The Inflation Cycle of 2002 to 2015 - Uhlmann Price Securities

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Industrial Portfolio Strategy The Inflation Cycle of 2002 to 2015 ⎯ April 19, 2002 -30- Legg Mason Wood Walker, Inc. work force. The huge influx of young and less experienced people joining the U.S. work force in the 1970s contributed to low productivity, as well as the political expediency of higher inflation for the purposes of job creation, in our view. The subsequent rebound of older, more experienced workers relative to young people since 1981 has boosted productivity, but that is nearing a peak, as Exhibit 21 shows. Perhaps it is the glacial pace at which demographic changes progress that causes population trends to be downplayed as a key driver of productivity. But if human capital is related to human experience, then it follows that human capital is cumulative, net of deletions (the retirement or death rate). As a result, our view is that human experience is the base from which productivity grows. Furthermore, we believe that the age 35 to 49 group forms the heart of the economy of any country, since they tend to invest in homes, families, and retirement savings. Our outlook calls for the level of productivity growth to be favorable in the next few years, but then slow appreciably as demographic headwinds emerge. Exhibit 21 – U.S. Productivity Growth Versus Demographic Measures: The Ratio of Experienced Workers to Less Experienced Workers as a Driver For U.S. Productivity Growth 1.25x 1961 age wave peak and productivity peak 2001 age wave peak 4.5% 4.0% 3.5% Ratio of 35 - 49 to 20 - 34 Year Olds 1.00x 0.75x Three-year centered average through 12/31/01 U.S. Census Bureau population estimates 2002 to 2020 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.50x Dec-48 Dec-53 Dec-58 Dec-63 Dec-68 Dec-73 Dec-78 Dec-83 Dec-88 U.S. Productivity Growth Dec-93 Dec-98 Dec-03 Dec-08 Dec-13 Dec-18 1981 = age wave trough and productivity trough 0.0% -0.5% U.S. Ratio of Experienced People Age 35-49 To Less Experienced People Age 20-34 (Left axis) Nonfarm Business Output Per Hour y/y % Change 3-Year Centered Avg. (Right axis) Source: U.S. Bureau of Labor Statistics, U.S. Bureau of the Census The Outlook for Productivity Improvement Overseas That Affects U.S. Competitiveness On an international basis, the demographics of productivity have implications for inflation cycles, profits growth and thus, stock market performance. As we show in Exhibit 22, both Japan and the United States began to show strong economic gains and robust stock markets at precisely the same time that the ratio of 35–49 year olds to 20–34 year olds began to rise rapidly. Japan’s postwar baby boom crested 10 years be-
Industrial Portfolio Strategy The Inflation Cycle of 2002 to 2015 ⎯ April 19, 2002 -31- Legg Mason Wood Walker, Inc. fore that of the United States, and peaked around 1990, which was the same year that the Nikkei stock index peaked. Since that time, Japan’s economy has had the twin demographic burdens of a rising retiree population and the absorption of a second wave of younger workers into the economy. Currently, we believe most investors focus on Japan’s large retiree population. But on an optimistic note, we observe that the ratio of older and presumably more productive workers to younger and presumably less productive workers in Japan is projected to bottom in 2002 and rise through 2019, perhaps signaling that a demographic cornerstone is in place to help bring Japan back from the economic brink. In contrast, as Exhibit 22 shows, the U.S. demographic situation in the period to 2015 emerges as a headwind, by this measure. Although we expect the situation to be less severe than the Japanese experience of the 1990s, or the U.S. experience of the late 1960s to early 1980s, the implication is clear to us: the need to absorb a wave of young workers into the economy at the same time that the most experienced hands are preparing for retirement has historically not been a recipe for strong economic or stock price performance. Also on the subject of rising powers, we observe in Exhibit 22 that China already has entered a favorable, rising demographic tide of mature workers relative to younger workers. China’s great baby boom did not occur until 1963–1975, due to the postwar shocks of the 1949 revolution and the severe 1959–1962 famine. The period from the beginning of famine recovery in 1963 to the widespread implementation of family planning in the early 1970s created a baby boom in China, and by 2012 the U.S. Census Bureau proj- Exhibit 22 – Comparative Demographic Trends That We Believe Shape Productivity, the Ratio of 35-49 Year Olds to 20-34 Year Olds, China, Japan and the U.S., 1950 to 2050E Ratio 35-49 Year Olds to 20-34 Year Olds 150% 140% 130% 120% 110% 100% 90% 80% 70% 60% 50% Nikkei 225 and Japan age wave peak (1990) DJIA and U.S. age wave bottom (1982) DJIA and U.S. age wave peak (2000) Japan rebounds? U.S. Census Bureau Projections China markets strong through 2015? 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 Japan United States China Source: U.S. Bureau of the Census., Bureau of the Census International Database
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