For assets, demographics may be destiny

August 11, 2010

Right about now a massive demographic shift is getting under way which will put substantial downward pressure on house and stock prices, perhaps suppressing global asset prices by one percent a year.

This is going to complicate the response to a series of thorny outstanding problems. Less buoyant asset markets will make it that much harder to work out from under a massive overhang of debt in many advanced economies. It will also put retirement plans in a vise, as more would-be retirees find the assets they had hoped to live off of in old age are not worth enough.

That means longer working lives but also higher savings, which may, you guessed it, hit consumption, company profits and give stock and other asset prices another shove lower.

And, if you believe that the sharply rising house and stock prices of the last generation were in part a social phenomenon, then look out for the opposite, as stocks and houses get a bad name as they suffer from a series of unfortunate effects.

A new Bank for International Settlements working paper by economist Elod Takats looks at the interaction of demographics and asset prices and finds not a meltdown but a long hard slog for house prices and, by extension, for other assets like stocks.

“If you look at the U.S., or most English-speaking countries, the next 40 years is substantially different from the last 40,” Takats said.

“We had demographic tailwinds over the past forty years and will have headwinds over the next forty.”

For the United States, over the next 40 years demographics will shave about 0.8 percent a year off of where house prices otherwise would be, having an aggregate effect of 40 percent. That is the exact opposite of the 0.8 percent per year uplift house prices in the United States have gotten in the past for decades, a period in which the U.S. public have been conditioned by continually rising prices to over-invest and over-consume housing.

In Europe and Japan the headwinds to housing prices will be even stronger. Germany and Italy face a headwind of about 3 percent per year, Japan even more than that.

There is also a read-across from the impact on housing to the impact on other financial assets. Globally, the paper sees about a 1 percent per annum impact on asset prices from demographics, something with very serious implications.

Takats’ study, which like any effort making predictions over a 40-year period is liberally seeded with caveats, concentrates on the effects of aging on house prices because they are less easily tradable internationally.

None of these predictions imply, in and of themselves, falling prices, but simply reflect an impact relative to a neutral demographic backdrop.

Going beyond the study into my own expectations, I think things get quite a bit more complicated and potentially dangerous when you consider the ways in which the demographic trends may interact with other issues.

Put simply young people save assets while older people eat them. Baby-boomer Americans, for example though, have probably saved less than they otherwise would have because of an illusion of value created by their collective impact on house and stock prices. As they move into retirement, voluntarily or not, they may need to sell down their assets, including houses, at faster than anticipated rates, both because of disappointing values and also if pension plans or social security deliver less than promised.

Of course there is always the alternative of working longer, and that will doubtless happen, but look too for the savings rate to rise structurally as people figure out which way the wind is blowing. That’s good, but not if you are selling most goods and services. All of this will become common knowledge, in much the same way it was common knowledge five years ago that stocks were a great investment and house prices only ever went up.

This all probably adds to the argument for emerging markets. These markets will be less pressured by these trends and, crucially, probably have a greater capacity to profitably absorb capital.

Even traditional emerging markets are not a magic bullet: Takats points out that by 2025 China will be older than the United States by some measures. It won’t be just Africans depending on a rising tide of African prosperity and development, granny will have a lot hanging on it as well.

In the end, the difference between the 80 basis-point tailwind and an 80 basis-point headwind is very significant, especially year after year after year.

Given that the problems of the United States and Europe, put very simply, boils down to too much debt secured by not enough assets and supported by not enough cash-flow, the demographic challenge should prove at least far from trivial for asset markets and at most, perhaps, decisive.

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Brilliant analysis.

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