Odd Lots - How Radical Demographic Shifts Around The World Are Changing How Assets Are Valued

Episode Date: January 22, 2018

When we think about financial assets, we usually think of their price as being derived from some set of intrinsic characteristics. A stock price may be a function of growth, margins, interest rates, and a few other things. For government bonds, we might say that inflation and growth are the big components. It's easy to forget that financial assets are goods sold on a market consisting of humans with their own demand and consumption needs. On this week's Odd Lots, we speak to Amlan Roy, Global Chief Retirement Strategist at State Street Global Advisors, about how radical changes to demographics all over the world has changed the supply and demand framework for financial assets, and thus the price of government bonds.See omnystudio.com/listener for privacy information.

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And I'm Joe Wisenthal. Joe, I am looking at a chart of the 10-year U.S. Treasury. The yield? No, you're not. I'm not actually. You know how I know you're not? Because we're actually sat together for once. Yeah, we're actually in studio together.

So normally we're on the phone. The last time we recorded an episode in studio together, I think we were both in London. Now we briefly crossed paths in New York. Yeah, which is a nice change. Okay, so I am not actually looking at a chart of the U.S. 10 year. But I'm imagining you looking at a chart of the U.S. 10 years. I'm visualizing the chart.

I can see the yield. It's above 2.6 percent for the first time in years, really. Is it yours? No, it's March 2017. It's really only a year. But nonetheless, it has been a sharp move up. And if we continue this sharp move up, we could soon see multi-year highs in long-term interest rates. Right.

So whenever we have. a spike in U.S. interest rates. We get a bunch of people who come out of the woodworks and start talking about the end of the 30-year bull market in government bonds. Yeah, this is something that if you're in markets, you know all about that the U.S. Treasury market has been in almost a nonstop bull market since the early 80s with yields grinding lower and lower. You know, I think to the outside world, when you hear bull and bear market, you think about the stock market and sometimes we're in a bull market and sometimes we're in a bear market. But amidst all these changing economic conditions, the bond bull market has been virtually nonstop for about three decades. Yeah, for most of our lives, basically. Yeah.

Now, whenever you get people talking about the end of the great bull market in government bonds, you also get people who start talking about demographics, which you wouldn't necessarily think about when you think about U.S. treasuries, government bonds. No, but I guess it makes sense because if a bull market could persist through changing economic conditions, that. And naturally, there is an inclination to look for structural explanations that could explain why something is persisting even when the economy is up and down. Right. So the kernel of the argument, why the bull market and bonds will never end because of demographics is usually we're going to have all these aging people and they're going to need assets in one form or another as they enter retirement. And those assets are most likely to be U.S. Treasuries and that will lend itself to some long-term demand for the assets.

I promise you it's more interesting than I just made it sound. Well, I'm very interested, but could it really be that easy? Can we really say, oh, a bunch of people are retiring and they're going to have to buy financial assets and they'll buy bonds? Like, that almost seems like it's free money. Well, I have the perfect person to ask this question. Our guest for this episode is Amlin Roy. He is chief retirement strategist over at State Street Global Advisors. And can I just say, before I bring him on, shout out to Bloomberg intelligence.

as Ira Jersey, our chief U.S. rate strategist for suggesting Amlan as a guest. So Amlin, thank you so much for joining us. Thank you for inviting me, Tracy and Joe. It's a pleasure to be on your show. Amlin, tell us a little bit about what you do. Before we get into the bond bull market and the structural reasons for it, what is your background? What is your area of study? I am a former academic specialized in asset prices, but for the last 18 years, I've been doing research, building macro models to try and understand demographics and pensions. So I started this in Credit Suisse about in 2000.

It started off as public policy advisory to governments of how to deal with the demographics time bomb, i.e. a growing mass of old people to be supported by a shrinking mass of young people. And then over time, I extended it to trying to understand growth rates, fiscal sustainability, and expanded the universe of interest to so-called short-term investors, hedge funds, private equity, because I believe that demographics is not just long-term, it is immediate short-term and long-term. And after 19 years at Credit Suisse, I had the privilege of moving to the buy side last year and in a similar role, but looking at global retirement promises across the world for private pension plans,

for public pension plans, also understanding demographics for sovereign wealth funds, endowments, and charitable foundations. So that's what I do. But my role is global and I'm very, very happy to learn globally from investors and people like you. So a specialist in asset valuations and demographics sounds like the perfect guest. Yeah, I would broadly agree with that. But, okay, so I have to ask. So you were specializing in asset prices.

