Thoughts On 'Mind The (Expectations) Gap: Demographic Trends And GDP'

There, I got your attention.

I find that when I start an article with the word “demographics,” eyes glaze over. But when I start the same article with “sex,” the reader snaps to attention. Funny how that works.

Yet in the context of the economy and the financial markets, they are the same thing. Consumer spending is roughly 70% of the economy according to the official GDP numbers. But the reality is that it is responsible for 100% of our economic activity. Adam Smith commented in The Wealth of Nations that “Consumption is the sole end and purpose of all production,” and he was spot on. Everything—investment in productive capacity, business-to-business spending, government spending, etc.—eventually flows down to consumer spending. And the biggest factors that influence our spending habits are family formation and stage of life.

Think of it like this. A young man spends his money attracting a mate…a man in early middle age spends his money raising the resulting offspring…a man in late middle age saves his money in preparation for retirement…and an older man doesn’t spend much on anything.

Oversimplified? Absolutely. But you get the point I’m making. Our age is a major factor in our spending habits as individual families.

Why does this matter? Because if it is true of individual families, it is also true of the country as a whole. An economy dominated by young families will see high rates of consumer spending and debt growth, whereas an economy dominated by those in late middle age will see slower growth and higher rates of debt repayment.

This is where we are today. America’s Baby Boomers are now on the downward slope of the consumer life cycle. Since the 1960s, they’ve provided economic tailwinds; but those tailwinds have now turned into some pretty harsh headwinds.

I bring all of this up because I saw a guest piece in John Mauldin’s e-letter co-written by Rob Arnott—one of the most respected minds in finance—that reaches the same conclusions (see Mind the (Expectations) Gap: Demographic Trends and GDP).

Arnott focuses more on workforce growth and dependency ratios than on consumer spending patterns (which I consider a case of the tail wagging the dog), but this is a case where all roads lead to Rome. We enjoyed higher-than-normal growth rates in the decades following 1950, and we will now suffer through lower than average growth rates in the decade ahead.

Importantly, we are going to experience growth; Arnott is not a “doom and gloomer” forecasting a multi-decade depression. But it’s going to be a much different environment than what we are used to.

Using Japan as an example, Arnott writes:

It is human nature to consider our personal experience to have been “normal,” so we evaluate subsequent events in comparison with this self-referential “norm.” If the people of Japan consider the former tailwind of 2–3% to be “normal,” then a future 2% headwind will feel like a ponderous 4–5% drag, relative to expectations. On average, the countries in this analysis enjoyed benign demographic profiles that boosted GDP growth by around 1% per year during much of the past six decades. (Read full article here).

What are we to do with this information? In truth, there is no much you can “do” about demographics. They are the future that has already been written. But you can invest accordingly. Understand that top-line sales growth will probably not be as robust as in years past. Earnings per share growth will come disproportionately from share buybacks—as has been the case for the past several years.

Importantly, you should also invest for income. Focus on companies with stable businesses that have a long history of raising their dividends. And, where possible, look for growth in companies that target emerging market consumers and young American families. The Millennials are starting to enter the family formation stage, and this generation will be the primary engine of domestic growth for the next 30 years.