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Aging Demographics - The Other Super Secular Trend

(June 24, 2004)

Dear Readers:

The Dow Theorists (and yours truly) have always emphasized that the most profitable way to invest in the stock market for the average American is to invest in harmony with the primary trend.  In Dow Theory terms, this would mean investing in a period of severe undervaluation and holding on to your stocks (or dollar cost-average into your portfolio) until the end of the bull market - such as September 1999 when the Dow Theory bear market signal was given -- and then stay out until the primary bear market has fully asserted itself.  I myself sold all my stocks in January 2000, and since then, I have maintained that we are still in a secular bear market, despite the fact that I am still bullish in the intermediate term.  When the current bear market bottoms, I believe that we will be seeing new lows in the major stock market indices -- such that stocks will be attractive from a valuation standpoint once again.

Dear readers, this particular commentary will be a little bit different.  In the previous paragraph, I discussed the importance of recognizing and investing in harmony with the primary trend.  Easy to say, difficult to do.  Secular bull markets are notorious for shaking the average investor out, and conversely secular bear markets are notorious for keeping the average investor in (such as the market we are experiencing now) - that is, keeping them in until it has parted them with their money.  Another secular trend that is or will not be difficult to recognize, however, is the super, secular trend of aging demographics around the world.  We have all heard it from the media, but how deep and pervasive is the "problem," really?  A good knowledge of this trend is very important.  I will also use this forum to discuss the possible implications as well as other trends that I see happening in the future.  I may well be wrong, but I definitely do not want to get caught off-guarded.

I am going to cut right down to the chase here.  There is an excellent report published by the Center for Strategic and International Studies (in conjunction with Watson Wyatt Worldwide), along with a report published by the United Nations that cover this issue and the half-dozen or so other related issues (such as possible implications).  The research of these two reports yielded similar results - with the CSIS taking a more conservative view in that it assumed a higher life expectancy rate for all the countries it covered.  Copies of those reports can be found here:

http://www.csis.org/gai/aging_index.pdf

http://www.un.org/esa/population/publications/worldageing19502050/

What I am going to do in this commentary is to provide a quick summary and to offer my own views - views that may or may not be obvious to some of my readers.  The following is Figure 1 from the CSIS and the WWW study:

number of elderly as a percentage of the population in developed countries 

Please note that this study covers more developed countries only - the UN report provides a broader perspective in that covers less developed countries as well.  Readers should read that at their own leisure; for now, readers should look at the chart above.  The "aging problem" that we have today affects countries in different ways (even among developed countries), but countries with a low birth rate and a tight immigration policy will suffer the most.  Japan, Spain, and Italy are prime examples.

But what does this mean in terms of the burden of this problem on society?  The second chart from the same study conveys the same message but provides a different perspective.  It ranks each developed country in terms of the "Aged Dependency Ratio," which is basically a ratio of adults aged 60 and over to working-age adults aged 15 to 59.  As readers can see, this is already becoming a problem in Japan and Italy, but the ratio is projected to rise to a shocking 1.00 and 1.03 (respectively) by the year 2040.

aged dependency ratio in developed countries

The question to ask is: Can we or how can we afford this?  If healthcare costs continue to rise and if we are forced to provide the same level of retirement benefits to tomorrow's retirees, will this bankrupt most of the developed world?  How would this affect the future trend of government spending?

To answer these questions, let's look at the final chart from this study:

public benefits to the elderly as a percentage of total government outlays, assuming cuts in other spending pay for all growth in public benefits

Assuming that the current level of benefits remain into the future and assuming the level of taxes is not raised, then public benefits to retirees would dramatically increase going forward.  On the extreme end, Japan and Spain will see a more than 100% increase in their outlays to retirees.  Clearly, this is not sustainable.  Either things such as defense or education spending will need to be cut, or the above countries will need to raise their taxes.  Neither of the two scenarios is optimal.  Borrowing more of their funds is not a long-term solution.  Cutting funding in defense and education will comprise a country's future, and raising taxes will place a huge social and financial burden on the population of the developed world - where taxes are already at a historically high level.  Think about this: If you were a bright, young, French industrialist and you were forced to pay 60% of your income as taxes to support the elderly, what would you do?  Why, you would vote with your feet and relocate to another country that is more tax-friendly and business-friendly - and so will other great talent that may have been a great contribution to the French economy.  The governments of the developed world recognize this - but there are no easy solutions.

