Date post: | 23-Jun-2015 |
Category: |
Economy & Finance |
Upload: | the-economist-group |
View: | 308 times |
Download: | 0 times |
Global Financial Institute
Your entry to in-depthknowledge in finance
www.DeAWM.com
.
Population ageing and capital market performance: Should we be worried?
March 2014 Dr. Paul Kielstra
Deutsche Asset & Wealth Management
S3 SPECIAL ISSUE
Population Ageing and Capital Market Performance2
Deutsche Asset & Wealth Management’s Global Finan-
cial Institute asked the Economist Intelligence Unit to
produce a series of white papers, custom articles, and
info-graphics focused specifically on global capital
market trends in 2030.
While overall growth has resumed, and the value
traded on capital markets is astoundingly large (the
world’s financial stock grew to $212 trillion by the end
of 2010, according to McKinsey & Company) since
the global financial crisis of 2008, the new growth
has been driven mainly by expansion in developing
economies, and by a $4.4 trillion increase in sovereign
debt in 2010. The trends are clear: Emerging mar-
kets, particularly in Asia, are driving capital-raising; in
many places debt markets are fragile due to the large
Global Financial Institute
Introduction to “Global Capital Markets in 2030“
component of government debt; and stock markets face
weakening demand in many mature markets.
In short, while the world’s stock of financial assets (e.g.
stocks, bonds, currency and commodity futures) is grow-
ing, the pattern of that growth suggests that major shifts
lie ahead in the shape of capital markets.
This series of studies by Global Financial Institute and the
Economist Intelligence Unit aims to offer deep insights
into the long term future of capital markets. It will employ
both secondary and primary research, based on surveys
and interviews with leading institutional investors, corpo-
rate executives, bankers, academics, regulators, and others
who will influence the future of capital markets.
Population Ageing and Capital Market Performance3
About the Economist Intelligence Unit
The Economist Intelligence Unit (EIU) is the world’s lead-
ing resource for economic and business research, fore-
casting and analysis. It provides accurate and impartial
intelligence for companies, government agencies, finan-
cial institutions and academic organisations around the
globe, inspiring business leaders to act with confidence
since 1946. EIU products include its flagship Country
Reports service, providing political and economic analy-
sis for 195 countries, and a portfolio of subscription-
based data and forecasting services. The company also
undertakes bespoke research and analysis projects on
individual markets and business sectors. The EIU is head-
quartered in London, UK, with offices in more than 40
cities and a network of some 650 country experts and
analysts worldwide. It operates independently as the
business-to-business arm of The Economist Group, the
leading source of analysis on international business and
world affairs.
This article was written by Dr. Paul Kielstra and edited by
Brian Gardner.
Dr. Paul Kielstra is a Contributing Editor at the Economist
Intelligence Unit. He has written on a wide range of top-
ics, from the implications of political violence for busi-
ness, through the economic costs of diabetes. HIs work
has included a variety of pieces covering the financial
services industry including the changing role relation-
ship between the risk and finance function in banks, pre-
paring for the future bank customer, sanctions compli-
ance in the financial services industry, and the future of
insurance. A published historian, Dr. Kielstra has degrees
in history from the Universities of Toronto and Oxford,
and a graduate diploma in Economics from the London
School of Economics. He has worked in business, aca-
demia, and the charitable sector.
Brian Gardner is a Senior Editor with the EIU’s Thought
Leadership Team. His work has covered a breadth of
business strategy issues across industries ranging from
energy and information technology to manufacturing
and financial services. In this role, he provides analysis as
well as editing, project management and the occasional
speaking role. Prior work included leading investiga-
tions into energy systems, governance and regulatory
regimes. Before that he consulted for the Committee
on Global Thought and the Joint US-China Collabora-
tion on Clean Energy. He holds a master’s degree from
Columbia University in New York City and a bachelor’s
degree from American University in Washington, DC. He
also contributes to The Economist Group’s management
thinking portal.
