Category Archives: Sami Karam

Europe: Was (Is) It Worth The Trouble?

February 22, 2013 – 5:40 am

by SAMI KARAM

(also published at Seeking Alpha)

No for indexers. Yes for macro trend investors. Maybe (but probably not) for bottom-up stock pickers.

European stocks face a unique situation, which is that, outside of the rolling debt crises from Ireland to Iceland to Greece to Spain, their performance has been, and will continue to be, driven by macro factors emanating from outside the European Union.  This is mainly because Europe itself has the worst demographics of any region of the world with declining or stagnant populations in several countries and rising dependency ratios (dependents per worker) in all countries (see tables or, for more on demographics, see Demographic Megatrends of the 21st Century).  Therefore, except for the cyclical recovery which may or may not show up this year or next, the longer-term prognosis for domestic demand growth is far from encouraging for a large majority of European companies.

UN   Estimate Total Fertility Ratio Population (millions)
  2010 2030 2050 2100 2010 2030 2050 2100
 France 1.99 2.04 2.06 2.09 63 68 72 80
 Germany 1.46 1.74 1.9 2.05 82 79 75 70
 Italy 1.48 1.75 1.91 2.05 61 61 59 56
 UK 1.87 1.97 2.03 2.08 62 69 73 76
 Europe  1.59 1.82 1.93 2.06 738 741 719 675

These estimates are from the United Nations medium variant. Note how the dependency ratio declined for the past four decades and is now expected to rise in the next four.

 Dependency Ratio 
1950 1970 1990 2000 2010 2015 2020 2030 2050
 Europe 52 56 50 48 46 50 54 61 75
 USA 54 62 52 51 50 53 56 64 67

It is fortunate therefore that Europe has some tremendous companies, large and small, which are global leaders in their sectors and which can find growth outside of Europe’s borders.  A large number of these companies have had a very strong performance in recent years thanks to slow growth in the US and fast growth in emerging markets, in particular China. Good examples are iconic automaker BMW, luxury goods powerhouse LVMH, chemical giant BASF, retailer Hennes & Mauritz and many many others.

(Note: stock tickers not shown in the text are shown in the tables, using the Bloomberg convention)

Some of these winners have been smaller companies. Consider for example the Finnish tire company Nokian Tyres (NRE1V FH) spun off from Nokia (NOK1V FH) in 1995. Although Nokia has for years been followed obsessively by investors, it is Nokian Tyres which has outperformed Nokia proper by a stunning margin over the past seventeen years (except for 1998-2002 and 2008-09) logging in a nosebleed gain of nearly 4900% since the spinoff vs. Nokia’s decidedly paltry cumulative 11.3% (excluding dividends). Even if you exclude Nokia’s decline after 2007, the outperformance would still be very large. (Note to Apple AAPL watchers: it may be better to look elsewhere).

In the 1990s, there was much talk of the benefits to investors from geographic diversification. Academic research made a case that greater returns could be achieved with less volatility, a case which was then amplified in the financial media by large mutual fund companies. It is not within my scope to rebut this case from a theoretical perspective. For the next section however, I looked at the numbers empirically and they show that a multi-country European stock index would have underperformed the US or other global markets in the past ten and twenty years. In many periods, this underperformance was not accompanied by a correspondingly lower volatility. In fact, the volatility of European markets in 1996-98 and 2005-08 seems to have been higher. A European indexed fund or ETF (VGK, IEV), to put it plainly, was simply not worth it.

Because the vast majority of mutual funds underperform their benchmark index, you could also say that European mutual funds were not worth it.  In the event of a large deviation between a foreign stock fund and its benchmark, such deviation could usually be explained by currency moves rather than the fund managers’ skill at selecting a portfolio of superior stocks.  This was certainly the case in the 2003-07 bull market when US dollar weakness greatly helped all funds which were not fully currency-hedged. Here the financial media usually gave all the credit to the fund managers’ superior stock selection (often alleged) and not enough attention to the currency moves (always real).

A MEMO TO CLOSET INDEXERS

European stock indices usually move in step with the US market.  This is not true in every single year but it is true in most years and on a multi-year basis if not in magnitude, certainly in direction. Going back ten years, the European markets moved roughly in line with the S&P 500 except for 2005 when the European index outperformed by a wide margin, and 2010-2011 when the S&P 500 outperformed for two years in a row.

