Baby Boomers have been a huge tailwind for equities and bonds from the 1980s until today, but now as they exit the workforce and increasingly move into retirement, this monumental demographic shift will exert enormous pressure on interest rates, bond prices, and equity market valuations.
This is the thesis of Will Denyer at Gavekal Research who we spoke with on our FS Insider podcast last week (see Major Demographic Shift Underway Spells Trouble for Bond Market).
Here's what he had to say...
WWII to Present
From 1946 to 1980, we saw a booming population that resulted in increased demand for houses, schools, cars, and a wide range of consumer goods and services, Denyer stated. This created a tendency for upward pressure in prices and interest rates.
“Then everything reversed basically in the early 1980s,” he said. Boomers entered the workforce en masse and, starting around 35 years of age, Boomers entered their peak production, peak earnings, and peak savings period, which lead to an abundance of production and capital, placing downward pressure on consumer prices and interest rates.
Savings not only bid up the price of bonds while driving down yields but also bid up the valuation of equities. What developed was a long-term bull market in bonds and equities.
“The broad story is that from the early 1980s until today, you didn’t have to get that creative to have a positive return,” Denyer said. “That’s the world that we’ve all grown accustomed to. For the last 35 years, we’ve had a secular rise in bonds, a secular rise in equities and a secular softening of inflation. But we shouldn’t count on that lasting forever.”
Turning Point Imminent
Based on global demographic data weighted as judiciously as possible, Denyer believes we are experiencing a turning point right about now.
The peak may have arguably already occurred in 2014 or 2015. There’s a significant margin of error and other factors that affect this outcome, but this demographic shift is likely occurring soon.
As a result, the secular bull trends we’ve grown accustomed to may not carry forward.
“The middle age providers are seeing their share shrink,” Denyer said, also adding that “the amount of savings being provided to the system is going to wane relative to demand.”
The difference now is that demand is skewed to the elderly population. That has interesting implications for inflation, he noted.
Services, Not Goods, Inflation
We’ll continue to see more services inflation and fewer goods inflation, as a result, because the elderly tend to consume more services and fewer goods.
“Where that leaves inflation going forward is an open question,” Denyer said. “It may not accelerate like it did in the 1960s and 1970s. But when it comes to investors deciding what to do in terms of interest rates … the decline in savings suggests that real rates should rise.”
If inflation picks up, it would just exaggerate the trend of rising nominal rates. If it softens, it might counter that trend, and interest rates may not actually rise much in nominal terms.
“My hunch at this point is that inflation is likely to be either flat or see some upward pressure,” he said. “I have a hard time believing that inflation is going to decline enough from here to offset the rise in real rates. That leaves me with a pretty cautious, bearish view on long-term fixed income.”
Equity Multiples Coming Down
The current high equity multiples are partially explained by the 1980s demographic tailwind, but that is reversing.
While timing is difficult, structurally, Denyer expects that over the next several decades we will see equity multiples fall.
With population growth stagnating, he has a hard time believing earnings are going to be very strong, though some sectors, such as healthcare, may retain strong earnings, as Baby Boomers are likely to consume more services and fewer goods.
“I think it’s going to be a huge wakeup call,” he said. “Today, what I would recommend is making strategic bets to areas that you see demand growth happening, but hedge that with some cash or short-term Treasuries.”
