Just Do The Math: Why Demographics Means Thinking Long-Term

We remember looking at demographic charts back in the 1990s which compared the population of the peak borrowing age group (28-40) with the peak savings age group (49-62). At that time, 10-year Treasury bonds were still yielding 7.5-8% and investors wondered where interest rates were going. As we look at the chart below, you can see that when baby boomers moved from peak borrowing (around 40 years of age) to peak saving age (around 58 years old), their sheer numbers would cause interest rates to plummet.

(Click on image to enlarge)

Source: Fundstrat, “The Long Game,” 2019 Strategy.

And boy have they ever plummeted to today’s rates around 2.5 to 3%. When 79 million savers replaced 44 million savers, the supply of savings increased massively. When 66 million borrowers replaced 79 million borrowers, the demand for borrowing went down. When supply goes way up and demand declines, prices fall. The interest rate is the price of money. Here is the chart of interest rates from March 1, 1994 to today:

(Click on image to enlarge)

Source: Bloomberg.

There are 74 million baby boomers leaving the savings mode in retirement, who are being replaced by approximately 66 million Gen-X savers in the peak income years. Those 66 million former borrowers are being replaced by 95 million borrowing-age millennials between now and 2038. Just do the math! This is almost exactly the opposite circumstance to 1994. Is it different this time or are rates headed higher the next 10 to 15 years?

How do rising interest rates affect long-duration common stock ownership? First, interest rates go up because capital is being demanded. Historically, mortgage debt makes up 70% of U.S. household debt. Therefore, the primary driver of rising interest rates is household formation. When 96 million people want a home and they are replacing 66 million who came through before them, home building and renovation become an extremely popular industry and sector.

Second, when demographics create economic growth and capital gets significantly more expensive, investors shift their focus from craving hard to come by revenue growth and move to the secular tailwind behind profitable companies who meet the demographic-demanded products and services. Earnings and free-cash flow growth replace price-to earnings (P/E) ratio expansion as the driver behind stock price movements.

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Disclosure: This article contains information and opinions based on data obtained from reliable sources, which is current as of the publication date, and does not constitute a recommendation ...

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