O’Connor Global Multi-Strategy Alpha Monthly Letter

With the prospect of continued higher rates, encompassing a key debate within the market, we see the topic of demographics worth exploring for this month’s letter. For years, a common narrative around demographics has been driven by the experience in Japan – that an aging population is deflationary and longer life expectancies lead to greater savings for retirement and push down the equilibrium interest rate. However, we recognize that this has taken place against a multi-decade backdrop of a positive labor supply shock. From 1990 to 2017, the increase in the working age population (ages 15 to 64) in China outstripped the combined increase in Europe and the US more than four times, as China added over 240 million workers. Moreover, the re-integration of Eastern Europe following the collapse of the former Union of Soviet Socialist Republics (USSR) added a working age population of around 200 million to supply. While goods inflation was mitigated by the rise of China in manufacturing output; In 2004, China’s share of world manufacturing output was 8.7%, climbing to 26.6% by 2017. By contrast, the current trend of trade barriers, more nationalistic policies and slowing globalization all run counter to this deflationary trend continuing.

As populations age, government borrowing will probably rise in order to protect retiree entitlements. In doing so, governments will likely increase the tax burden on a smaller number of workers, even if these workers gain stronger bargaining power due to a smaller workforce. Additionally, as a general trend, workers consume less than they produce and retirees consume more than they produce, so this demographic shift may increase inflation due to both a higher tax burden for workers and consumption growing at a faster pace than production. There also appears to be a trend of wealth transfer from older to younger generations, which in turn brings down the collective propensity to save and increases consumption.

It is reasonable to assume that demographics have few practical financial market implications on a short-term basis, but anecdotally, we do not see the ongoing outperformance of the US over Europe, or of India over China, as completely unrelated. Empirically, we see that over the first quarter of this century, real GDP growth has had a high correlation with total population growth (figure 1).

Figure 1: Real GDP vs. total population growth 

(2000-2024 CAGR in %)

CAGR: compound annual growth rate

Source: Global Financial Data, United Nations, Deutsche Bank (note real GDP data are up to 2023)

As we think about themes for the next several years, we expect to see some significant demographic changes, compared to the previous 25 years where most countries experienced growth in total population. The quarter century from 2025 to 2049 might be the first one where many large countries will see declines in their population (figure 2). Up until this point, the only countries that have seen negative population growth over this long of a period are China, from 1850 to 1874, and both Japan and Russia from 2000 to 2024.

Demographic changes have meaningful implications in several areas of our investment focus. In China, an aging and declining population presents both opportunities and risks for companies in the consumer and healthcare sectors. As the Chinese government continues to support the industrial sector, we have seen the increasing presence of exports in markets outside of the US, challenging cost positions for certain European exporters. With the Chinese industrial sector growing against the backdrop of an ageing population, there will likely be an increasing need for automation software and hardware alongside other digitalization initiatives, a core area of expertise in our European industrials coverage. Divergence in workforce demographics along with geopolitical forces are already shifting trade flows and transforming energy value chains, relevant for the work we do in the Energy Transition and Commodities teams. Overall, we plan to increase our allocation to areas like emerging markets and Europe, where there are clear divergences between countries, where markets are less crowded, and where policies from the new US administration may add to market volatility and opportunity.