Monday, October 18, 2010

Japan and Aging Populations

Commenting on a several recent articles discussing demographics, and the aging of the population in many countries around the world:

First, on the front page of the New York Times yesterday, there was long article about the long-running economic malaise in Japan. Japan, of course, has been mired in a deflationary, slow growth world for more than 20 years despite massive fiscal and monetary stimulus.

Although I have read and written about Japan frequently over the last few years, what was striking to me was the depressing effect that deflation can have on a society:

But perhaps the most noticeable impact here has been Japan’s crisis of confidence. Just two decades ago, this was a vibrant nation filled with energy and ambition, proud to the point of arrogance and eager to create a new economic order in Asia based on the yen. Today, those high-flying ambitions have been shelved, replaced by weariness and fear of the future, and an almost stifling air of resignation. Japan seems to have pulled into a shell, content to accept its slow fade from the global stage.

What the article does not discuss is the decline in birth rate in Japan, which is slowly becoming an important issue not only in that country but globally as well.

There was the piece in the Times's Business Section talking about aging, and how important a role that demographics can have in determining government finances. This paragraph in particular caught my eye (I have added the highlighting):

For the first time in human history, people aged 65 and over are about to outnumber children under 5. In many countries, older people entitled to government-funded pensions, health services and long-term care will soon outnumber the work force whose taxes help finance those benefits. This demographic shift also means that the number of people living with dementia, whose treatment is estimated to cost $604 billion worldwide this year, is expected to more than triple, to 115 million, by 2050, according to a report this year by Alzheimer’s Disease International, a group representing 73 Alzheimer’s associations around the world.

Slipstream - How Aging Populations May Crimp the World’s Finances -

Besides the effect on government finances, the private sector is obviously affected as well. In particular, many older Americans have viewed their houses as sources of funds if they need money in their later years. However, in the midst of the current housing crunch, a large amount of supply coming from seniors looking to "cash out" could also prolong the decline in housing prices, not to mention the strain it could put on seniors.

So the question for the investor: What should one do to protect your future?

Well, to me at least, common stocks need to play an important role for savers, especially if one has a longer term time horizon. While not screaming "buys" based on current valuations, stocks can offer reasonable returns along with, in many cases, dividend yields that are higher than many higher grade bonds.

But apparently my views are not shared by everyone, according to this morning's Wall Street Journal. Pension funds - pools of cash that should have a very long time horizon, especially given the trend towards longer lives noted in yesterday's Times - are pulling back from stocks:

After making the same kinds of investment blunders as many individuals, corporate pension funds now are seeking the same remedies: fleeing stocks for the perceived safety of bonds.

A growing number of pension managers are concluding their pursuit of maximum returns was a mistake, interviews with managers and consultants show. Instead, many funds are trying to achieve stable returns that more or less keep pace with the plan's obligations.

This to me makes no sense. There were several reports last week that pension plans in the public sector continue to use return assumptions of around 8% in deciding whether they are actuarially sound. With bonds yielding around 3% (unless you're buying much longer maturities), why does an increased allocation to fixed income make sense for a fund with a longer term time horizon?