Global Financial Institute
Introduction to Global Financial Institute
Global Financial Institute was launched in November
2011. It is a new-concept think tank that seeks to foster a
unique category of thought leadership for professional
and individual investors by effectively and tastefully
combining the perspectives of two worlds: the world of
investing and the world of academia. While primarily tar-
geting an audience within the international fund inves-
tor community, Global Financial Institute’s publications
are nonetheless highly relevant to anyone who is inter-
ested in independent, educated, long-term views on the
economic, political, financial, and social issues facing the
world. To accomplish this mission, Global Financial Insti-
tute’s publications combine the views of Deutsche Asset
& Wealth Management’s investment experts with those
of leading academic institutions in Europe, the United
States, and Asia. Many of these academic institutions
are hundreds of years old, the perfect place to go to
for long-term insight into the global economy. Fur-
thermore, in order to present a well-balanced perspec-
tive, the publications span a wide variety of academic
fields from macroeconomics and finance to sociology.
Deutsche Asset & Wealth Management invites you to
check the Global Financial Institute website regularly
for white papers, interviews, videos, podcasts, and more
from Deutsche Asset & Wealth Management’s Co-Chief
Investment Officer of Asset Management Dr. Asoka
Wöhrmann, CIO Office Chief Economist Johannes Mül-
ler, and distinguished professors from institutions like
the University of Cambridge, the University of California
Berkeley, the University of Zurich and many more, all
made relevant and reader-friendly for investment pro-
fessionals like you.
4
Ageing: A developed- and emerging-market trend
Rapid streams of numbers flashing across electronic
screens in trading rooms and brokerage offices worldwide
seem to reflect the deeply impersonal nature of the world’s
capital markets. Ultimately, though, these exchanges
are driven by the decisions of individuals – whether
executed as one-off trades or adopted as strategies
programmed into machines. Therefore, the attributes of
the people buying and selling assets, as well as of the wider
populations in which they live, are intrinsically linked to
how markets perform. This is most evident during a bubble
or an ensuing panic, where emotions can quickly inflate or
destroy the value of any number of securities overnight.
More generally, though, any widespread changes to the
prevailing needs, wants, productive capacity or views on
risk in a society are likely to feed through, sooner or later,
to asset prices on capital markets.
Several such shifts may be driven by societies’ ageing.
One economically important result of this demographic
change is the increase in the proportion of people who are
retired and a reduction in their working-age populations.
In 2010 in the developed world, according to data from
the United Nations Population Division, 16% were already
65 – a common retirement age – or older. In the oldest
societies, such as Japan, Germany and Italy, the figure was
over 20%. In the years ahead, for the developing world as
a whole, the total number of the over 65s is expected to
rise by about 2% annually, so that it reaches 22% of the
population by 2030.
This issue also has particular resonance in Asia. Because
China’s retirement age is 60, the proportion of people
beyond normal working years is 15% and is expected
to reach 24% by 2030. This makes the issue much more
immediate there than in the United States, where the
equivalent figures are 15% and 20%. As the Chinese
example suggests, one way to reduce the impact of these
changes could be to increase the age at which employment
typically ends. The political difficulties of doing so, however,
raise questions about whether increases in the retirement
age will keep up with advances in life expectancy.
A policy challenge
Older populations will require societies to make a wide
range of adjustments, many with direct impacts on
national economies and, indirectly, on capital markets.
According to respondents to a survey conducted by the
Economist Intelligence Unit of 353 senior executives of
companies actively involved in capital markets, one of
the biggest predicted impacts of population ageing will
come from increased government spending to cover the
associated costs in areas such as healthcare and pensions
(cited by 41% of respondents).
James Poterba, Mitsui professor of economics at the
Massachusetts Institute of Technology, believes that
“the greying of the population in the United States is an
important driver of long-term [government] spending to
GDP. We are seeing that today.” America is far from alone.