As things stood last December 31st, Europe had returned 38% in a decade and the US 62%. Much of this underperformance can be attributed to the strengthening of the Euro which nearly doubled against the US dollar in 2001-2008. A strong Euro/weak dollar is detrimental to European indices which are heavily weighted with exporters. A dollar-based investor in Europe who did not hedge out the currency would have benefited from the stronger Euro and would have recorded, in the decade ending on December 31st 2012, a gain of 67% from European indices, marginally better than the S&P 500.  On a twenty year basis, the European index returned 162% for a currency-hedged investor and 196% for an unhedged investor, in both cases less than the S&P 500 which returned 227%. (These returns and the ones shown in the table do not include dividends).

Nonetheless, the overall European index (I use MSCI Europe) masks important differences between countries.  Although the EU has gone a long way to reduce these differences, they continue to be relevant because regulation, taxation, work ethic and basic business practices remain largely country-specific. It is trite to say that Germany is the uncontested leader in Europe, but it has emerged by now in early 2013 as the primary beneficiary of the Euro project.  I made a case here that Germany should in a strange way be thankful for Greece, because it is the presence of Greece (and Italy and Portugal) within the Euro sphere which has kept the Euro at a level that is weak enough to help German exports and to sustain the German economy on a growth path.  Without the Euro, the Deutsche Mark would have been stronger against other leading currencies and Germany’s economy would have probably fared worse than it did.

Twilight or sunrise?

Twilight or sunrise?

When you look at country indices going back two decades, a few things stand out quickly. First, the US, UK and Germany have recovered nearly all their losses of 2008-09, whereas France, Spain and Italy have not.  Second, Germany has outperformed the US by a wide margin in the past ten years and in the past twenty years. Spain has also outperformed the US in the past twenty years but that is mainly due to the first decade 1993-2002 when the Spanish stock market, along with Italy, was a huge beneficiary of the convergence trade preceding the adoption of the Euro.  The UK has lagged the US and Germany but has done better than France in the more recent decade.  All in, of the large markets, Germany stands out as a big winner, Spain a winner only in the first decade, Italy as a big laggard, and France and the UK somewhere in between.

The smaller Nordic markets have done exceedingly well over the past two decades.  Norway was greatly helped by its exposure to oil and oil services in the past decade.  Sweden and Denmark did very well in both decades thanks to stellar performers Hennes & Mauritz, Atlas Copco, Novo Nordisk (NOVOB DC) and TopDanmark (TOP DC). Finland’s index benefited from Nokia’s large market cap weighting in the 1990s and suffered from it in the last five years.  Ex-Nokia, the Finnish index would in fact show an impressive performance in recent years. On the two decades 1993-2002, Finland is still the best European performer by far. Like Germany, it has many world-class exporters.

 1993-02  2003-12 1993-12 2003-07 2008-12
 USA  S&P 500 101.9% 62.1% 227.3% 66.9% -2.9%
 Europe Local  MSCI 89.8% 38.2% 162.3% 85.9% -25.7%
 Europe USD  MSCI USD 77.9% 66.7% 196.4% 144.5% -31.8%
 UK  FTSE 100 38.4% 49.7% 107.2% 63.9% -8.7%
 Germany  DAX 30 87.2% 163.2% 392.7% 178.9% -5.6%
 France  CAC 40 64.9% 18.8% 96.0% 83.2% -35.1%
 Spain  IBEX 157.5% 35.3% 248.4% 151.5% -46.2%
 Italy  FTSE MIB 138.9% -30.8% 65.3% 62.8% -57.8%
 Switzerland  SMI 119.8% 47.3% 223.8% 83.2% -19.6%
 Netherlands  AEX 148.8% 6.2% 164.2% 59.8% -33.6%
 Sweden  OMX 174.6% 124.0% 515.0% 119.3% 2.2%
 Norway  OBX 320.0% 332.0% -2.8%
 Denmark  OMX 166.8% 148.7% 563.5% 132.7% 6.9%
 Finland  OMX 596.7% 0.5% 599.8% 100.8% -50.0%
 Brazil  Bovespa 166089.0% 440.9% 898832.0% 467.0% -4.6%
 Brazil USD 111.3% 836.5% 1879.1% 1030.2% -17.1%
 China  Shanghai 74.0% 67.1% 190.8% 287.6% -56.9%
 Hong Kong  Hang Seng 69.1% 143.1% 311.0% 198.4% -18.5%
 Japan  Nikkei 225 -49.3% 21.2% -38.6% 78.4% -32.1%

Among emerging markets, Brazil was a very strong performer.  The Brazilian Real’s devaluation against the US dollar in the 1990s explains much of this performance.  But Brazil has been one of the best global performers even on a dollar basis.  China has had a respectable performance, but perhaps one more muted than many would have guessed from the steady barrage of headlines about the rise of the Chinese superpower. And Japan as we know has been a dismal place to be an indexed investor, except for brief spurts in the mid-90s and in 2003-07.

