Why demographic shifts matter so much for investors

Market Realist

3 big-picture shifts you should pay attention to (Part 5 of 5)

(Continued from Part 4)

So why do these three shifts matter? It’s vitally important for you to attempt to understand the broader secular factors impacting economies and markets today. Appreciating their influence can help you position yourself defensively, when needed, or potentially capture compelling investment opportunities.

For instance, as my colleague Russ Koesterich wrote in a Market Perspectives paper a while back on the developed world’s changing demographics, in an aging world, markets offering growth are likely to command a premium.

Market Realist – This effectively means that investment strategies focused on emerging markets (EEM) are likely to do better in the long run. Emerging economies like India (EPI), Brazil (EWZ), China (FXI), Mexico (EWW), and the Philippines—with younger populations—could be good investment opportunities.

U.S. demographics are good compared to the rest of the developed world. But some unique challenges face the U.S. market (SPY). According to Russ, when healthcare and pension plans were formulated, the ratio of workers to retirees was 25:1. But now, it has reduced to 3:1. This could pose a challenge.

At the same time, once you have an understanding of these shifts, it’s easier to grasp why we may well see the Federal Reserve (or Fed) raise rates earlier than many market participants expect. Today’s excessively low rates are encouraging many potential retirees to stay in the labor force longer, crowding out the younger generation and helping fuel high levels of student debt. At the same time, they’re also encouraging corporations to engage in aggressive stock buybacks at the expense of capital reinvestment.

Market Realist – The current level of the federal funds rate is between 0% and 0.25%. This is extremely low compared to historical data. Lower interest rates are spurring future retirees to stay employed in the workforce longer. They feel that fixed income products aren’t returning adequate yields for a comfortable life after retirement.

Low rates are also causing capital misallocation as investors in search of higher income shift to equities from bonds. This trend in turn gives rise to crowded trades, correlated risks, and overly stretched valuations.

The graph above shows you federal fund rates in the U.S. economy since 1990. The rates are at historical lows currently, as you can see.

Read A must-know guide to interest rates and your investments  to learn more about how to position your fixed income portfolio.

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