This spending in turn presents societies with a fundamental
choice. Alexander Ludwig, professor of macroeconomics at
the University of Cologne and an expert on the economics
of ageing, explains that governments can choose debt or
taxes to fund the coming spending needs for the elderly.
Too high a tax burden, though, will reduce savings by
those in their middle years, and therefore investment in
capital markets. Too high a level of government debt, on
the other hand, may crowd out demand for other relatively
risk-free assets. Furthermore, if households foresee that
higher debt today will have to be financed by increased
taxes in the future, private spending will also go down.
Population ageing and capital market performance A collaboration between Deutsche Asset & Wealth Managment‘s Global Financial Institute and Economist Intelligence UnitMarch 2014
Population Ageing and Capital Market Performance Global Financial Institute
Written by
5 Population Ageing and Capital Market Performance
According to Professor Ludwig, “it is certainly true that
increased government spending will have an impact on
capital markets one way or the other”. The shape of that
impact, though, will depend on the specifics – and the
success or failure – of the policies chosen to address the
changing needs of ageing societies.
Global Financial Institute
6 Population Ageing and Capital Market Performance
A people challenge?
The difficulty in predicting what capital markets will
look like in a world where investors, like the population
in general, are older is that the world has never seen
population ageing on the current and predicted scale.
Hard data about what will happen do not exist. Expressions
of concern tend to begin with references to the life-
cycle hypothesis. This holds that, as individuals attempt
to smooth out consumption over the years, they save
during their working lives and spend those savings in
retirement to cover living expenses. A higher proportion
of retirees in the population therefore means that there
are more people selling off accumulated capital assets
and fewer interested in buying, leading to a general drop
in asset values. Another issue – which survey respondents
identified – is a shift by older, more risk-averse individuals
into traditionally safer investments, such as government
bonds, from more volatile ones such as equities. Done en
masse, this would reduce share prices and lower interest
rates, as more retirees seek security in debt instruments.
This theory, however, is far from airtight. While it has
substantial predictive value, this hypothesis ignores two
important investor motives: precautionary savings by the
elderly, who know neither how long they will live nor all
the expenses they might face; and the bequest motive.
As Professor Poterba notes: “Research of the last decade
has shown that late life behaviour isn’t driven only by
drawing down capital. A simple life cycle model is an
oversimplification.”
Similarly, any movement away from risk may be more
apparent than real. For many individuals, pensions and
annuities form a significant proportion of personal assets
in retirement. Increasingly, however, the pension fund
managers and insurance firms which oversee the assets
used to fund private pension payments are finding that
traditionally safe government bonds – long a default
asset for the industry – now pay far too little to meet their
obligations to pension and annuity holders. Therefore,
managers are buying a wider range of assets, including
alternative investments, in the search for yield.
Furthermore, underlying assumptions about retirement
ages – and therefore the time when retirement-related
expenditures begin – are not as solid as they seem, in part
because people are, on average, healthier and therefore
able to work longer. For example, in the United States
between 2003 and 2013, even without pension reform, the
Bureau of Labour Statistics reports that the labour market
participation rate of those aged between 65 and 69 rose
from 27% to 33%. Indeed, of those Americans still working
at 65, the majority do not retire. And according to Statistics
New Zealand, the labour market participation rate in that
country for those over 65 doubled between 2002 and
2012, from just under 10% to 20%. Cultural differences
may slow change. International Labour Organisation (ILO)
data show that European countries, although they too
have seen some increase over the last decade, still have
very small labour market participation rates among the
elderly. Nevertheless, as Professor Ludwig notes, even
there, “if you live longer, and need higher savings, the
average retirement age will probably increase without
regulatory reforms”.
