Demographics: the missing piece

Christopher Dembik

Head of Macro Analysis

Summary:  The younger population, whose size is shrinking, is for the first time on record less optimistic than the oldest generation.


The view of many investors is that the latest market developments related to the COVID-19 outbreak are a temporary downturn in a 10-year secular bull market, similar to those previously seen in 2016 and 2011. Their main argument is that loose monetary policy, including low interest rates alongside accommodative monetary policy such as QE, will continue to serve as the main market driver. 

We have been here before, notably during the secular bull market of the 1950s and early 1960s. During most of that period, the Federal Reserve followed a ‘lean against the wind’ monetary policy that ultimately lead to the Great Inflation. Too-loose monetary policy had a dramatic effect on the economy and the level of inflation. Policymakers at the Fed misjudged how hot the economy could run without increasing inflation pressures and when CPI started to rise, monetary response was too slow. Oil and food prices only exacerbated the issue.

In 2020, the global economy is facing a much more difficult challenge that may lead to similar consequences if not controlled: stagflation. In the coronavirus era, state emergency and the double shock on supply and demand are likely to depress growth sharply, thus increasing risk of recession. Governments are ready to do ‘whatever it takes’ to mitigate the crisis. We are moving from ‘bailout the banks’ in 2008 to ‘bailout SMEs and anything else’ in 2020. 

The huge fiscal stimulus that is coming is likely to increase inflationary pressures in months to come. Contrary to common thinking, at Saxo we doubt that the coronavirus is a temporary market shock. We think that the COVID-19, along with another underestimated factor, demographics, will precipitate the end of the secular bull market. 

In our view, demographics are the ultimate indicator of how the economy and the market will evolve decades in advance. In 2011, a research paper released by the Federal Reserve Bank of San Francisco entitled ‘Boomer Retirement: Headwinds for U.S. equity’ pointed out the strong link between stock market performance and the US population’s age distribution. Using data from 1954 through 2019, it found that booming population explained about 61% of the variation of the P/E ratio over the sample period.

In the post-war period, a phenomenal increase in the population generated record levels of income, great wealth, higher consumption and increased economic activity. At the same time, groundbreaking innovations increased productivity and created new industrial clusters. The combination of booming population and industrial innovations were key factors behind the bull market.

Now, the booming population is the missing piece that may put a definitive end to the secular bull market. The baby boomer generation — which represents more than 76 million people in the US alone — is transitioning out of the workforce and drawing down on its retirement funds. This may structurally depress equity valuations in the coming years. 

There are not enough buyers in front of them to compensate when they eventually sell. The younger population, whose size is shrinking, is for the first time on record less optimistic than the oldest generation. This will have a direct impact on money behaviour and favour saving rather than investing, despite low interest rates. 

Even if they want to invest on the stock market, millennials cannot. The everyday consumer has never really recovered from the last recession and inequality is increasing, at least in the US, which does not draw a bright outlook for spending in the future.  We can already observe the same exact situation in the US real estate market. Baby boomers are offloading their huge rural properties, but millennials cannot afford to buy them. Demographics will disrupt not only the stock market — they’ll disrupt the financial sector as a whole. 

Retirement of the baby boomers happens at the worst time ever for the stock market, when other structural factors are already affecting the macroeconomic outlook. Loose monetary policy, for example, has dramatically increased debt-to-GDP ratios — which are now at unsustainable levels — and diverted capital from productive investment. The amount of debt in the system, especially in the private sector, is dragging down productivity and the economy overall. 

The system that prevails, which is centred on central banks providing unconditional liquidity, is inefficient and has not been able to foster the emergence of decisive disruptive innovations. We are reaching the limits of this system, with spreads on high yields reaching crisis-levels on the back of the COVID-19 outbreak. 

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