For today's Outside the Box we have a very special research piece by Rob Arnott of Research Associates and his colleague Denis Chaves. Rob was with us at Leen's Lodge last week, and in the final evening discussion session he asked an interesting question having to do with demography and GDP growth. I was intrigued by it, but the group soon moved on without fully exploring Rob's idea; so I mentioned it to him again later, and he was good enough to send along the following paper.
Rob's description of their work, in an email to me this afternoon, gives us a pretty good synopsis:
[W]e show that the past 60 years—which we think of as “normal”— enjoyed a demographic tailwind which we can quantify. It was worth about 1% per year, meaning that, if we think of 3% growth as normal, it’s really 2% growth plus a demographic tailwind of 1%.
The coming decades—due to the rising support ratios from the aging boomers—will experience a demographic headwind of (very roughly—these will be wildly out-of-sample conditions) roughly the same 1%. So, if 3% growth was normal, 1% growth (again, very roughly) becomes normal. This is the reason behind my concerns regarding the legacy of monetary and fiscal experiments, and debt and deficits we leave our children.
One can see the potential for higher growth from new sources of ingenuity and the ongoing human experiment with technology, but the headwinds Rob talks about are very real and need to be factored into our analysis of the future structure of our portfolios.
Rob is one of my great friends, and we have spent a lot of time together over the years. We first met at the home of the late Peter Bernstein and soon found that we shared a great deal in terms of how we view the markets. Rob was then the editor of the Financial Analysts Journal. He has won no fewer than five Graham and Dodd Scrolls, awarded by the CFA Institute for best article of the year, plus lots of other honors. He is the largest outside manager at PIMCO, and he is the intellectual light behind the Fundamental Indexes I have written about so many times. He is simply one of the smartest guys on the planet and one of the most fun as well. What many people don't know is that he has one of the top three or so motorcycle collections in the world. His bikes don't just sit around looking pretty, either—they can all still go on the road. I don’t do motorcycles, not having a death wish, but Rob thinks riding them at 140 MPH (on a legal track) is entertaining. Quite the contrast to the conservative investor image he projects at meetings.
I am back in Dallas and catching up on a few things, but I'm still remembering the weekend. The fishing in our boat was the best Trey and I have had in seven years. We caught more fish the last morning than we had in an entire week in some previous years. We stayed busy pulling in one fairly large bass (catch and release!) after another. At one point we had three lines hit at the same time. Nothing fancy in terms of bait, just funny-colored plastic worms. Technically, I won on the most fish caught, after losing that contest for six years running, but Trey had me on the size of fish. He caught some monsters. And we enjoyed ourselves more than on any previous outing to Camp Kotok. The annual Maine fishing trip has become my gauge on Trey's growing up.
I stopped off to see my mother after I landed Monday evening. She will be 96 next week, and though she is now bedridden, she is mentally as sharp as ever. She is not sick or suffering, thank God, but her body is just slowly rebelling. None of her ten brothers and sisters ever got to 96 (although a number made it to 95), so every time I leave home there is a certain emotion in me that I don't really want to confront.
That old Jimmy Durante song from my youth kept playing in my head as I sat next to her:
Don't you know that it's worth
Every treasure on earth
To be young at heart?
For, as rich as you are,
It's much better by far
To be young at heart
And, if you should survive
To a hundred and five,
Look at all you'll derive
Just by being alive!
Now, here is the best part:
You have a head start
If you are amongst the very young ...
Your never gonna grow up analyst,
John Mauldin, Editor
Outside the Box
Mind the (Expectations) Gap: Demographic Trends and GDP
By Rob Arnott and Denis Chaves
A large body of research in psychology and economics shows that human beings tend to form their expectations by relying on past experiences—especially recent ones. Malmendier and Nagel (2011), for instance, talk about investors who live through long periods of poor stock market performance and how this experience affects their risk-taking propensities... for life. The most famous example…