Net net Europe has underperformed the US on both a one decade and a two decade basis whereas several emerging markets have performed in line or much better than the S&P 500.  All of this may be discouraging if a person worries about the indices too long. But for those who ignore the indices, Europe offers outstanding opportunities.

A MEMO TO THE REST OF US

After the closet indexers have left the room (or clicked away from this page), we can now talk about two incontestable reasons to invest in Europe: 1) an early warning system and 2) a leveraged play on other markets or trends.

Europe as an early warning system

The first reason is that early signs of an impending crisis often emerge in Europe before they do in the US. This is true not because Europeans are more prescient than Americans, but because their stock market is more fragmented into individual countries.  It would be the same here if each state of the United States had its own stock market.  In that case, we might have , for example in 2007, picked up on signs of distress in the subprime market through the Arizona, Nevada or Florida stock markets several months before they became visible in national indices temporarily held up by other, more buoyant sectors.

If a manager has some holdings in Europe, he is likely to pick up on signs of trouble before his competitors do and long before they appear in the major headlines. This was certainly true in 1997 and 1998 when European banks with large exposures to faltering Asian markets and to Russia telegraphed signals to the bullish markets in the late spring and early summer that all was not well. And it was also true in 2000, when stodgy companies like Alcatel (ALU FP) and the old state-owned telecom operators were trading at very inflated multiples normally reserved for hot new companies coming out of California.

This ‘Europe as an early warning system’ delivered again in the crash of 2008, in particular for people who were paying attention to Ireland. The S&P 500 recorded a small gain in 2007 but Ireland which had wholeheartedly embraced the housing bubble saw its index fall by 27%. Italy too was down in that same year, but by a less alarming 7%.

When the US subprime crisis erupted in 2007 and 2008, there was in Europe widespread belief and barely concealed schadenfreude that the Americans, already out of favor on the continent because of the Iraq war, were getting their comeuppance and that Europe, reinforced by a growing Euro sphere and a billion eager Chinese customers, could now promote its economic success as a new model for other countries. As we know, reality came back unsparingly when all Euro markets crashed in late 2008.

In 2011-12, the US market was to some degree driven by the daily news flow from Greece, Spain, Italy and other parts of Europe. For a while, exploding sovereign yield spreads threatened to throw in reverse the conversion trade of the late 1990s and to tear the Eurozone apart. And now Europe has combined bailouts and austerity and the US has combined bailouts and stimulus, with the net result that Europe is in recession and the US is growing modestly. In the coming years, it will still be a good idea for US investors to keep an eye on Europe, even if its importance has diminished in the global sales mix of American companies because of emerging markets.

I recognize that getting an early distress warning is by itself an insufficient reason to draw investors into Europe.  Insurance is a good idea but no one wants to overpay for it or feel that it has become a distraction. A larger and more positive reason to invest in European stocks is that they offer an excellent way to get exposure to other markets.

Europe as a leveraged play on other markets

Investing in Europe to get exposure to other, non-European, markets and trends can be exceptionally rewarding.  Most of the news that may push many large and midsize stocks higher or lower comes from outside of the European continent, chiefly from the US and China.

Exposure to the US dollar and US economy

Until China became a major source of export demand for European goods, the US economy was the most important driver of earnings growth for a large number of European firms. For this reason, the exchange rate of the dollar vs. European currencies was an important factor in the earnings of these companies. European stocks were a leveraged play on the US dollar. If the dollar moved 5%, some stocks would move 10 or 20%. It is true that you could instead invest directly in the currency markets but stocks gave you more leverage and also gave you the possibility of gaining from periodic efforts to create shareholder value. In the 1990s, for example, you had a wave of restructurings, followed by the tech boom. In the 2000s, you had the commodity boom and the rise of emerging markets.