So was demographics a natural jump for you? is the impact of demographics on asset prices that pronounced? Absolutely not. It came as a surprise to me. I used to do emerging markets currencies for 36 countries and teach derivatives and asset pricing. So it came as a shock. But the way I've evolved and looked at demographics

has become quite innovative because it plays to two of my strengths. I'm a macroeconomics professor who looked at growth and why countries grow faster than others and some other countries go slower. At the same time, I was teaching finance. of derivatives, asset pricing. So I said, when people said, do demographics, I said, let's try and understand why countries

are growing faster than others, how demographics plays to it. And that's when I discovered that a lot of what I taught in asset pricing in macroeconomics missed out on understanding demographics because economists, investors, actually took a very distorted and a very nuanced, narrow view of demographics. demographics, I went to the English lexicon to understand where does the term come from. Demos's people, Grapherst's characteristics. Nowhere is there a reference to something called age. So if you consider Demos and Graphos, to me, the most important characteristic of Joe or you or myself is that from the time we are born until the date we die, we are consumers.

There are 7.55 billion consumers today in the world. a baby born in Mass General as a consumer, so is the oldest living woman in Okinawa, Japan, aged 113. They are consuming different things. Then if we look at three of us, we are also workers. Workers contribute to GDP and consumers consume about 70% of GDP. And I want to quote the biggest management guru of 20th century who highlighted this in a way, but we as economists didn't pay attention. He's also called the biggest pensions guru of the world.

His name is Peter Drucker. He said in management challenges for the 21st century, demographics is the single most important factor we don't pay attention to, but when we do pay attention, we miss the point. And that's because all of us contrived of this framework where we thought demographics is all about age. Rather, I think it's about consumers and workers, and that makes it much more interesting because consumers are people for a company who give revenues to companies and workers are costs. If you look at it that way, demographics affects income statement and balance sheets for individuals, households, corporates, and nations. And I've managed to connect it to heterogeneity, asset prices, robotics, geopolitics, discount rates, et cetera, and previous research that I've done. So we're all consumers. And that term consumer, one thing I think we consume is, and in different ways throughout our life, is we consume financial assets. We buy financial assets so that we have them later in life. So how much is this aspect of our consumption understood, or more specifically, how important

is this aspect in understanding the link between demographics and financial asset prices? Brilliant question, Joe. And I will tell you something that we all got wrong, everybody in financial markets. And that is that we decided to classify all the consumers into three age groups. And this is what Sam Wilson, Modigliani, Merton, all of us. and I taught for 20 years that between zero to T, there are three types of life cycle that we go through. Young non-workers, which is zero to 15, workers 16 to 64, and the retirees who are 65 plus. But we've missed out on a very, very, very, very important thing.

That is that the retirees fall into two groups, young retirees, 65 to 79, and old retirees who are 80 plus. The 80 plus behave very, very differently than the young retirees. And the 80 plus population in the world is the fastest growing population over the last 45 years from 1970. They've grown at 400% when the whole world population has only grown by 100%. Let me take it down to markets. In Japan, the 80 plus population in 1970 was 1%. In 2015, it's 8%. So they've grown 8fold.

In U.S., they were 2%. It's double to 4%. In Italy, it was 2%. It's gone to 7%. The question you should say is, Why should we care, Amlan? We should care because in 1970, Japan's debt to GDP was roughly about 43%. Today, Japan's debt to GDP is roughly about 260%.

And a lot of it is attributed to the very fact that these old people are very expensive, much more expensive than the young retirees, and they are growing at a very fast rate. And that's a universal change. The fastest growing is Hong Kong, where there's been a change of 3,800-plus percent. Singapore, 1900 percent, and in the world we've seen a change of 400 percent, Japan with roughly about 700 percent of increase. And we need to disentangle the fact that these older retirees are not buying the same kind of financial assets as the 65 to 79 year olds. And that is quite, quite important because when I look at the share of the, a lot of people talk about the 100-year-life,

when I look at the share of the 100-plus population, that's hardly 0.14.4%. in Japan and 0.03% in US. But when I look at the share of the 80 plus population in Japan, that's where we see that it's projected to grow from somewhere close to 8% to 12% in about 20 years' time, and it's close to about 1%, 4%, 6% in countries such as Italy. And that's a very, very major thing. We need to disentangle the very old retirees from the young retirees. Now let's move to Joe's question. What we said is baby boomers born between 1946 to 64, and I taught this, and part of it is wrong, and I corrected it in 2001, 2002, once I started learning a bit more of demographics. We said that the older retirees, the first baby boomers, will start turning 65 around 2011 or so,

and once they start turning 65, they will take all their equities, move into Treasury bills and cash and there'll be a big stock market meltdown. I raised three questions and so did people like Robin Brooks and Goldman Sachs and we and Milton Friedman and others saying that that was common folklore. My question was, who would they sell it to? A huge big generation of baby boomers to a smaller generation of other people. What kind of prices will they get? Second, I want you people to popularize a question which I've been asking and no one's answered and the question I'm going to put in the following way. Joe says, Amlan, you're age 65.

