Playing Demographic Divergence Now

Transcript

The number of people of working age is shrinking across developed markets but still growing in emerging markets.

Demographic divergence is a mega force, or a big structural shift, that we see driving sector and company dispersion.

1) Developed markets’ demographic challenge

By 2050, one in six people globally will be over the age of 65, up from one in 11 in 2019.

In developed markets, fewer workers mean slower economic growth, higher inflation and increasing debt due to healthcare and pension spending.

2) Favoring emerging markets

Including more foreign workers, women and people over 65 in the workforce can offset some of the impact of aging – but not completely, we think. That means slower future growth in developed markets.

Instead, emerging markets like India and Mexico could benefit from a working-age population that is still growing.

3) Opportunities in spending shifts

Older populations spend differently than younger ones. That changes the outlook for individual sectors and companies.

Markets are typically slower to price in those shifts than the broad country growth outlook.

Here’s our Market take

We prefer developed markets that are better adapting to aging and emerging markers capitalizing on younger populations.

We lean into sectors like healthcare that stand to benefit from new spending patterns.

Mind the DM-EM gap

Change in domestic working-age population, next 20 years vs. past 20 years

Forward-looking estimates may not come to pass. Source: BlackRock Investment Institute, United Nations, with data from Haver Analytics, April 2024. Notes: The chart shows the percentage change in the domestic working-age population (aged 15-64), 2003-2023 vs. 2024-2044. The domestic working-age population is calculated by subtracting the UN’s migration projections from the UN’s population projections that include migration, assuming the overall age structure does not change.

Life expectancy is rising and birth rates are falling across the globe. In many DMs, that means the working-age population is set to shrink over the next 20 years. See the chart. That has vast macro implications. Fewer workers means slower growth. It is also inflationary, in our view. Retirees stop producing economic output, but do not typically spend less, historical data show. Plus, governments are likely to spend more on healthcare and pensions. The resulting inflationary pressure is one reason why we expect central bank policy rates to stay above pre-pandemic levels. Aging-related spending also threatens to push up government debt, with global public debt having already tripled since the mid-1970s to 92% of global GDP in 2022. And that debt is likely to be subject to higher interest costs. The economic picture looks quite different in EMs, like India, where the working-age population is still growing.

We think the broad growth impact of diverging population trends is well understood by markets. Yet as we outline in our new research paper, countries can respond differently – creating an uncertain outlook. We believe this will affect asset prices as markets adjust to how countries adapt. Within EMs, we seek those more likely to capitalize on their demographic advantage by bringing more working-age people into the workforce or that look to ramp up investment in productive capital, like public infrastructure. Growing populations consume more energy, so we expect rising spending on energy infrastructure in places like India and Indonesia. We think higher returns are likely in EMs with stronger growth and greater investment demand.

Seeking winners across countries and sectors

In DMs, we look for those that could better adapt and outperform the growth outlook markets have priced. DMs can mitigate the hit to growth by finding more workers – from other countries, or among women and other groups underrepresented in the workforce. Japan has somewhat lessened the impact of aging by substantially raising female participation. The recent immigration surge in the U.S., UK and Canada is boosting their workforces, as reflected in last week’s bumper U.S. jobs report, but it would have to persist for years to fully offset working-age population declines – unlikely, in our view. We’re monitoring how much artificial intelligence (AI) can boost the productivity of a smaller workforce.

Even less understood by markets, we believe, is the sectoral impact of mega forces – or big structural shifts driving returns. Older populations spend differently than younger ones. For example, healthcare spending rises with age. Real estate demand could change since older people typically move less frequently. Yet research shows even predictable spending shifts are not priced in until they hit. That was true for healthcare in Japan, where valuations have risen broadly in lockstep with the well-signposted growth of the country’s retired population. That appears true now in the U.S. and Europe – one reason we like healthcare in both regions. We also think AI names will benefit from investment in automation to boost worker productivity.

Our bottom line

In EM, we favor countries best able to capitalize on their demographic advantage. We prefer DMs whose responses to aging could be underappreciated. We target sectors and firms poised to benefit from new spending patterns.

Market backdrop

The S&P 500 dipped 1% last week but was near a record high and 10-year Treasury yields jumped to their highs of the year near 4.40%. The March U.S. payrolls data showed job gains easily beating expectations. We think this reflects an unexpected surge in immigration helping expand the workforce. Markets are pricing in between two and three quarter-point Fed rate cuts this year. We think June is no longer a given for the Fed to start cutting rates – but see rate cuts coming as inflation falls.

U.S. inflation data is in focus this week. We expect inflation to fall toward the Federal Reserve’s 2% policy target this year as goods prices keep falling from pandemic highs. Yet we still see inflation on a rollercoaster back up in 2025, led by stubborn services inflation. We think core inflation will settle closer to 3% – higher than pre-pandemic levels. We watch for the European Central Bank (ECB) to give more clues on the timing of rate cuts at next week’s policy meeting.