demographics, aging populations, and China

I first learned about the importance of demographics from the stock market from an economist at Donaldson Lufkin & Jenrette (which was ultimately acquired by Credit Suisse) in the mid-1980s.

He used to say that you can’t just manufacture a whole bunch of 30-year olds out of thin air–in other words, that a country’s population profile can have a profound influence on consumption patterns for a very long time.  Yet, in the rough and tumble of everyday trading on Wall Street, demographics is often forgotten.

At that time, his main point was the enduring influence on consumption of the post-WWII Baby Boom.  The sheer size of the cohort was important.  But not only that, but so too was its aging–and the resulting age-related shift in their buying habits.  Today, I imagine he would be stressing the age-related fading of the Baby Boom’s influence on consumption, as well as the issues surrounding the cohort’s longevity in retirement.

There are already two examples of aging advanced economies where the work force is significantly older than in the US.  They’re Japan, whose workforce is the oldest in the world and which has already been shrinking for many years due to age; and the EU, whose workforce age is about midway between the US and Japan.

I’ve written often about the social/cultural basis for Japan’s protracted economic decline.  I think this is the main reason, both for that country’s quarter-century of stagnation and why Abenomics won’t work.  But sometimes I wonder how much of Japan’s troubles are simply demographic–and therefore a harbinger of what may be in store for the US at some point.  It doesn’t help my mood that the next-oldest area in the world, the EU, is exhibiting many of the same symptoms that Japan did in the 1990s.

Although I’m not sure how well-known it is, China is, despite all its current economic dynamism, the other important aging country–thanks in large part of the policies of Chairman Mao.  Stratfor (a service I don’t subscribe to but which has competent analyses of world affairs) has just published a good summary of the situation.  The prose is a little too breathless, in my view, but the facts are basically correct.  China is facing workforce retirement issues comparable to those in the US.  Its industrial base is relatively unstable,  It’s in the early stages of transformation from labor-intensive, export-oriented manufacturing, to higher value-added production.

It seems to me that the new Chinese administration is well aware of its demographic problem and is taking sensible steps to redirect its economy to cope.  In fact, Beijing appears to be acting as if its aging workers are its principal long-term issue   …which I think it is.  That would also explain why China is so willing to sacrifice short-term economic growth in order to establish a more advanced, and more stable industrial base.  It would suggest, as well, that investing in basic industry in China–no matter how cheap the companies look–would be (to my mind, anyway) a big mistake.

Bain’s “A World Awash in Money” (II)

Let’s assume that Bain is correct that the world will be awash in capital over the next decade or so, and that this money will be coming both from investors in the developed world and–increasingly–from the emerging world as well.

I draw two conclusions from this (keeping in mind that Bain may, or may not, be correct):

1.  Interest rates won’t rise as much as the Wall Street consensus expects.  The Fed is saying that the normal rate for overnight loans in the US is 4%+.  This implies that 10-year Treasuries should yield at least 5%, probably more.  If Bain is correct, these figures are much too high  …and, therefore, the rise in bond yields following Fed hints that monetary tightening is on the horizon may have already achieved as much as half the total rise that tightening will bring.

2.  Consider the factors of production:



–land/materials/resources and

–knowledge (technology, entrepreneurship, craft skill).

Which of these will be in short supply relative to the others?   I.e., which will be the most valuable?

If Bain is correct, it won’t be capital.

The natural resources boom of the past decade has resulted in mining companies making massive investment in new capacity.  Shale oil and gas are beginning to provide new low-cost sources of energy.  So the shortage factor is probably not land etc.

There’s still massive amounts of unskilled labor in emerging economies.  There’s also significant unutilized labor in the US and EU.  So labor isn’t the key factor.

That leaves knowledge, either as technology, craft skill or entrepreneurship as the factor of production in short supply.


For investors, the main takeaways are that:

–the current monetary tightening cycle may not be as negative for bonds or stocks as the consensus fears

–like the Internet, ready availability of capital undermines the defensive position of large companies with significant manufacturing capabilities and established brand names.  Think:  Hewlett-Packard, Dell, Barnes and Noble, J C Penney.

There’s a second point to this list, as well.  In all of these cases, finding leaders with the right knowledge base to put the firms’ substantial assets to work has proved to be very difficult.  It may be that in an environment where capital is easy to come by, talented entrepreneurs have much better alternatives than masterminding turnarounds for financial buyers.  If so, the value investor tactic of buying shares in asset-rich companies and waiting for something good to happen may not retain its traditional allure.  So-called value traps will outnumber successful turnarounds by a lot.

A world awash in money?: the Bain view

The other day I was reading a column in the Financial Times that referred to a study by the consulting company Bain.  Published late last year (I missed it then), it’s called A World Awash in Money.

Its basic premise is that the present condition of a “superabundance” of investment capital looking for a place to go to work is a permanent feature of the financial landscape.  Therefore, asset prices will remain higher than the consensus expects; interest rates will remain lower.

