Ageing and Financial Markets - Going for Yield?
I did a brief entry on this subject about a week ago which dealt with a recent speech by the governor of the Bank of Finland. It spurred me to continue to work on this since I find it to be an important piece of the grand puzzle which is the global economy. As such, it has turned into a longer note over at GEM. Here is my summary;
In this note I have reflected on the effect of ageing on financial markets. Ageing is not, of course, the only determinant of the evolution in financial markets but given the trajectory of the process in the developed world it is likely to have a significant impact. Many commentators have pointed to the transition towards a process of rapid dissavings where households and most notably retiring baby-boomers realize their assets at great pace. I have tried to nuance and qualify that claim.
Firstly, I talked about the supply of and demand for sovereign debt in the light of Stephen Jen's hypothesis of a shortage of assets. Apart from Jen's point that the recent years of extraordinary strong economic growth have deterred, or removed the need as it were, for economies to issue new bulks of sovereign debt (save most notably the US), ageing itself, I think, is already having a strong impact on the issuance of sovereign debt. This is particularly the case in countries where ageing has already entered the prolonged stage where the countries in question will find it very difficult to issue more debt. Also for example under the EMU framework there are very concrete institutional boundaries as to the issuance of debt beyond a long term threshold of 60% of GDP, which of course is a level that could be nudged upwards more or less at will (or perhaps as part of a battle of wills between the EU Commission and the ECB).
Secondly, I noted the situation of Bretton Woods II where some energy exporters and key emerging markets have piled up massive amounts of reserves, a situation which does not make it likely that we will see substantial issuance of sovereign debt from this angle either. Instead, these countries are pushing yields down - most notably on US treasuries - as a result of their dollar (or whatever) peg. On equity markets SWFs are bound to make their presence felt to an even greater extent. More specifically on equity markets it is difficult to see a direct impact on the supply of equities as a result of ageing. However, as with pension funds and ageing, retail investors hungry for yield are moving more aggressively into equities, and thus demand could potentially outstrip supply on a long term basis thus pushing up valuations, especially if the current wave of private equity deals continue along the same path. Another point here are the IPOs and also M&As in emerging markets where there seems plenty of room for increased capital deepening which could push the supply of assets up.
On balance I think that there are reasons to believe that ageing will affect financial markets in the following ways. First of all ageing will most likely increase the demand for assets, and more specifically for yield, and this in turn will mean that ageing also will be a source of global liquidity. Another point which is of note is how ageing might influence financial markets indirectly by prompting governments to intervene. As such, and even though it does not form part of my general analysis, the paper (noted above) by W Todd Groome, Nicolas Blancher, Parmeshwar Ramlogan and Oksana Khadarina from the Australian Reserve Bank offers the proposal that governments act alongside financial markets to insure and essentially hedge against longevity risks associated with ageing. More generally, and in the same tune, the paper speaks of 'financial innovation' as a way to deal with the obvious financial risk associated with ageing. Finally, and very much to the point I think, the financial literacy of households needs to increase, especially in a world where the challenges of ageing to an increasing degree will rest on the individual household.
*In this note I have left out detailed description of the increase in leverage and sophisticated structured products. This is clearly a caveat, but to the extent that these instruments are important (I think that they are) I believe a seperate note
should be devoted to them.