Looking for evidence
These problems with the theory may explain why it has
been difficult for researchers to find conclusive evidence
– although population ageing has been taking place for
some time – of an impact on capital markets. A study by
Professor Poterba, for example, found very little, if any, sign
of a link between the changing age structure of the US
population over several decades and the value of equities
or government debt in the United States. It also found
that, although household asset holdings do rise when
people are in their 30s and 40s, they remain largely stable
throughout retirement except for defined benefit pensions
- which decline by design.1
The best evidence so far of a link between ageing and
equity values relates not to asset prices specifically, but to
the price/earnings (P/E) ratios of equity assets. Research
carried out by economists at the Federal Reserve Bank
of San Francisco found a surprisingly tight positive
correlation between average US P/E ratios and the ratio
of middle-aged people – which the study defines as those
aged between 40 and 49 – and the old-age cohort likely to
be selling off shares – those aged 60 to 69.2 Presumably,
1 James Poterba, “The Impact of Population Aging on Financial Markets in Developed Countries”, in Gordon H Sellor Jr, ed., Global Demographic Change: Economic Impact and Policy Challenges, Federal Reserve Bank of Kansas City, 2005, pp. 163-216.2 Zheng Liu and Mark M Spiegel, “Boomer Retirement: Headwinds for U.S. Equity Markets?”, FRBSF Economic Letter, August 2011.
Global Financial Institute
7 Population Ageing and Capital Market Performance
where the number of middle-aged people is higher, their
greater interest in shares compared with other securities
drives up prices.
Even with such an apparently good data fit, however, the
study warns that many other factors could obliterate this
effect. Moreover, Mark Spiegel, vice president, economic
research at the Federal Reserve Bank of San Francisco
and one of the study’s authors, explains: “It is correct that
a lot of people hold a lot of scepticism. The study works
off very clear patterns in historical data, but you can tell a
special story for the sub-periods going back to the 1950s
for each of the big swings in the trends. The ultimate test
[of whether there is a link] is if it shows up in data [in the
coming years].”
Examinations of other types of assets yield a similar
combination of possible pressure on asset prices owing to
ageing, alongside high levels of uncertainty about what
might actually happen. Real estate is one of the more
studied, as housing, along with pensions, is among the
most widely held assets for retirees. A Bank of International
Settlements (BIS) working paper which looked at house
prices over 40 years in 22 countries found a link between
ageing and lower prices. It therefore predicted downward
pressure on prices resulting from older populations.
The paper stressed, however, that projected house price
“headwinds” would be insufficient to produce an asset
meltdown and offered the well-deserved caveat: “Long-
run projections and estimates should be treated very
cautiously as their track record is dismal.”3
The international dimension
Capital markets are not just about long-term assets, but also
about flows of money. International differences in the rate
of ageing might affect these transfers and, indirectly, asset
values in different markets. In particular, economic theory
would suggest that investment should flow from wealthier,
older countries with surplus capital and restricted labour
supply towards developing, younger ones, where capital
will be more productive and yield a higher return.
Questions of international labour and capital availability
go beyond demographics to include areas such as pension
and labour market reform. To address how this range
of issues might interact with ageing to affect capital
markets in an internationally open economy, Professor
Ludwig and his colleagues have put together a complex
model.4 Its projections, though, vary dramatically based
on government policy and individual lifestyle choices. In
scenarios in which people take advantage of opportunities
to work later in life and where governments do not reduce
spending on pay-as-you-go pensions, the model suggests
that asset returns will drop by about 5% between 2015 and
2030, but then rise by the same amount again by 2050.
However, without a change in labour regulations and
working habits but with a shift to funded pensions, which
increases the capital available, asset returns could drop by
over one-quarter. Put simply, the policy response is likely
to define how asset returns, and therefore capital markets,
react to ageing.
Like most experts, Professor Ludwig advises caution. The
study itself suggests that continued high growth in Asia
would counteract any downward pressure and more than
compensate for reductions in asset returns in several
scenarios. Moreover, he warns that the available data
are based on the “baby boom” and “baby bust” years in
developed countries, which are insufficient to draw firm
conclusions. “This is why we have to work with simulation
models grounded in economic theory,” he adds.