Exposure to the Chinese economy and other emerging markets

Europe’s relationship to the US dollar and US economy still exists but it has been diluted by the rise of another very large client, the Asia-Pacific region. For a majority of large and midcap European companies, the Asia-Pacific region has replaced the US as the main source of sales growth. China and Japan are obviously the two main poles of demand, with China showing by far the fastest growth rate in the sales mix of European firms. One of the best ways to get exposure to the growing Chinese economy has been through a portfolio of European exporters which are global leaders in their industries.  In fact, such a portfolio would have handily outperformed the stock markets of China and Hong Kong in recent years. This may not be intuitive but investing in European exporters has been one of the best ways to invest in Chinese growth.

Nowhere is this more true than in luxury goods and prestige brand companies which have seen a growing percentage of their revenues coming from the Asia-Pacific Region. Luxury goods companies Hermès, Richemont and Swatch now have about 50% of their sales in that region.

 Luxury & Spirits     Market Cap   AsiaPac % 
     Billions USD   2011 Sales 
 Burberry  BRBY LN           9.49 34%
 Campari  CPR IM           4.44
 Diageo  DGE LN         74.33 10%
 Ferragamo  SFER IM           4.44 34%
 Heineken  HEIA NA         42.50
 Hermes  RMS FP         35.91 46%
 LVMH  MC FP         91.18 27%
 Pernod Ricard  RI FP         33.49 39%
 PPR  PP FP         27.16 24%
 Remy Cointreau  RCO FP           6.46 39%
 Richemont  CFR VX         46.74 51%
 SAB Miller  SAB LN         79.62
 Swatch Group  UHR VX         29.85 54%

European companies are by far the world leaders in luxury goods, and the French among them own some of the strongest brands. LVMH is the largest luxury goods company in the world, with an extensive portfolio of brands, including Louis Vuitton, Bulgari, Dom Perignon and Tag Heuer (see full list of LVMH brands here).  France also has Hermès and spirits companies Pernod Ricard and Remy Cointreau. Switzerland has the Swatch Group, the parent of Blancpain, Breguet, Omega, Glasshutte and, as of this year, Harry Winston (see Swatch Group brands here). Also in Switzerland is Richemont, the parent of Cartier, Montblanc and Vacheron Constantin (see Richemont brands here). Italy has Salvatore Ferragamo, spirits company Davide Campari, eyeglass leader Luxottica (LUX IM) and leather company Tod’s (TOD IM). Germany has automotive luxury with BMW, Porsche, Audi and Mercedes.  Porsche and Audi are part of Volkswagen, and Mercedes is part of Daimler (DAI GY). All of these countries also have many more luxury goods companies which are not publicly listed. I have also written about the luxury goods market in BMW, Louis Vuitton, Swatch: Can the Boom Continue?

The US is active in many of these sectors but has few dominant companies.  Coach (COH) and Tiffany (TIF) offer excellent products but cannot match the pricing power, brand supremacy, geographic footprint and cash flows of Hermès, LVMH or Swatch. US firms have also enjoyed better growth in their home market and have not felt the need to expand into the Asia-Pacific region as aggressively as the Europeans have.

Another sector which has benefited from the growth of emerging markets is industrials.  Here too, Europe has some global leaders in autos, chemicals, machinery, industrial gases, aircraft and heavy trucks. In the first nine months of 2012, for the first time ever, BMW sold more cars in China than it did in the United States.  BMW also owns Rolls Royce cars and the Mini brand. And Volkswagen in 2012 delivered nearly four times as many cars in the Asia-Pacific region as it did in North America. All three of BMW, Volkswagen and Daimler are present in both the luxury sector and the industrials sector: BMW through its own brand, Rolls Royce and Mini; Volkswagen through its own brand, Porsche, Bentley and Audi and its ownership stakes in Scania (SCVB SS, 46% of capital) and in MAN (75%); and Daimler through its Mercedes cars and trucks and Freightliner trucks.

