Three Big Picture Shifts Worth Paying Attention to

By Rick Rieder | July 25, 2014 AAA

In today’s era of increasingly abundant information, separating truly meaningful market signals from the mountains of daily noise has never been more challenging, or more vital for investment success.

Larry Fink recently advised you to “tune out the noise” if you want to be a better investor. He suggested focusing on your long-term investing goals rather than on all the information swirling around in news media about the markets’ daily ups and downs.

In addition to focusing on what you’re trying to achieve, I believe three big picture changes happening today are also worth tuning into, as they have real implications for the economy, markets and portfolios over the long term. In other words, it’s worth stepping back and considering these three broad shifts that I believe will hold an outsized impact on effective investment decision making in the years ahead.

The developed world’s aging populations. Populations are rapidly aging in most developed countries. The proportion of the developed market population older than 60 years came in at roughly 15% in 1975, but it’s expected to double to 30% by 2025, according to United Nations estimates.

Demographic shifts of this kind can stress an economy because it’s generally the working-age population (say, those ages 20 to 59) that delivers both gross domestic product (GDP) growth and capital market appreciation, while the tails of the population distribution (children and retirees) tend to be dependent on others and have less of an impact on growth in the economy or markets.

In addition, as more and more people reach retirement age, labor forces typically shrink, and greater numbers of people take advantage of entitlement programs. In combination with developed countries’ already high sovereign debt levels, this is likely to challenge the ability of many governments to maintain entitlement spending (i.e. programs like Social Security).

The phasing out of financial repression. The United States seems to be in the process of departing a regime of financial repression, i.e. one where a government takes measures to channel funds into its own debt.  Overall leverage in the United States has come down from peak levels in many segments of the economy, including the corporate and housing sectors. And while government sector indebtedness is still quite high on an absolute basis, higher-than-expected revenue attainment and modestly lower spending levels have brightened the picture for this segment of the economy. Indeed, the budget deficit as a percentage of GDP has improved markedly over recent quarters and this has required lower levels of debt issuance.

A U.S. economy slowly emerging from financial repression, coupled with robust credit availability, should continue to allow corporations, especially higher-rated ones, to benefit shareholders through capital structure arbitrage, while not appreciably hurting debt holders. In other words, cheap financing and easy financial conditions can create a framework for equity optimization that allows risk asset prices to grind higher even in the face of what some believe are extended valuations.

The pace of technological changes. In recent decades, new technologies have displayed a remarkably rapid diffusion into general use, displacing employment in many sectors of developed world economies. This is only likely to continue in the years ahead as many more jobs are automated and fewer workers are required. As such, structural unemployment is likely to remain elevated and broad-based wage growth should stay suppressed, helping to hold down core inflation (inflation in the real economy is driven by increasing wages for the labor force).

So why do these three shifts matter? It’s vitally important for you to attempt to understand the broader secular factors impacting economies and markets today. Appreciating their influence can help you position yourself defensively, when needed, or potentially capture compelling investment opportunities.

For instance, as my colleague Russ Koesterich wrote in a Market Perspectives paper a while back on the developed world’s changing demographics, in an aging world, markets offering growth are likely to command a premium.

At the same time, once you have an understanding of these shifts, it’s easier to grasp why we may well see the Federal Reserve (Fed) raise rates earlier than many market participants expect. Today’s excessively low rates are encouraging many potential retirees to stay in the labor force longer, crowding out the younger generation and helping fuel high levels of student debt. At the same time, they’re also encouraging corporations to engage in aggressive stock buybacks at the expense of capital reinvestment.

 

Source: BlackRock Research

 Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Fundamental Fixed Income, is Co-head of Americas Fixed Income, and is a regular contributor to The Blog

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