Whatever the other uncertainties, Professor Ludwig, citing
existing, separate research, feels confident that differential
ageing patterns promote the flow of capital from older,
wealthier countries to younger, emerging markets.5 Others,
though, are less certain. If this were the case, says Professor
Poterba, “you would have expected North America and
Europe to be large saving countries, to be lending to other
parts of world. That is not what we see. This reminds us that
many other factors also affect capital flows – demography
is not everything.”
The most relevant economic theory, however, raises red
flags about population ageing. It could place some pressure
on asset prices in the coming decades, and while the full
Global Financial Institute
3 Előd Takáts, “Ageing and asset prices”, BIS Working Papers No 318, August 2010.4 Axel Börsch-Supan and Alexander Ludwig, “Aging, Asset Markets, and Asset Returns: A View From Europe to Asia”, Asian Economic Policy Review, 2009.5 See, for example, Melanie Lührmann, “Demographic change, foresight and international capital flows”, Mannheim Research Institute for the Economics of Ageing, Discussion Paper 38-03, 2003.
8 Population Ageing and Capital Market Performance
scope is unclear, the extent does not seem likely to cause a
crisis. Moreover, such evidence as exists does not provide
solid support for strong predictions. It may be unlikely ever
to do so: demographic changes are highly predictable. A
market made up of rational actors should foresee them
and may have already priced in any relevant risk. Similarly,
companies facing a reduction in labour capacity can alter
their production models to ones that optimise the likely
future mix of labour and capital.
What applies to rational markets hopefully applies to
rational policymakers. Capital markets are not facing an
unavoidable “silver tsunami”. Population ageing may well
affect asset values, just as it will affect society in general,
but the way it does will be shaped largely by choices
those societies make addressing the new demographic
environment.
Global Financial Institute
Disclaimer
Deutsche Asset & Wealth Management represents the asset management and wealth management activities conducted
by Deutsche Bank AG or any of its subsidiaries. Clients will be provided Deutsche Asset & Wealth Management products
or services by one or more legal entities that will be identified to clients pursuant to the contracts, agreements, offering
materials or other documentation relevant to such products or services.
This material was prepared without regard to the specific objectives, financial situation or needs of any particular person
who may receive it. It is intended for informational purposes only and it is not intended that it be relied on to make any
investment decision. It does not constitute investment advice or a recommendation or an offer or solicitation and is not
the basis for any contract to purchase or sell any security or other instrument, or for Deutsche Bank AG and its affiliates
to enter into or arrange any type of transaction as a consequence of any information contained herein. Neither Deutsche
Bank AG nor any of its affiliates, gives any warranty as to the accuracy, reliability or completeness of information which is
contained in this document. Except insofar as liability under any statute cannot be excluded, no member of the Deutsche
Bank Group, the Issuer or any officer, employee or associate of them accepts any liability (whether arising in contract, in
tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage whether
direct, indirect, consequential or otherwise suffered by the recipient of this document or any other person.
The opinions and views presented in this document are solely the views of the author and may differ from those of
Deutsche Asset & Wealth Management and the other business units of Deutsche Bank. The views expressed in this docu-
ment constitute the author’s judgment at the time of issue and are subject to change. The value of shares/units and their
derived income may fall as well as rise. Past performance or any prediction or forecast is not indicative of future results.
Any forecasts provided herein are based upon the author’s opinion of the market at this date and are subject to change,
dependent on future changes in the market. Any prediction, projection or forecast on the economy, stock market, bond
market or the economic trends of the markets is not necessarily indicative of the future or likely performance. Investments
are subject to risks, including possible loss of principal amount invested.
Publication and distribution of this document may be subject to restrictions in certain jurisdictions.
© Deutsche Bank · March 2014
9
R-xxxxx-x (x/xx)
Global Financial Institute