonable to assume that the Communist party will be faced with significant backlash if they are unable to sustain economic growth near current levels… and demographics will make that difficult.

Economic and Financial Market Implications

We believe demographics will have the largest impact on the future level of interest rates and the evolution of global supply chains.

Interest Rates

The “cost of money” may be the most impactful variable in all of finance, so the potential consequences are worth understanding.  All else equal, in countries where demographic trends are more extreme (China), the impact will, of course, be larger.  Depending on the time horizon, the impact on rates is likely to be very different.  In the near/medium-term – say the next 10 years – demographic and policy trends are likely to put downward pressure on interest rates.  Looking out further, empirical evidence shows that eventually, an aging population will put upward pressure on rates.

Forces Pushing Rates Up Over the Long-Term

The conventional wisdom on this topic is straight forward.  People save the most during their working years as they prepare for retirement and other future expenses.  Upon retirement, people begin to spend more as they draw on those savings.  Toward the end of life, spending increases even more as people tend to consume expensive healthcare.  In combination, this increase in consumption (and lower level of savings) puts upward pressure on interest rates.  Especially now, as people are more frequently living to an expensive old age, the argument for higher rates of interest is compelling.  As populations age, labor market dynamics would also suggest upward pressure on interest rates.  When the working-age population of an economy starts to shrink, the supply of labor becomes smaller.  Companies are forced to compete for a smaller pool of workers, putting upward pressure on wages.  Higher wages typically put upward pressure on inflation, and when inflation rises investors demand a higher yield in compensation, so rates rise.  China is a perfect example.  As the “one child” policy works its way through the age cohorts, we see a clear inflection point in the number of prime-age workers (ages 15-64).  Peaking in 2013, this means fewer savers and more spenders in the economy, therefore less appetite for bonds and higher rates of interest.

There is one (potentially very powerful) force that now exists, that could render this theory somewhat less relevant.  In the age of “activist” global central banks buying up billions, if not trillions, of dollars of financial assets, a new buyer of has emerged that is not at all impacted by age or retirement status.  Depending on the level of central bank intervention in the future, the upward pressure on interest rates may be muted.  Although we don’t know how active central banks will be in global bond markets going forward, we feel it is safe to assume that they will be a source of additional demand, somewhat offsetting the demography-driven lack of demand described above.

Forces Keeping Rates Low in the Medium Term

Interestingly, aging populations have not yet put any obvious upward pressure on rates, as interest costs remain at historically low levels around the world—again, central banks may be part of the reason.  Higher rates, encouraged by aging populations, seem to be an unavoidable eventuality; however, current market and policy dynamics may delay this for some time.  There is a political element to this, stemming from programs like Medicare, pensions, social security, and other equivalent programs throughout the world.  These assistance programs allow aging individuals to stop working, helping provide financial assistance in retirement.  As entitlement programs become increasingly stressed, it is not unreasonable to assume later retirement ages, including things like less (or delayed) government assistance with healthcare and other expenses.  Saving will continue later in life, because people will work longer, and future entitlement programs will become less certain.  Joachim Fels, an economist at PIMCO, wrote a book called “70 is the new 65: demographics still support lower interest rates for longer.”  His contention is that people are retiring later, and the people who retire latest do the most saving.  In conclusion, this evolving dynamic is likely to increase the high-end of the traditional “prime working age” definition, leading to more saving, a higher demand for bonds, and, therefore, lower-for-longer interest rates.  Mr. Fels believes that as people continue to work longer and save more, the demographic tipping point when savings start to fall (and pressure on interest rates begin) could be delayed by at least a decade.

Market Implications

In truth, the ultimate impact on financial markets is unclear.  However, we see two obvious possibilities.

  • The expected return from bonds is likely to stay low for some time as people work longer and save more, keeping downward pressure on bond yields.
  • Second, lower interest rates can help perpetuate higher equity market valuations. Lower rates are not a panacea to perpetually higher stock returns, but in the near term, they can keep valuations elevated above what might be considered historically average.  In simple terms, bonds are the primary competition for stock market dollars.  With persistently low yields, investors are more likely to push more money into equities than they may under “normal” circumstances – keeping valuations high.  Further, owning a stock is a claim on a company’s future stream of cashflows. When those future cash flows are discounted back to today, doing so at a lower interest rate increases that present value.

