Ageing demographics and a sea change between the number of working-age citizens and retirees spells trouble for investors, warned Legal & General Investment Management’s James Carrick, who said the headwind is happening “here and now” as opposed to decades into the future.
The global economist said the ‘population pyramid’ – which traditionally has a large base of young people at the bottom and fewer elderly people at the top – has become a “population skyscraper” which will exert immense pressure on productivity levels and wealth generation.
“Soon we’ll have the same number of old and young people, which means it becomes very hard to tax these people to pay for the required pensions and healthcare of the older people,” he explained.
“You might have heard of a pyramid scheme, where a few people recruit more members, who recruit more members and can make lot of money, so long as they recruit more members.
“But, what happens when you can’t recruit any new members? The whole thing goes bust. That’s the theme I want to work through, as one example of a pyramid scheme is the pension system.”
Carrick said that when the pension system was created in 1908, it was given to citizens over the age of 70. Not only were people less likely to survive childhood, those aged 20 in 1908 lived to an average of just 66 years of age.
Fast forward to 2015, and life expectancy has increased to the point where the pension duration trebled over the course of 20 years, which the global economist warned was not anticipated when the initial pension scheme was introduced.
Average life expectancy of 20-year-old vs state pensions ages since 1908
“On top of that, we’ve had declines in birth rates,” Carrick continued. “The UK fertility rate – the number of children per woman – has fallen with a so-called replacement rate of just over two since the 1970s.
“Basically there are 1.8 children per woman, and I always get confused when people tell me that. I think we need to think about how many baby girls there are per woman. There are 0.9 baby girls per woman. That means that if you had one woman, in the next generation you have 0.9 women, the next generation you have 0.81 women, the next generation you have 0.72 women. The population is naturally going to shrink.”
In a bid to solve this, the UK government announced a state pension review in March last year, which will gradually increase the pension age for women from 60 to 65 – in-line with the current male retirement age.
While this has indeed increased participation rates, Carrick said the results aren’t as clear-cut as many people believe.
“There are more 65-year-old women working, but what kinds of jobs do they tend to do? They tend to work part-time. You cannot compare a 40-year-old man to a 65-year-old woman as they are working in different industries and different sectors,” he reasoned.
“So, we take into account how many hours and the job types different people are doing. Increasing the retirement age is helpful, but it might not be as helpful as you think.
“When we look at the UK labour force adjusted for how intensively people of different ages work, the average growth rate in recent decades has been 0.75 per cent per year. And, if we do not see further increases in male and female participation, I expect the UK labour force to stagnate. That is a big deterioration compared to history.”
On top of this, Carrick said this data is extrapolated from the United Nations’ database, which takes immigration levels of 180,000 per year into account. However, he pointed out that the current UK government wants to reduce this number significantly.
“If immigration falls to zero for argument’s sake, what is remarkable is the increase in the labour force from delaying retirement is pretty much one-for-one offset by the disruption of zero migration,” he explained.
While the demographics for the UK look unfavourable, the global economist said the outlook is even worse for the US as participation rates from males and females have already stagnated.
He said this has happened because the US doesn’t have a fixed retirement age and it is illegal to let somebody go because they have reached a certain age. Other contributing factors he listed include the fact their state pension is not as generous and they have more health problems due to the country’s obesity epidemic.
“The US already has a high percentage of elderly people working and it’s not getting any better. The UK clearly has scope to improve the participation rate of elderly workers but that’s not the case in the US,” Carrick said.
“So when we project the labour force in the US, historically it has grown faster than the UK. What is fascinating is that the outlook is plus or minus zero. Plus a quarter per cent if immigration continues in line with what the UN expects, but minus a quarter per cent if Trump does build that wall and immigration in the US falls to zero.
“The basic message is there’s a massive negative change in the growth of the US labour force, partly because they haven’t had scope to increase the participation rate of elderly workers because they were already working pretty hard.”
Given the unfavourable backdrop in developed markets, many investors have been focusing their attention on emerging markets. Despite a five-year slump from 2011 to the end of 2015, emerging market equities have increased in popularity recently due to perceived higher growth prospects and more favourable demographics.
Since the start of 2016, the MSCI Emerging Markets index has outperformed the likes of the FTSE 100 and S&P 500 indices by 26 and 13.08 percentage points respectively with a total return of 52.69 per cent.
Performance of indices since 2016
Source: FE Analytics
“Yes some countries still have fast-growing populations, particularly in emerging markets. So a lot of clients say, ‘I know the demographics in the UK and the US aren’t so good, but can’t we just invest our money in emerging markets?’” Carrick continued.
“Well, some of these strong demographics are not necessarily in places you want to be putting your money. Brazil, for example, encountered yet another corruption scandal [yesterday]. It is a country with weak political institutions – is that where you want to put all your money?”
The global economist said India is more promising, given Modi’s government is implementing significant structural reforms.
However, he said investors need to pay attention to the size of its economy.
“Our clients are giving money to us in pounds and they want to get paid back in pounds. What matters is how much companies can generate in terms of dollar or pound revenues. So, yes there are a lot of people in India, but they don’t earn a lot of money,” Carrick pointed out.
“So, if you buy shares in Ford, how many cars can Ford sell in India? Not that many.”
On the other hand, he said China is a very large, middle-income country so companies can make a significant amount of money from selling products there. Like the US and the UK, though, the global economist pointed out its demographics are deteriorating.
“Although there are some countries which have good demographics, when you aggregate the world as a whole, whether the number of people is deteriorating or, what really matters for our customers, the amount of money that can be generated by their customers, we’re on a deterioration trend and it could well be stagnant over the next few years,” Carrick explained.
“Demographics is not a long-term issue. It is a here and now issue.”