Many investors yearning for a return to “normalcy” after the savage economic and stock market distortions of this year’s pandemic and war in Europe tend to rely on the slow aging of populations to return to the trends of past decades.
Labor, goods, energy and food supply shocks around COVID-19 and Russia’s invasion of Ukraine will likely resolve on their own as that the world will continue to gray no matter what, many argue.
And as this inexorable force has for four decades created a “savings glut” depressing real interest rates and inflating the value of assets generally, it will return and overflow again.
But even this comforting cold is now rethought.
In recent years, some economists, including former Bank of England politician Charles Goodhart and ex-Morgan Stanley economist Manoj Pradhan, have argued that – unlike the Japanese experience of deflation and falling economic potential – aging populations and shortages of workers could actually turn out to be inflationary.
And this week, JPMorgan long-term strategists Alex Wise and Jan Loeys published research suggesting that the decades-long influence of demographics on saving and investment trends had already changed and would now be a factor forcing real, or inflation-adjusted, yields to rise over the next decade.
Even if population aging continues, perhaps even exacerbated by the pandemic, JPMorgan’s model hinges on how it affects the behavior of private and public saving versus investment before and after the big waves. of retirement.
The crux of the argument is that savings have ballooned in recent decades as the “boomer” cohorts approached retirement and saw post-retirement life expectancy rise sharply. People increased their savings in anticipation of a likely longer twilight without work.
But now, when they are effectively retiring and old-age dependency ratios are rising, they are actively dipping into these savings as governments “dissave” even more to support them through health care and pensions. pensions.
Using data from nearly 200 countries over 60 years to 2020, Wise and Loeys concluded that there was a clear “demographic reversal” around 2015, when the rise in old-age dependency exceeded the life expectancy as the main influence of households on savings and has begun to put upward pressure on real global returns.
The link with public savings was less clear, but they predicted that public dissaving would increase as the share of withdrawals increased.
And it is the global picture that matters most, given that large pools of private and public savings have proven to be mobile across borders over the past year, in particular by seeking refuge and reserves in bond markets such as that of the United States.
And like current economic and television trends, it could see us catapulted 40 years back in terms of bond market returns.
“By 2030, the effect of demographics on real interest rates will likely return to levels last seen in the 1980s,” JPM concluded, showing charts illustrating how trends extrapolate from population and savings corresponded to the real yields of the aggregate indices of all US bonds.
CHART: Actual Benchmark Returns (https://fingfx.thomsonreuters.com/gfx/mkt/akvezlekjpr/Three.PNG)
CHART: JPMorgan Real Yield and Demographics Chart (https://fingfx.thomsonreuters.com/gfx/mkt/zgpomdagzpd/Two.PNG)
BACK TO THE FUTURE
Given these metrics, a return to the 1980s could lift real US Agg yields by around 5% by the end of the decade, from the current negative.
The implications of this change in the valuations of all asset markets could be immense.
To be fair to JPMorgan, they’ve paired the paper with another showing how errors in long-term, or 10-year, economic forecasts over the past 40 years tend to be large and overly optimistic and better in real terms than nominal. .
Actual 10-year Treasury yields have historically been lower than expected 10-year yields and the 2032 consensus expects them to remain below 1%. In this context, a real return of 5% would be a real shock.
Yet at a time when many asset managers are compiling “age-old” five-year outlooks that aim to see beyond current inflation, politics and economic headaches, the demographic question is central to where you see the world reappear.
And not everyone is convinced that the situation has changed so much.
Giant bond manager Pimco concluded this week that while the world is past the “new normal” of the teenage years, it is only entering a “new neutral period” where low real rates will persist.
“The secular factors that have driven neutral policy rates down – including demographics, the global savings glut and high debt levels – will likely continue to anchor policy rates at low levels,” wrote Joachim Fels, Andrew Balls and Dan Ivascyn of Pimco in their five-year outlook.
Nominal Treasury yields could be higher due to greater macroeconomic and inflationary volatility, they added, and investor demand for higher “term premiums” to compensate for holding bonds in the long periods.
But would a shocking revaluation of real yields according to the JPMorgan model have such a significant impact on stock markets?
This would certainly be in line with long-term historical studies that suggest stock prices need to go much lower than the more than 20% they have experienced so far in this bear market.
Solomon Tadesse, a quantitative analyst at Societe Generale, has looked at market crises and rallies over the past 150 years and concluded that the S&P500 needs to lose another around 15% from today to be consistent with the level of the markets. previous valuations during this period.
But if real returns of 5% were on the horizon, that might just be the start.
GRAPHIC: Societe Generale graph on market crises (https://fingfx.thomsonreuters.com/gfx/mkt/gdvzygkokpw/One.PNG)
CHART: 40 years of bull market (https://fingfx.thomsonreuters.com/gfx/mkt/byvrjamynve/Four.PNG)
The author is chief financial and markets editor at Reuters News. All opinions expressed here are his own.