BLACKROCK INVESTMENT INSTITUTE
Demographic divergence
Demographic divergence is one of the five mega forces that we track. Aging populations in major economies are poised to limit how much countries can produce and grow. By contrast, selected emerging market economies can benefit from younger populations and growing middle classes.
Explore this interactive page and read our latest report, Decoding demographic divergence.
Q: What mega force will most influence the way you invest in 2024?
RICK RIEDER: So, I think there are a couple of things that are big mega forces influencing the markets. One is obviously artificial intelligence that I think is going to be, continue to take productivity technology to the next level. How it impacts inflation is going to be extraordinary. How it affects growth and spend I think’s going to be a big one.
The other one that I would throw out there that I think’s going to be with us next year and going forward is the demographic evolution is extraordinary. I mean, the need for people to get income, a need for spending on healthcare. I mean, all of this, this aging demographic, and you think about how it’s impacting China’s growth, how it’s impacting Japan. Anyway, that’s going to be something that’s going to be very significant.
There are two major mega forces. I would say technology, demographics are going to be big ones next year and I would argue for years to come.
Q: Many investors have been hiding in cash, but it looks like the Fed will be on pause in 2024. Should investors be redeploying it to bonds? Where are the opportunities in fixed income?
RICK RIEDER: So, I think for the first time in a really long time, it’s time you can actually extend out from cash, and I’ve said for a long time this year, you know, sit in things like one-year commercial paper, front end of the yield curve, why take the risk? Fed’s hiking rates.
I think the Fed’s on pause, and I think next year, just to keep real rates where they are in a restrictive way, they need, the Fed has to drop the interest rate 100 basis points or so. You know, if you assume inflation’s coming at 2.5, you know, the real rate, if you think about where the Fed fund’s rated, 5.5-ish, you almost have to get rate down 100 basis points.
For the first time, because of the pressure you’ve seen on interest rates the last couple of years, the convexity, your risk versus return in owning, particularly things in the three-to-five-year part of fixed income, you could absorb still a 100-basis point, even a 200-basis point rate rise now given how much yield and carry there that, boy, I’d start to move some money out the yield curve.
I don’t think you have to go all the way out to 30-year point, but I know for the first time in a while I feel really comfortable that you can take a little bit of risk with a Fed that’s on pause even if they go a little bit more. There’s so much carry in the portfolio, you can absorb that.
Q: How do you manage risk in a fixed-income portfolio with today’s uncertainties?
RICK RIEDER: So, you know, it’s a really different dynamic around risk, and when you think about fixed income today, for years you had to own, you think about for 20, 30 years, interest rates came down, stable inflation. Today, it’s a really different dynamic. I don’t think you need to own long bonds nearly to the extent that we have in the past.
First of all, the treasury’s going to issue an awful lot of debt over the next couple years. I really like, the way you manage risk, is you don’t have to take a lot of beta risk to get income today in fixed income. You could buy high-quality assets, investment-grade credit, agency mortgages, treasuries. Stay in a part of the yield curve five years, and then keep your beta down.
You know, you some emerging markets, you own some high yield, some European credit, that swaps back to dollars at aggressive levels. But you can build a really high-quality portfolio, your carry in your income, just ticks away for you, you know, in such a generous way over the next year or so, that I think you can run a lower level of beta, doesn’t require a lot of risk management, and just clip carry for a while.
And then see where we are six months from now, nine months from now. But boy, I, it’s very different than, you know, years past. You had to get a lot of higher, you know, lower graded credit, a lot of risky assets. I just don’t think you have to do that today.
Fixed income opportunities with Rick Rieder
CIO of Global Fixed Income
Aging versus younger economies
Aging populations in major economies are poised to limit how much countries can produce and grow, leaving governments with less tax revenue to support rising retirement and healthcare expenses. Fewer workers likely mean lower corporate profits and higher government debt – unless economies adapt to mitigate these pressures.
We see potential for technology and medical breakthroughs to help offset these risks – and present opportunities. By contrast, selected emerging market economies are poised to benefit from younger populations and growing middle classes.
Aging dilemna
Aging generally poses a bigger challenge for developed markets than emerging markets. The working-age population in high-income economies is set to fall in coming years, whereas it’s poised to jump in low-income economies.
Growth and inflation
All else equal, a shrinking workforce means an economy cannot grow as fast as before. That’s because expanding what a country produces relies on expanding the number of workers and/or expanding how much each worker produces. Governments can try to boost a shrinking workforce by attracting workers from other countries, increasing the share of women and other underrepresented groups in the labor force, and/or raising productivity by investing in automation and artificial intelligence. We think these strategies can provide some offset, but not enough to keep G7 workforces – and economies – growing as fast as before.
Aging could also prove inflationary, in our view. Retirees stop producing economic output but don’t typically spend less. And governments are likely to spend more on healthcare. That means central banks will likely have to keep interest rates higher than before the pandemic – and governments will face higher debt servicing costs at the same time as slowing tax revenues.
Case study: Japan
Japan’s working-age population has been shrinking since 1994. The country didn’t see higher inflation because economic activity was hurt by the bursting of its asset price bubble in the early 1990s. Yet it does give a glimpse of the growth effect: Since 1990, government data show that hours worked in Japan fell as the working-age population peaked and started to shrink. Still, Japan was able to offset some of the fall in working-age population by substantially growing the share of women in the workforce.
Investment implications
Demographic changes – and their effects – will vary across countries. We think that dispersion of outcomes will create plentiful investment opportunities. We believe the key for investors is to be selective and assess what markets have priced in. Research finds they can be slow to price in the impact of even predictable demographic shifts. That looks to be the case now in the U.S. and Europe – and is why we like the healthcare sector in both regions.
Within emerging markets, we see opportunities in those that can best capitalize on their still-growing working-age populations – for example, by improving workforce participation or look to ramp up investment in productive capital, like public infrastructure. That could enable them to outperform what markets have already priced. We think higher returns could be on offer in countries with greater demand for investment – like India, Indonesia, Mexico and Saudi Arabia.
Read more in our Weekly market commentary, Playing demographic divergence now.
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