You need to retire. Tracy says, I've got the best inside line to God. You will die when you're aged 85. My simple question to the whole world is 20 years is post-retirement. How much money do I need for 20 years of post-retirement? Can anyone answer that question? And the answer to me is no, because we don't know inflation. We don't know healthcare expenses, which are MSME Parkinson influenced.

We also don't know how GDP growth is going to behave. We don't know what's going to happen to the equity premium. So I claim that the biggest mistake of corporate governance over the last 100 years has been long-term promises made on DV pensions, when no one even can guarantee me what my salary increase next three years is going to be. How can you tell me that 20 years later I'm going to get paid X, Y or Z? So if we can't answer questions over long-term horizons, we should not make long-term promises. And this is why Peter Drucker in his book, Unseen Revolution. the pensions revolution said that these long-term promises aren't sustainable,

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But, Amlin, I'm still fascinated by the impact of demographics on asset prices. So when you look at demographics from this much more nuanced view and from a sort of consumer behavior view, how does that change the overall picture of the idea that you're going to have a bunch of old people who are going to need longer term safer assets? Very good question. And I'm going to take you to safer assets have to come, but we are in a world of low growth. And low growth is linked to demographics. And one of the key paradigms, to understand growth is a framework developed by the ECB, which I use a lot over the last 10, 12 years. It says GDP growth comes from three components. Working age population growth. How have the people between the working age group consider it 16 to 64, 20 to 65 grown? Second is labor productivity growth.

And third is labor utilization growth. If you were to be able to predict these three components, you could add and get GDP growth. And I've done analysis looking at GDP growth across the G6 countries, which is U.S., UK, France, Italy, Japan. And across all these countries, the biggest reason why we've seen a decline in growth over the last 10, 15 years, has been declined in labor productivity growth. And labor productivity growth is defined as real GDP divided by ours' work. So growth in real GDP divided by ours worked. And all over the world, we are seeing that this is the culprit for lower GDP growth. And I have a very simple solution to increase GDP growth because if the GDP growth pile increases,

then savings will increase. And that savings can then be used to defray income from those savings towards paying for retirement promises. And to increase labor productivity growth, you need to do just two things. Increase female labor force participation growth and increase youth labor progress. participation growth. So to me, GDP growth is suffering because these two components, youth unemployment is at an all-time high, and I show that there's a big gender gap, even in countries like U.S. and U.K., which is 12, 13 percent, and there's also a wage gap. So on average, women in UK and U.S. gets paid, let's say, a dollar, then the male gets paid 50 percent

more. In Japan, the male gets paid 130 percent more. In France and Germany, it's 50, 60% more, but in Nordic countries, the gap is hardly 10%. So I claim that we need to close the gender gap and we need to deal with youth unemployment, which people haven't paid enough attention to. And youth unemployment has come about largely because of two reasons. A global workforce where you've taken an immigrants and the impact of technology. In terms of savings, to pay for people, the big uncertainty is, if I'm at age 65, how much will I live? Again, finance and economics has been quite wrong in focusing on life expectancy at birth.

What we should focus on is life expectancy at age 60, 65, 70, 75. And that has been expanding. Because of that uncertainty, a lot of people who are baby boomers expecting to retire at 2011, 2012, have extended. And we claimed in the demographic manifesto, that's what should happen. So in countries like Japan, in countries like Sweden, in countries like Korea, people are working beyond their official retirement age, not because somebody's holding a gun to their head, but rather they realize that they don't have enough money to last out the uncertain 20, 25 years. So the big picture, you know, sort of combining some of these trends that you've identified, you know, we started off the conversation talking about the sort of unquenchable thirst for. or safe assets, the great bond bull market that's last since the early 80s, how much would you say these trends have contributed to that? And then is there anything on the horizon that could say

this is going to end? Or will, is this just another false dawn for the bond bears? Brilliant question. So I go back to what we taught our students. And again, I claim finance theory of the 60s, 70s, 80s is flawed because it didn't consider the fact that rates would be low and real rates would be negative. So typically insurance companies and pension funds were told in the 60s, 70s, 80s, we learned and we taught our students that for long-dated liabilities, so you retire at 60, you have got a 20-year liability or you retire at 50, you've got a 30-year liability. To meet long-term liabilities, the safe assets were considered to be long-term bonds. But at that time, the long-term bonds were giving you three, four, five percent in real terms were giving you sometimes seven, eight,

10% in nominal terms. Today, when government bonds, I will say, are giving you negative real returns, I would claim they should not even be considered the admissible asset to match liabilities. What we should do is broaden the universe of fixed income to include things which give better returns, such as emerging market bonds, such as high yield bonds, such as credit. But because they are risk here, we need to do some risk management. and therefore, I do believe that the right assets are not long-term bonds giving you negative real returns. There's another aspect to it, and this was my biggest call in 2001.