Although we believe both stock and bond returns will likely be below average over the next decade due to the high price of both asset classes, one can argue that equity returns will be somewhat higher than current valuations would predict because of the current dynamic of global demographics.  However, once the tipping point is reached, and the world’s older working population does begin to retire en masse, the forces describes above are likely to reverse.

Supply Chains

Supply chain issues have already become a problem for both Chinese exporters and global manufacturers with a Chinese manufacturing base.

The best explanation may be explained using U.S.-based Procon Pacific, manufactures bulk containers as an example.  Over the course of the last year, Procon relocated 90% of their production out of China, citing the effect of U.S. tariffs in combination with rising labor costs.  But the tariffs were more of a tipping point than a pure impetus.  Procon’s labor costs had quadrupled over the last decade, and increasing social welfare taxes – symptomatic of a rapidly growing shift toward an older demographic – had also increased operational costs.

Procon Pacific shifted most of their facilities to India and Vietnam.  But even companies not fully committed to moving all labor out of China are trying to diversify their supply chains to better weather potential political and economic storms, avoiding concentration in China and its uncertain future.[7]

Preliminary November 2019 reports indicated that U.S. imports from Vietnam increased 34.8% from 2018, but prospective manufacturers have indicated that Vietnam is faced with more demand than it can supply, as their labor force is strained as well.  Thus, while Vietnam has acted as a labor resource spillover during the 13.4% shrinkage of Chinese imports to the U.S. in 2019, it is not necessarily a sustainable long-term solution. India, projected by the U.N. to surpass China’s population by 2027, and promising to invest 1.4 Trillion USD into its currently lagging infrastructure over the next 5 years, remains one of the most likely contenders for supply chain shifts, alongside countries like Malaysia and Indonesia.  Although India has work to do to make itself a true competitor to China, demographics appear to be on their side. Comparisons to China in the 1990s abound, and with untapped rural migration, low labor costs, a growing population, and budding infrastructure, it is easy to see why companies find it an attractive bet for the future, even if there are currently many issues to iron out.

Source: https://data.un.org/Data.aspx?q=total+population&d=PopDiv&f=variableID%3a12

At a glance: China and India

Exports (USD)2.41T292B
Avg. Manufacturing Labor Cost (2015)$3.52$0.92
Manufacturing % of GDP31%17%

Source: https://oec.world/en/profile/country/chn and https://oec.world/en/profile/country/ind/

So the question remains: will demography be destiny? Although there are certain actions that can be taken, mainly around technological advancement and productivity enhancements, demographic trends are powerful and the effects likely irreversible.  Population trends across the world will have a significant impact on interest rates, financial asset returns, consumer spending patterns, and global supply chains. Emerging economies such as China, and developed economies like Japan, may have to make significant technological investments to drive productivity growth, as well as political and social changes to avoid major economic disruptions.  We think countries like the United States are better positioned to deal with many of these challenges given the access to immigration and culture of technology innovation.  No one is quite sure what the effects of the 21st century’s unique demographic challenge will be, but we believe the subject will become of increased interest to both economists and investors in the coming years.

[1] As well, importantly, on productivity of the population; however, that is a subject for future discussion.
[2] World Bank: https://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&met_y=ny_gdp_mktp_cd&idim=country:JPN:CHN:DEU&hl=en&dl=en#!ctype=l&strail=false&bcs=d&nselm=h&met_y=ny_gdp_mktp_cd&scale_y=lin&ind_y=false&rdim=region&idim=country:JPN:CHN:DEU&ifdim=region&tstart=-285361200000&tend=1513400400000&hl=en_US&dl=en&ind=false
[3] https://hbr.org/2019/09/can-china-avoid-a-growth-crisis
[4] https://www.pewresearch.org/fact-tank/2019/07/10/for-world-population-day-a-look-at-the-countries-with-the-biggest-projected-gains-and-losses-by-2100/
4 http://data.un.org/Data.aspx?q=total+population&d=PopDiv&f=variableID%3a12
[5] https://www.scmp.com/economy/china-economy/article/3005759/chinas-state-pension-fund-run-dry-2035-workforce-shrinks-due
[6] The Belt and Road Initiative (BRI), also known as the One Belt and One Road Initiative (OBOR), is a development strategy proposed by Chinese Government that focuses on connectivity and cooperation between Eurasian countries. It is short for the Silk Road Economic Belt and the 21st-century Maritime Silk Road.
[7] https://www.supplychaindive.com/news/china-alternative-sourcing-manufacturing/567183/

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