This picture gets grimmer when one takes note of a study that was done by the Bank Credit Analyst.  In that study, the BCA predicts that by the year 2050, the percentage share of the developed countries of the global population will drop from over 30% in 1950 to less than 14% -- or about equal to the population of the Islamic nations of the world.  Similarly, Yemen will be more populous than Germany in 2050; while Iraq will be 30% more populous than Italy (Iraq is less than 40% the size of Italy today).  Russia's population is projected to continue to decrease - at a rate such that the population of Iran will be even higher to that of Russia's in 2050.  India will be the most populous nation in the world, and Pakistan will only lag the U.S. by approximately 50 million people.  If the developed countries of today do not choose to work harder or become more efficient, then they will ultimately lose their comparative advantage, as the younger population of the world is inherently more hard-working, energetic, innovative, and creative.  In today's globalized world, this will be a killer for the average worker in the developed countries - the more so once the language barrier is eliminated (the successful commercialization of universal language translators is projected to happen in ten to fifteen years).  I am generally more optimistic, as the elimination of the language barrier will greatly enhance business opportunities and efficiencies, but a person such as the average American worker will loss his or her comparative advantage in the global workforce.  The availability of a huge supply of labor should also drive down wages in the global marketplace - and most probably increase the maldistribution of wealth in today's developed countries.

There is no easy way out, unless GDP growth deviates (in a positive way) from recent experience - most likely because of increasing technological breakthroughs.  This is always a risky bet.  My thinking is that the workers of today will have to work harder, save more of their money, or work until the day that they die.  Keep in mind that where there is danger, there is also opportunity.  The aging of the global population also means there is huge money to be made for the opportunistic entrepreneur - in industries such as the assisted living industry, the nutritional industry, and the financial planning industry.  Moreover, this aging problem may induce more technological breakthroughs and the ultimate commercialization of things such as household robots, "nanotech clothing" which would give some of our elderly people the strength to walk properly again, or even a standard procedure to treat Alzheimer's successfully.  At the same time, the globalization of the workforce means there is also a larger market to sell one's services to - so that if one has the talent, knowledge, and is willing to work hard, then he or she can easily sell his/her services to the highest bidder.  My advice: Only the paranoid survives (and thrives), and it is probably a good idea to start getting paranoid right now. 

The Stock Market - the Bulls have the Upper Hand

Wait - this was supposed to be a commentary about the stock market.  Given today's action, I would have to say that anyone shorting into strength here is playing with fire.  The Lowry's Buying Power Index surpassed its recent highs, suggesting a more sustainable period of healthy demand for stocks going forward.  Margin debt data was just released for the end of May, and it shows a slight pullback in margin debt (suggesting the uptrend is still intact) while showing a healthy increase in free credit balances in both cash and margin accounts at the same time.  This is the best of both worlds.

The Dow Transports made a new 52-week high today, while the Dow Industrials has broken through the downtrend line which dates back to January.  The Dow Industrials is now a mere 100 points away from surpassing its second peak, and only 260 points or so from confirming the Dow Transports on the upside:

Breakout of the Dow Industrials from the down trend line - accompanied by a new 52-week high in the Dow Transports

Given the fact that the intermediate trend is still bullish, my guess is that the Dow Industrials will confirm the Dow Transports in due time.  The odds still favor a continuation of the intermediate uptrend (which I have been emphasizing) and while the ST indicators are at neutral to overbought levels, trying to short the market remains a very tricky process - not unsimilar to dancing between the raindrops during a huge thunderstorm.

Signing off,

Henry K. To, CFA

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