Industrials   Market Cap AsiaPac %
    Billions USD 2011 Sales
Air Liquide AI FP          38.73 22%
Assa Abloy ASSAB SS          14.86 9%
Atlas Copco ATCOB SS          34.79 28%
BASF BAS GY          89.56 20%
Bayer BAYN GY          79.07 21%
BMW BMW GY          62.00 17%
Duerr DUE GY            1.75 39%
EADS EAD FP          39.13 29%
Henkel HEN GY          34.96 15%
KUKA KU2 GY            1.51 24%
MAN MAN GY          17.48
Rolls Royce RR/ LN          28.61
Volkswagen VOW GY        108.79 14%
Zodiac ZC FP            6.46

Because of its Airbus division which competes with Boeing, EADS may be of particular interest to US readers. Last year, I wrote about the epic battle between the two aircraft manufacturers in Boeing vs. Airbus: Orders and Profits. Since then, EADS has undergone some important changes in its shareholding structure. Its free float which is now 54% is expected to rise above 70% after large legacy shareholders reduce their stakes. Management has expressed a new commitment to transform the company from a conglomerate of state-owned or state-sponsored businesses into a more ‘normal’ company which is more responsive to shareholders.

Finally, Europe has some outstanding companies in the mass-market consumer and retail sector which expect to grow in emerging markets as well as in the United States.  Notable among them are Hennes & Mauritz and Inditex, the parents of retailers H&M and Zara, and cosmetics giant L’Oreal.

 Consumer/Retail     Market Cap   AsiaPac % 
     Billions USD   2011 Sales 
 Adidas  ADS GY           19.63 16%
 BAT  BATS LN         100.55 28%
 Beiersdorf  BEI GY           22.32
 Bic  BB FP             5.78
 Hennes & Mauritz  HMB SS           60.76
 Hugo Boss  BOSS GY             8.47
 Inditex  ITX SM           88.35
 L’Oreal  OR FP           91.98
 Nestle  NESN VX         226.60
 Unilever  UNA NA         118.07 41%

What Europe does not have

Outside of indexing and macro driven investing, what about simple bottom-up investing?  Ideally, we would like to invest in names which are insulated from the big macro questions of US and China growth.  However, it is difficult to imagine many large or midsized European stocks doing well in the event of a Chinese slowdown and US recession.  Under this scenario, it would be best to find a handful of smaller names with their own domestic growth dynamic.

Yet, if this seems like a desirable strategy, the US market is more fertile ground to find such small companies for two reasons: 1) the US has more new companies which go public and 2) these companies can grow domestically for longer because the size of the domestic market is many times larger. A good example is Whole Foods (WFM) which was still a small cap name in 2000 (and again briefly in late 2008). It now has over 300 stores in the United States (and 15 in Canada and the UK) and added ten new stores in the last quarter, eight of which were in the US. A similar European company would have hit the wall in its home market at a much earlier stage.  Outside of the large trends described above, there is, in my view, little reason for a US-based investor to put money in a small European company unless it is really a very unique and irresistible story with no US equivalent.

The clear Nordic air

The clear Nordic air

You might think that Nokian Tyres fits that profile. But even here, much of the company’s growth is directly linked to demand from Russia, which is itself tied to the rise in energy prices and ultimately, to the growth of the Chinese economy.  Should that economy slow down, the price of oil would decline which would dampen Russian demand for all sorts of goods, including tires.  Because European companies have a smaller domestic market than their US counterparts, it is more difficult to find good secular growth stories which are not dependent on the global growth picture.

If we redefine a company’s domestic market as the whole of Europe instead of just its home country, we find a handful of steady growth names. A notable pan-European success is the Swedish retailer Hennes & Mauritz which has 406 H&M stores in Germany, 226 in the UK, 182 in France, 177 in Sweden and hundreds of others elsewhere. It also has 269 in the US (from none in 1999) and 111 in China. H&M is among a handful of retailers that have gained market share in several markets (another is Inditex’s Zara). Today, the company’s growth is very much tied to globalization given that its cash flow (and ability to invest) is derived from a very high gross margin, the result of sourcing its products from 700 independent suppliers mostly in Asia. Hennes’ gross margin has expanded from 44.6% in 1998-99 to a blistering 59.5% in 2012 (it was over 60% in 2010-11). As a comparison, Gap’s gross margin in 2011 was 36.2%, down from 45.3% in 1999.

Other interesting growth companies include food caterers Compass (CPG LN) and Sodexho (SW FP), eye lens maker Essilor (EF FP), lock manufacturer Assa Abloy (ASSAB SS), diabetes care leader Novo Nordisk (NOVOB DC), health product suppliers Coloplast (COLOB DC) and Getinge (GETIB SS) and oil services companies Technip (TEC FP), TGS Nopec (TGS NO) and Seadrill (SDRL NO).  Yet they all seem in varying degrees to have grown to their current size because of demand from outside Europe. I maintain that the odds of finding several small or mid cap stocks which will grow year after year from domestic demand alone are significantly lower than in the US.

