Of all the mega-trends that are routinely discussed by the financial media such as emerging markets or the commodity supercycle, the one concerning ageing populations gets relatively less attention.
This is surprising, because as one demographics expert argues, it is probably the most powerful trend of all – especially in the context of market valuations.
For instance, it means the days of getting an expected annual average 7% return from the stock market just by holding an equity index over the very long-term are probably gone for good and the commodity supercycle, in terms of oil at least, is likely to have run its course. On the other hand this 'new normal' of uncertainty and volatility should be supportive of gilts as investors seek the sanctuary of relative safe havens, even at the expense of very low returns.
“Demographics drive demand,” says Paul Hodges, chairman of UK-based strategic consultancy, IeC. “Western baby boomers have created the largest and wealthiest generation that has ever lived. But since 2001 they have been entering the age 55+ cohort.” He says this highly significant demographic shift is bringing about fundamental changes in terms of stock market performance and the economic environment. Economic growth tends to drive corporate earnings and it's those numbers and future expectations of them, which influence long-term valuations. As the world transitions towards this new normal it is likely to lead to lower equity valuations, says Hodges who has advised a number of major companiesand investment banks on demographic trends.
Hodges argues that deleveraging, austerity and the woes of the financial sector are simply the symptoms of the real issue facing us. For him, their cause is the result of the ageing of the Western population
Seeking new explanations
As economists and policy makers struggle to find explanations for continued sub-normal GDP growth there are some who are beginning to examine the demographic argument as a possible cause. After all, over three years of ultra-low interest rates and quantitative easing have not brought about sustained economic recovery.
In June financial services group Standard Life published a report looking at the demographic perspective and argued that differences across age groups can have substantial influences on asset prices and inflation levels. It added that the size and differences across various age cohorts leads to divergences in the supply and demand for financial assets and goods and services in general. “Arbitrage opportunities remain because most investors’ time horizons are measured in months whereas demographic changes occur over years or even decades,” the report said.
On May 30, the governor of the Bank of Japan, Masaaki Shirakawa warned that Europe and America could be facing a similar economic pattern Japan has been going through due to the decline of working age populations. “I cannot entirely rule out the looming menace that may unveil itself into downward pressure on inflation rates if such demographic changes are to undermine the momentum toward income creation in the economy,” he said speaking at a conference hosted by the Bank of Japan.
The 25-54 age group, which has historically been the wealth creating demographic, grew 44% between 1970-2010 to 392 million in the West and brought with it three decades of almost constant GDP growth. But today, the 55+ age group already makes up 29% of the western population at 272 million. By 2030, the UN forecasts that this population segment will be 364 million, around 36% of the West's population, clearly making them a growth market for companies that can provide for their needs. “One of the characteristics of the 55+ age group is that they consume less and save more as they focus on retirement and lower than expected pension incomes,” says Hodges. By contrast the 25-54 age group will shrink from 392 million in 2010 to 369 million in 2030.
Trading down is not a fad
He says for companies to survive in a world where people have less to spend means providing them with necessities at affordable prices. It is a reversal of the premiumisation trend, which for decades has served companies so well looking to grow profits. “The middle ground is being hollowed out and that has been very noticeable in the retail sector,” says Hodges. “Trading down is not a passing fad of the recession. This trend is here to stay.” He argues that the lower end of the market will continue to do well as will probably the high end luxury segment as the rich will always be around.
Among the retailers that are well positioned to serve this growing demographic include the German discounters Aldi and Lidl. “Retailers who have previously focused on the middle market are going to have to make a quantum leap in their thinking to win over this growing population segment,” says Hodges.
They will have to adapt by focussing on smaller urban shops and away from huge out of town shopping centres. Equally they can tap into the growing demand for convenience by allowing shoppers to order online and collect their goods in-store.
The big food retailers seem to be cottoning on by launching more often cheaper 'own label' merchandise, which is challenging branded goods. And Tesco, for example recently announced that it is broadening its Internet offering in the UK, increasing staffing and will build more local stores.
The pharmaceutical sector could be a big winner, but Hodges says they will need to rethink the way they develop their medicines and reduce their costs. Medicines will have to be more affordable for cash strapped consumers and governments. Also, “not enough research is going into diseases such as Alzheimer's, which will become much more prevalent,” he says.
The big pharmaceutical groups such as GlaxoSmithKline are trying to re-engineer their models of drugs development and are aware of the need to reduce their development costs. Many are looking at areas such as biologicals or taking over biotechs with promising pipelines.
The winners from the New Normal
According to Michael Porter, a professor at Harvard University, shared values will drive the next wave of innovation and productivity growth in the global economy. Hodges agrees. He believes that providing products and services tailored to this older generation represents a huge opportunity. “It's a very under-served market,” says Hodges. “Also, this generation are going to live a lot longer than previous ones and will carry on consuming, but in a different way.”
He points out that this age group is more price sensitive, is looking for simpler life styles, convenience, trust, more interaction with friends and family, whilst luxury will be down to small moments of indulgence. “The big holiday package firms may well continue to struggle in this environment, as foreign holidays are simply not a necessity,” says Hodges.
Hodges warns that investors shouldn't look to emerging markets for salvation either. Many such as China and Russia have their own demographic time bombs ticking away. Also, definitions of middle class in emerging markets are misleading with the Asian Development Bank classifying it as those who earn as little as $2-$20 a day. Only 4% of China's population earn more than that. “Those income levels are classified as being poor in the West. This is less than what many westerners get on welfare benefits,” says Hodges. “Most of these people will never be able to afford expensive western products.”
Nonetheless, he still sees plenty of opportunities in emerging markets. “There will be a lot of money to be made around increasing food production, improving water availability, increasing life expectancy and in reducing the carbon footprint,” says Hodges. “The key is to provide affordable necessities, which offer real value for money.”
One consumer goods company that is successfully tapping the Indian mass market is Unilever via its holding in Hindustan Lever (HUL). For instance, it has empowered local women to sell items such as soap in their local communities, creating an income for them, as well as growing HUL's market share in rural areas.
The Western world appears to be following in Japan's footsteps and in terms of ageing populations was actually just over a decade ahead of the West. It was also about ten years ago that its economy started to stagnate.
Demographics expert Paul Hodges and Asian specialist John Richardson, have just completed a free e-book on this subject titled Boom, Gloom & The New Normal. The book looks in more detail at how ageing Western Baby Boomers are changing global demand patterns.