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Sunday, 13 December 2009

The IPOD Generation (Indebted, Pressured, Over taxed, Depressed)

Paul Kedrosky has just written a widely cited piece on the subject of contrarianism. The inspiration, he says, came from an article in the New York  magazine, on the subject of counterintuitive thought. Writers, like Malcolm Gladwell, have become rich and famous popularising this style of thinking. 

In finance, we worship the counterintuitive and the contrarian. Think of John Paulson, George Soros, and the late Jimmy Goldsmith, each of whom became as rich as, well: Paulson, Soros and Goldsmith. They had the nerve to take huge contrarian bets while the rest of us scratched our heads and bottled it. 

Kedrosky’s believes that contrarianism is the new consensus, which is a shame because most of time it doesn’t work. Contrarians might make interesting dinner party guests and they certainly goose up dull investor conferences, but they are seldom right. At least, they are seldom right in a time frame that is useful. Contrarianism only works, he says, when you arrive at a turning point. He has stuck the drill into a nerve hasn’t he? We have just entered the forecasting season, when strategists and economists give their predictions for the coming year.  

Turning Points
Kedrosky is right, trends do stay in place for much longer than most realise. The great bull market of 1982 to 1999, being a case in point. I entered the stock market in 1986 and throughout my career there were always a number of very clever people predicting the demise of the US consumer. They were right, eventually, like after more than twenty years later.

Where, though, are we now? The main reason why so many of us are nervous must certainly have something to do with the increase pace of change we experience in our lives. The influence of technology is certainly one reason for this. There are around 1.7bn internet users to day and 4.3bn mobile phone users.  Within five years there will be more than 3bn internet users and most of those will connect to the network from a mobile device. Linked to this great cycle of connectivity is the burst we are experiencing in social networking. Facebook was only created in the first years of the current decade, yet it already has more than 300m subscribers.

Our global population is becoming more intimately linked and as result fear and ecstasy can zip around the globe in the click of a mouse. In parallel to what is happening in cyber space there is the breakneck pace of change of the real world. In 1960 the global population was 3bn. Today, forty years later, there are more than 6.5bn people alive. This may be the key. When you look at demographics it is extremely easy to believe that we have arrived at a turning point, a fork in the road after which some of those dire predictions, so loved of contra thinkers have more chance of coming true.

Prediction is a fiendishly difficult task to get right, in fact it is impossible to consistently get right. However, when you look at population the numbers are large and the pace of change is slow. We therefore have more chance of being right, or at the very least, being wrong, but in the right direction. 

Over the course of the last century we have experienced two over arching mega cycles. Demographic change and the steady and continuous march of technological innovation.
When it comes to demographics, as we have seen, population growth has been explosive. As a result of this growth millions of young people have joined the workforce and helped increase GDP growth. In addition, the workforce got a boost from the number of women entering employment. In the US, in 1970, 40% of woman were in some form of employment. By this decade that had risen to 70%. 

Population growth and an explosion in the rate of female employment are two of the main reasons that wealth increased in developed countries like the US. These are megatrends. Another megatrend, which boosted wealth, was an increase in the number of hours worked. On average, Americans today work two weeks longer than they did in 1970. 

The next megatrend that boosted GDP has been the increased availability of credit and rising property prices. Consumers have been able to use the rising value of their homes to raise money.

The last megatrend, as we suggested above, has been technology. According to George Magnus, in a recently published book called, The Age of Aging, the only one of the megatrends that can continue is technology. We have arrived at the mother of all turning points. 

The iPod Generation
Many of you will have come across Magnus in his role as UBS’s senior economist. I worked with him briefly, in the mid 1980s, when he was the chain smoking economist at Chase Manhattan, where he was teamed with Gavin Davies, who then went on to fame and fortune at Goldman Sachs. 

Magnus’s focus in his book is the Boomerangst generation, which is the generation who will have to clear up the mess made by the Baby Boomers. A subset of the Boomerangsters is the cohort that was born during the 1980s and 1990s, which Magnus calls the iPod generation. That is iPod as in: Insecure, Pressured, Over Taxed and Debt ridden. I so wish I had thought of that.

The iPod generation has a lot to worry about. In the UK, according to a study carried out by Credit Action, 7.5 million, or 40% of parents had to help their children pay off their debts. Another survey, by the Nationwide gives a clue as to why: in 1997 the average cost of a house for a first time buyer represented 2.5 times their salary. Today that number has risen to 5.23 times. 

In the US two thirds of 20 year-olds have debts. The average debt for the group aged between 22yrs to 29yrs was $16,120 as of August 2006. The fastest growing volume of debt was for those who had borrowed more than $20,000.

Overindulged and over nurtured the iPod generation are not well equipped for the new reality: 15% of 18 to 24 year-olds think an ISA is an add-on for an iPod. Weep? Now cry, 10% of them think it’s an energy drink. 

Global View
One Magnus’s key points is the aging and the shrinking of the workforce. This, together with increases in life span, will affect the dependency ratio. The dependency ratio measures those in the working age group, between 15 and 64, and compared to those who are dependent upon them for support. Dependents are children and the old. In the West the declining birth rate has resulted in a drop in in the proportion of young dependents. However, the increase in life span has resulted in an increase in older dependents.

According to data that Magnus quotes from Ronald Lee, the total dependency ratio hasn’t changed much in over 300 years. But, as Magnus explains, that overall number hides a very important change. The reason the overall number is not expected to change much in future years  is,  as we have seen, child dependency is falling. By contrast, the number of old dependents is rising rapidly. It is forecast to increase from 23% to 45%. Just examine what this will do to health care costs. More than half the total amount spent on a person’s healthcare occurs in the last five years of life.

Taken globally, the proportion of the population that is over 65 will rise from 7% today, to 16% by 2050. However, when you look at individual countries the change is more stark, more worrying. Japan is at the forefront. Today, there are 3.4 people of working age to support each person over the age of 65. By 2050 that number drops to an astonishing 1.3. Two things will have to happen to counter this. Either Japan allows more immigrants in, or the right investor will find the right robotics company and make out like King Midas.

The changes in European dependency rates are also sobering,  particularly for Italy, Spain, France and Germany. For America, because of the high levels of immigration, the change is more benign. In China today, there are 9.5 workers to support each of the over 65 group. Another encouraging sign for China is that the work force will continue to rise over the coming ten years. However, after that it starts to go pear shaped rapidly. The dependency rate will drop to 2.5 by 2050.  

We appear to have arrived at a demographic turning point. Maybe that's why so many contrarians are starting to voice concern.

The complete version of this post, together with charts, was published by Cykepartners

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