Europe also does not have a large investable technology sector. Among larger companies, there are SAP (SAP GY) and ASML (ASML NA). Every country has a smattering of smaller companies which operate in services or in manufacturing niches.  What some Europeans call technology tends to be larger scale and sometimes state-sponsored, an R&D effort which may very well be on the cutting edge but which has more to do with machinery and engineering than with computers, data processing or the internet. This includes high speed trains and nuclear plants where the French are leaders. Perhaps there will be another new technology where European companies will take a lead, but if the history of mobile phones is an indication, this leadership will probably be short-lived.

The conclusion is two-fold:  1) the main reason to invest in Europe has in recent years been non-European demand for some superior products and 2) Europe has been the first place to see early signs of an emerging crisis. One has to approach European investing with a macro perspective developed elsewhere, by analyzing demand in the US and China, and then choose the global leaders which are best leveraged to that macro perspective. Obviously, this could work in reverse with a vengeance.  Any evidence of a prolonged Chinese slowdown would tumble some luxury goods and industrial stocks by 20%, 30% or more.

Because Europe is now in recession, a recovery would certainly result in a cyclical upturn in earnings for many companies. Value investors today should be sifting through the long list of beaten down names, among them the long suffering French volume auto producers Peugeot (UG FP) and Renault (RNO FP). But European demographics are poor and cannot contribute a sustained source of demand.  This means that, beyond the cyclical recovery, the longer term growth driver for most European equities will still have to come from outside Europe.

By populyst | Also posted in Airbus, Analysis and Opinion, Asia, Boeing, China, Dependency Ratio, Economy, Emerging Markets, Europe, European Union, Investment, Wall Street | Comments (0)

On ‘America’s Baby Bust’

February 12, 2013 – 9:34 am

by SAMI KARAM

(also published at Seeking Alpha)

Jonathan Last’s recent article in The Wall Street Journal is sufficiently alarmist and buzz-generating to please his agent and publisher on the eve of the release of his book What to Expect When No One’s Expecting, with the doom and gloom tagline America’s Coming Demographic Disaster.  ‘No One’ is an exaggeration since there were about 4 million births in the US last year, but I understand the appeal of using a title which is reminiscent of Heidi Murkoff’s blockbuster book on pregnancy.  As to the phrase ’Coming Demographic Disaster’, it could put Last, years from now, in the category of pessimistic forecasters who were proven spectacularly wrong, alongside Paul Ehrlich, author in 1968 of The Population Bomb. Forecasting is a difficult task and extrapolating the known past and present into the future has often proved to be an inadequate approach.  There are usually new hitherto unknown factors which intervene down the road and which derail any linear or semilinear prediction.

However, none of this should diminish the fact that Last’s article is an excellent must-read for anyone who still believes that US demographics are strong and supportive of future economic growth.  As I wrote a few months ago, there are many, including many in leadership positions, who still live with this illusion. Last’s main point is absolutely correct.  The birth rate (and fertility rate) has declined since the 1970s and the growth rate of the US population has been on a downward trend.  This phenomenon yielded a large demographic dividend from about 1982 to 2005, but it is now leading to large negative consequences for the economy. I covered several of these points in previous articles on this site. Most critical in my view is the rise in the dependency ratio which is likely to last now for several decades.  US demographics provided steady tail winds to the US economy for decades and added a large demographic dividend when the birth rate fell and more women joined the work force, but we are now over that hill and are facing intensifying demographic head winds.

I differ with Last on his recommendation that we need more children now.  Children born now will not contribute to the economy for another twenty years and their numbers will only further exacerbate an already climbing dependency ratio.  We cannot rewrite the past but what we need now are more adults in their 20s, 30s and 40s, in other words more children born in the 1970s, 80s and 90s.  Yet, had we had these children back then, the economy would not have been as strong in the 1980s and 1990s because less capital would have been available for saving and investing.  In many ways, we front-loaded demand, saving, investment and prosperity in those two decades and now face some inverse complications.

