Demographic decline is an unfamiliar problem for investors. Populations haven’t shrunk before. Well, not outside of a pandemic. But, now that the pandemic is over and excess deaths in England and Wales are only running at five times the pace of 2020, and dramatically higher than the year of the vaccine too, we can return to more normal considerations. What will demographic decline do to your brokerage account in coming decades?

Like I said, history isn’t much of a guide. The best we can do there is Japan. While people in the UK love to talk about stocks and property prices, people in Japan avoid the same conversations. Too many people’s relatives committed suicide when the Japanese stock market and property markets crashed.

Tell a Japanese person that the stock market goes up in the long run and they’ll smile politely. Which is the Japanese way of saying “you foreign barbarians are so clueless”.

The idea that property is a good investment is equally mystifying to the Japanese. A lot of them have inherited their parents’ properties, which is seen as a burden, not a blessing. A suspicious amount of house fires occur shortly after Japanese people inherit their parents’ homes…

At one point the country tried to give away 8 million abandoned homes…

The problem is not so different in the stock market, with the Japanese central bank owning about 7% of the stock market and 80% of exchange-traded funds (ETFs) to try and soak up excess supply of stocks! But the market still hasn’t recovered from its never-ending bear market. Adjusted for valuations, they’re practically giving away Japanese stocks.

All this might sound like a complete nightmare for the country. I mean, how do people survive without booming stocks and property?

But, as far as I could tell when I lived there for two years, Japan has a very high standard of living. Admittedly, that’s tough to measure given how differently Japanese people live. Their quality of life seems dramatically better than the UK’s in some ways and quite a bit worse in others. They don’t have much furniture, but their food…

Anyway, you don’t get the impression that falling share or house prices are inherently disastrous.

That may be about to change if action in the yen and Japanese government bond (JGB) markets are anything to go by. But let’s leave that for another day.

I’m not exactly sure what a successful investment strategy would look like if you agree we’re turning Japanese and really think so. Perhaps there’s a reason why so many Japanese people invest so heavily overseas, leading to bizarre second order effects such as many Australian school children learning Japanese.

But I want to explore a different angle to the same demographic problem. Instead of analysing the rather limited historical example of Japan, let’s consider the logical implications of demographic decline for stocks. Perhaps we can reason out the future of your brokerage balance.

We all understand that demand and supply is what makes markets move. This suggests that, as demographic change shifts spending habits, the best types of stocks will be those featuring spending by older demographics.

Cruise ship companies were a popular example, until 2020… Retirement village and nursing home companies were another idea… until 2020. That leaves healthcare, although the companies dominating that space haven’t acquitted themselves too well either.

But I’m worried that investors making such plays have skipped a step in their analysis.

Who exactly is going to buy these cruise ship stocks, to make their prices go up?

Japan’s bear market hasn’t necessarily been driven by declining earnings or a poor economy. It’s been driven by the lack of stock investors. A lack of demand for stocks, not for stuff the stocks make, is behind falling share prices.

The same could occur in the West. If there are less investors because of demographic decline, that means less demand for the stocks themselves. And less demand means… well, it’s only half the equation determining prices.

What about the other half – supply?

Well, how are retirees going to pay for all those cruises and retirement village fees, presuming the NHS doesn’t send them infectious people again?

They’re going to be selling stocks to pay for their cost of living. Which means a flood of accumulated supply of financial assets is going to hit markets in coming decades. That is something that has also never happened before.

We’re not really familiar with whether the idea of saving and investing for retirement actually works on a system-wide basis. Are financial markets meant to be retirement funds? Or does this subvert their purpose and cause a bubble as people bid up prices in their middle-age and then pop the bubble as they sell out in retirement?

As I see it, the idea of plonking everyone’s money into stocks so they can pay for their own retirement is only a few decades old now. The first real tranche of sellers who accumulated vast financial assets are retiring. I wonder what this might do to the supply of stocks as they sell out. And thereby prices.

It’s a bit odd though, isn’t it? If we don’t have enough young taxpayers to pay for state pensions, necessitating corporate pensions, which were unaffordable for companies, necessitating building up your own personal pension pot by saving and investing, then what made us believe that doing so by way of financial markets would become sustainable?

Do financial markets have a greater capacity to solve a basic supply and demand problem than the tax system or corporate Britain? If there’s an imbalance between working taxpayers and retired pensioners, why isn’t there an imbalance between working pension contributors buying up investment assets and retired people selling them? They’re the same bunch of people, after all.

Maybe there is such an imbalance. We’ve merely transferred the problem from the tax system to financial markets.

Perhaps the boom in asset prices in the 1990s, and to a lesser extent since then, was because people began ploughing their paycheques into the markets while there was no corresponding cohort of savers selling their investments to pay for retirement. But in the future, there will be the corresponding amount of selling as these people retire. That’ll push prices in the other direction.

Perhaps financial markets are not supposed to be pension plans for an entire society. Not without subverting returns in the future as people actually start to sell out as they retire.

Of course, all of this is only a gradual demographic shift. As it was in Japan, when stocks and property crashed in spectacular fashion in 1990…

It seems to me that young Japanese people realised rather suddenly, consciously or not, that financial markets are in a demographic imbalance. They refused to bid up assets in the face of a sustained wave of selling. And, at some point, people in the West will realise the same. And they may start to avoid the stock market as the Japanese do.

For now, though, ploughing people’s money into the market is practically compulsory. In Australia, literally so for many people, via the superannuation system. It’s tough to opt out or direct your compulsorily saved money elsewhere.

But this system also creates opportunities in the markets. Because the phenomenon of turning financial markets into retirement plans has many other effects on those markets.

For example, in the United States, it creates a wall of money that hits financial assets each time payrolls roll over. A decent chunk of almost every person earning money gets sent to asset managers to invest.

I wonder what the impact might be on markets each time this occurs? If only there was a way to profit from it…

Nick Hubble
Editor, Fortune & Freedom