Three factors are involved:

–financial innovation, high-speed computing and increased use of leverage have allowed the pool of investment capital in the advanced economies to expand at a very rapid rate over the past couple of decades

–during the same time, GDP in the US and EU has been growing slowly, providing fewer new investment opportunities, and

–emerging economies like China will soon turn from being capital users to capital exporters, significantly increasing the amount of global capital searching for high-return projects to invest in.

In Bain’s view, this situation will have a number of important consequences:

1.  interest rates will remain (much) lower than the consensus expects

2.  in a capital-glutted world, bubbles like those in 1999-2000 and 2006-2007 have a high chance of recurring.  Therefore, investors must be ready to anticipate them and take defensive action

3.  investors will be forced to consider projects with extremely long duration (think: 20 or 30 years) to achieve superior returns

4.  the risks of investing in the developing world, where capital will be needed the most, will become more palatable to return-starved global investors

5.  achieving substantial real returns will require that both portfolio investors and company treasurers abandon their buy-and-hold, long-only mindset and become more like hedge funds.


I always find studies like this one interesting.  It’s not necessarily because they turn out to be correct.  It’s that they force you to think about the “big picture” and form an opinion on important investment issues.  In this case, it’s what happens if interest rates stay low.

I also find studies that argue, in effect, that the current state of the economic/financial world will persist for a long time to be particularly worrying.  In my experience, most times they come just before some dramatic and unanticipated change.

My take on the Bain study tomorrow.

institutions reacting to poor hedge fund/private equity returns

A couple of days ago, the Dealbook section of the New York Times reported on a recent meeting of the Institutional Investors Roundtable in western Canada.

The purpose of the organization, founded in 2011, is to help large government-linked investment bodies, like sovereign wealth funds and managers of government employee pension plans, cooperate to solve common problems.

According to the NYT, the agenda of the latest meeting was hedge fund and private equity investments.  Although the proceedings are secret, it doesn’t take a genius to figure out what went on.

The institutions’ dilemma:  on the one hand, they want and need the diversification and the high-return investment opportunities that hedge funds and private equity promise.   On the other, despite their colorful brochures and persuasive presentations, many hedge fund/private equity ventures produce pretty awful returns.

There are two main reasons for this:

–some hedge fund/private equity operators are brilliant marketers and well-connected politically, but that’s it.  They’re not great investors.  It doesn’t help matters that academic research shows a significant number of them bend the truth in stating their qualifications, track records, assets under management…

–the hedge fund/private equity fees are so high that there’s little extra return left over for the institutions who supply the investment capital.

The IIR solution?

It’s to try to develop hedge fund/private equity projects among the members themselves, thereby cutting out the fees charged by third parties.  One institution cited in the NYT article says doing so adds 5 percentage points to the annual returns it received from such projects.  On a world where bonds yield next to nothing and where stocks may produce 6%-8% annual returns, a 5 percentage point pickup is enormous.

This movement is in its infancy.  Not every institution will be able to participate, either because of political pressure at home or lack of even minimal expertise.  But even that may change in time.

The most important thing to notice, I think, is the evolution away from traditional Wall Street practices that make the financiers–and no one else–rich.  I think that sovereign wealth funds, bot from China and the Middle East, will take leading roles in this development.

housing boom and retail sales

Last week, Macy’s, Kohl’s and Wal-Mart all reported disappointing 2Q13 results–leading to worries that economic growth in the US is beginning to slow.  In Wal-Mart’s case, I think the problem is structural, not cyclical.  The manufacturing  jobs much of the chain’s lower-income customer base has traditionally had have disappeared forever.  With them, fat paychecks have gone as well.

But what about Macy’s and Kohl’s?  Why are their results so at odds with general economic indicators?

One possibility is that the weakness in general merchandise they’re exhibiting is a result of the housing boom.

In most areas of the world, and over most periods of time–except for the US during the past few decades–a cyclical housing boom alters consumers’ retail spending patterns.  The change usually appears with a modest time lag.

After buying a new residence, the owners typically redirect their spending in two ways:

–more of their income goes into paying their mortgage, and

–they redirect what remains toward furnishing and decorating their new home.

So spending on furniture, kitchen appliances, paint, carpeting… rises.  Spending on restaurants, cellphones, clothing… falls.  The latter category doesn’t drop to zero.  But consumers cut back–both on big-ticket items and on shopping-as-entertainment, where the items in question aren’t unique or special.

The only exception to this pattern that I’m aware of comes close to home.  During the long period when interest rates in the US were in decline–from the early Eighties until now–falling interest rates made housing prices rise so quickly that new homeowners weren’t forced to cut back on spending.  They could borrow against their fast-appreciating home equity, instead.

It’s too early to tell for sure, but the lackluster sales we’re seeing from Macy’s and Kohl’s may just be a return to normal by US homeowners after an extended period of excess.  If so, the situation is a threat to department store profits, and stock prices, but not to the overall economy or stock market.