The day the U.S. Treasury said no more 30-year bond issuance, I was on the west coast of California meeting the biggest bond and equity investors where I made a call that U.S. will come back and reissue 30-year bonds, and the supply of 30-year-plus bonds in the G10 countries is roughly 1-7th the demand of long-term bonds. So if the demand for long-term bonds is so much higher coming from pension funds, reinsurers and insurers, then the price of the long-term bond will be high, and the yield at that time used to be 4%. I made a prediction will go from 4 to 3 to 2 for the 30-year bond. Now there's been a bit more pickup in supply of longer-term bonds. Demand for long-term bonds yet hasn't fallen that much.

So we are seeing a little bit of a pickup. But ultimately, we forget the fact that long-term demand and supply are affected by behavior, are affected by supply affected by what the debt management office of UK does relative to the U.S. Treasury, relative to Germany and Japan. They all behave in slightly different ways. And that is going to drive the yields, and we should not forget that. So, Amlin, I have a sort of theoretical question, but you brought up the 30-year bond. And if we know that we have this expanding group of old people who will need a certain amount of safe assets,

should we be creating more assets to satisfy them? And do those assets necessarily have to come in the form of a longer-term government debt? Excellent question. I attended a lunch with the debt management office of UK and Germany just a few days ago. And the answer to your second part of your question is not every government has the appetite and the inclination to issue 50, 60, 70 year bonds which have been issued by Japan, which have been issued by UK, but have not been issued by Germany and few other countries. So countries which don't issue all these longer-term bonds can oftentimes manage with 10 and 30,

then they have to be very active in terms of rolling them over, in terms of managing them, and in terms of understanding that the demand dynamics of the shorter-term bond instruments, if they are 10 or 15, will be very different than 30- or a 50-year bond instrument. Now, I do believe, and this is what I've been going and speaking to treasuries over last 8, 10 years about, that whether it's Netherlands, whether it's Germany, whether it's Switzerland, we should be issuing a lot more long-dated bonds because it's easier to try to match a 30-year employees, probably 60-year liability rather than trying to match it using rolling over 20-year bonds to get 60 years. So I do think that there needs to be, but it depends, again,

on the appetite of governments. My personal view is we should be having more inflation-linked long-term bonds, just like the tips, like the OATs, as well as the GILS, because once inflation kicks up, which I expect it to, hopefully if we go back to normal conditions, I consider these conditions to be abnormal, disequilibrium conditions that central bankers, and we have never seen before earlier, and we don't know how to deal with properly, and that's why we've taken so long to recover from what I call the global financial crisis. I do not ascribe to the term of great recession on this, though. Right. Amlin, I'm afraid we're going to have to leave it there. Amlin, Roy, from State Street Global Advisors. Thanks, Amlin. That was absolutely fascinating. Really

appreciate you coming out. Okay. Thank you, guys. Joe, that was a really interesting conversation about demographics, the longer term impact on asset markets. And I got to say, I liked Amlin's point about markets are essentially about selling something to someone. There is a consumer out there buying these goods or securities. I think that's really easy to forget. So we talk about a bond and we say, okay, well, inflation is this and GDP is this. We talk about a stock and we say earnings are this and growth rate is this and competitive landscape is this. But there's also a supply of the asset and someone has to buy it and people have needs and they have to plan for those retirement needs. And if you look at assets in isolation and not think about the market

where real humans need to accumulate these assets, it sounds like you miss a pretty big aspect of it. Yeah. And the other point I think he made is that we have had this massive demographic change where we have just a lot more older people who are living for longer. And our financial market hasn't necessarily evolved in step with that demographic change. So he used the example of the 30-year U.S. Treasury. I feel like we could be more creative when it comes to meeting that demographic problem. Like, why do we just need to be focused on longer-term U.S. government debt? Surely there's a banker out there who is coming up with some really esoteric, exotic thing to meet retirement needs. We should do an episode soon specifically on annuities.

And because the people who run that stuff think a lot about very specifically about these questions. And I think we could dive a lot more into the aspect of what changing demographics mean for sort of planning people's future financial security. Oddlots, the retirement series. Let's do a series. I can see our producer looking worried in the corner. Looking skeptical. All right. That is it for this episode of the OddLLot.

podcast, I'm Tracy Allaway. You can follow me on Twitter at Tracy Allaway. And I'm Joe Wisenthal. You can follow me on Twitter at the stalwart and follow our producer, Tofor Forges at Forrest T. And the Bloomberg head of podcasts, Francesca Levy at Francesca Today. On April 4th, 2023, around two in the morning, a man was found stabbed multiple times on a sidewalk in downtown San Francisco. Hey, who did this to you? What happened next turned the story into a political firestorm. Reports have identified the victim as Bob Lee, the founder of Cash App.

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