Love it or hate it, demographics matter for an investor (Part 1)

Allison Wagner

    This is a two-part article that addresses economic and investment implications of demographic trends. Today, I look at what happens when we ignore demographics. In tomorrow’s column, I look at some investment opportunities supported by population and demand trends.

    I still remember presenting David Foot’s book “Boom, Bust, and Echo” in my high school economics class. It was the first time I was exposed to the idea. It was clear, succinct, and for me, absolutely mind-blowing (I was 17, ok?). Its sociological, marketing, economic and political implications kept me engaged and excited for weeks leading up to my talk. I still remember feeling exasperated at not being able to present the explanatory power of this concept within an hour of allotted time. This was before Powerpoint came along to provide structural assistance and graphics entertainment. So God bless my fellow classmates for sitting through the hour of what must’ve been an excruciatingly boring experience: me, with questionable level of articulateness, wildly gesticulating with my right hand, while waving pages of notes with my left.

    It’s been a while since high school, and the over-use and abuse of the term has since left me disillusioned with its clairvoyance. The rest of the world must have discovered the magical potential of a concept that is always readily available to provide digestible explanations for, well, everything.

    When I worked in the oil boom town of Calgary in western Canada, any high school drop-out rig worker or administrative assistant, when asked about the sustainability of sky-rocket crude prices, would shrug their shoulders and say: it’s China and India, they need oil, it’s all about demographics. The same line of reasoning was used to explain the rise of food prices last year: developing countries are getting richer and eating better, there’s an increase in demand, again, it’s demographics. The same explanation sufficed for the bio-tech and pharmaceutical stock rallyevery few years: the baby boomers, they’re getting older and need medication, it’s demographics!

    Then the oil boom ended, the food crisis abated, and has anyone heard anything about the explosive growth of the pharmaceutical industry lately? For a while, demographics became a mere pop-cultural sound bite: a convenient simplification of complex problems. The flagrant abuse of the term, combined with its questionable predictive powers, led me to more or less abandon my earlier enthusiasm.

    Lately, the idea of demographics has returned in a slightly different incarnation. As frivolous as some broad-brush generalizations of this concept can be, I found numerous instances of past disaster and future opportunities off the backs of demographics. I’m now convinced that demographics is still a credible tool, but only when paired with common sense. Here’s an example of what happens when we desert demographics and common sense.

    Demographics and housing prices

    One school of thought that addresses the “irrational exuberance” of the property bubble is this. There was no underlying demographic trend that supported the astronomical rise in housing prices. The population demographics signaled no spike or increase in the demand for real estate.

    In fact, some argue that housing prices moved up over the past half century because of the steady progression of baby boomers through various ladders of the property market. This growth has all but halted during the past decade. Population growth has not been large enough to justify price inflation in the hot zones, even if one takes into account the emergence of Gen X and immigrants as property buyers. From a demographics perspective, once the boomers’ needs are met, realistically, the market should have plateau and flatten out, if not trending down. Given some members of the baby boomers have already entered retirement, thus further reducing the demand for housing, it’s reasonable to deduce that the pattern over the past fifty years cannot be extrapolated infinitely into the future. By that measure alone, the idea that real estate prices will never go down was plain wrong.

    Just to show that demographics analysis only work in conjunction with good sense, you can also make an opposite case given the same numbers, or with a different set. You can also confuse your readers by throwing around the terms “demographics” and “baby boomers” that neither support nor refute your point.

    Employment based on a false boom

    What are the employment implications of the housing bubble? Here’s one scary statistic: 30% of job creations in California since 2000 had been in real estate related fields, i.e. real estate agents, construction, Home Depot, insurance brokers, mortgage brokers, stock brokers investment banking, etc. Suffice to say, originally created to sustain and support a castle in the sky, once the delusion ends, these jobs are not coming back anytime soon. The re-education and the re-absorption of the unemployed back into the economy is an interesting phenomenon to watch. Many are going back to community colleges in the fields of nursing, engineering, or accounting: fields that have high demographic demands going forward, and will be discussed in tomorrow’s column.

    Output outpaces spending, a new paradigm?

    The whole world is in recession, but there are two kinds of recession. Export-led economies such as Germany, China and Japan are facing a recession of the real economy, whereas the US, UK, and Iceland, are facing problems in its financial economy.

    It might be a good time to acknowledge how a large number of western countries had been able to sustain its growth and wealth accumulation despite a lackluster real value-generating economy. Let’s not forget how the U.S. was able to grow during the last couple of decades: for the most part, businesses and individuals borrowed to invest in over-inflated assets, whether they were tech stocks or bundled housing assets.

    Now the bubble has burst again. Is it time to re-examine the issue of value creation as a sustainable path for growth? With the downfall of Detroit and Wall Street, where do we turn to next? What will we invest in going forward?

    First, turn on our protective coping mechanism. Many are dealing with the uncertainties and financial challenges of this crisis by doing what our ancestors must have done for thousands of years: by paring our needs down to what is absolutely necessary. Gone are the days for designer clothes and barely used appliances piling up in a 3-car garage.

    This new consumer behaviour is duly reflected in the game of retail survival. Sellers of inessential goods and services are either doing badly or going out of business altogether; where retailers of basic necessities are going strong.

    Of course, we are doing this in face of economic hardship. Nobody in their right mind would prefer to forego Starbucks or trading in Chanel for Wal-Mart. It is not the American way. But if structural adjustment of the economy is allowed to continue, and people are forced to stop buying thing they don’t need with credit that they don’t have, then perhaps the not-so-subtle shift towards a more frugal mentality will take permanent hold.

    Perhaps our investment choices in the future will follow a similar trajectory as our  consumption behaviour, and more merits will be given to businesses that satisfy the needs and necessities, versus the wants, of our global society?

    In tomorrow’s column, I’ll discuss my thoughts on some investment ideas that are driven and supported by demographic trends.