All is not lost however. Instead of boosting the birth rate now, a four-point solution would include 1) raising the age of eligibility for Social Security and Medicare, 2) improving labor force participation, 3) continued innovation and 4) more exports.  The first two would slow, delay or neutralize the rise in the dependency ratio.  Innovation is the most important driver of the economy but innovation without a large demographic audience does not achieve its full wealth creating potential.  An iPhone introduced to a market of 3 billion people clearly will create more wealth than an iPhone introduced to a market of 30 million people. Because US demographics are getting weaker and US demand will be less strong than in the past, an obvious solution is to look for new sources of demand outside our borders.  For this reason, it is essential that the US cultivates new export markets, in particular in countries with attractive demographic profiles.  As I wrote in this article, these markets are chiefly India and the countries of SubSaharan Africa, notably Nigeria, Tanzania and Uganda where the population is large and the fertility ratio is expected to decline, raising the possibility of a demographic dividend in coming decades.  This dividend is not guaranteed to happen. It is only a window of opportunity which opens and closes. And countries are able to capitalize on it only if they strengthen their institutions and improve their governance and transparency.

By populyst | Also posted in Africa, Analysis and Opinion, Demographics, Dependency Ratio, Economy, India, Sub-Saharan, United States | Comments (0)

US Demographics not as Strong as Widely Believed

August 22, 2012 – 11:15 am

by SAMI KARAM

A recent op-ed in the Wall Street Journal by Mr. Ben Wattenberg, a senior fellow at the American Enterprise Institute, takes an optimistic view on US demographics and on their likely impact on the economy.  The WSJ today published my response in which I repeat the argument I made in America Heading Towards Zero Population Growth? that the growth of the US population is in a multi-decade decline.

Text of my letter:

“Regarding Ben J. Wattenberg’s (“Immigrants and ‘Comparative Advantage’,” op-ed, Aug. 9): It is true that the U.S. is in better shape than Europe or Japan, but the rate of growth of the U.S. population has fallen below 1% per year and will decline further over the next four decades. Due to the passing of baby boomers in increasing numbers, the two decades starting in 2030 will see no population growth except for immigration.

Mr. Wattenberg’s figure of 400 million Americans in 2050 is too high and would be reached only if the birth rate, life expectancy or the number of immigrants rises significantly in coming decades. My own estimate is 375 million in 2050, which is 61 million more Americans than we have today. This may appear nominally attractive, but the population grew by 60 million, or 24%, in the 22 years since 1990. A 60 million increase by 2050 would be equivalent to growth of only 19% in 38 years.

Even Mr. Wattenberg’s optimistic scenario would be growth of 27% in 38 years, a rate which is well below that of recent decades, with predictable consequences for domestic consumer demand.”

End of letter.

Mr. Wattenberg is not alone in holding an optimistic view.  In fact, robust population growth is seen by many as one of the unique assets of the US economy.  Last month, Goldman Sachs CEO Lloyd Blankfein argued that US economic prospects look promising in part due to demographics:

“The U.S. has a number of major competitive advantages that we sometimes overlook — especially given the focus of the 24-hour news cycle on sensational, and mostly deflating, events. First, the U.S. has favorable demographics — thanks to its relatively high birth rates and immigration. While the BRIC countries — Brazil, Russia, India and China — have generated extraordinary economic growth, the U.S. remains a magnet for many of the smartest, most ambitious people in the world. [...] Immigration is one of the main reasons why the U.S. has grown faster than many other developed economies. The growth in the foreign-born population contributed roughly 30 percent to 40 percent of total U.S. population growth from 1980 to the mid-2000s. New immigrant workers provide a boost to economic growth. Just think about the effect new workers have on demand for housing, let alone creating new businesses.”

Because they are only partially accurate, some of these comments end up painting an overall picture which is too optimistic. First on the birth rate, it is higher than that of Japan or Europe, but it had been until recently near replacement level, equivalent to a total fertility rate (TFR) of 2.1 children per woman.  But since the financial crisis  began in 2008, the TFR has fallen below 2.1, as recently reported by The Economist. The TFR may well recover to replacement level as the economy improves. That is better than sub-replacement but a TFR of 2.1 is not sufficient to turn demographics into a source of economic strength. In addition, discussing birth additions without mentioning death subtractions presents only half of a full picture.  As increasing numbers of baby boomers pass away in the next three decades, the population will grow at a slower rate than in recent decades.

Another factor to consider within the overall population numbers is the evolution of each age group.  The expected increase in the number of older people has been widely documented and discussed, in particular as it relates to the pressure it will place on government social programs. A subsidiary measure of this development is the rise of the dependency ratio, which is the number of dependents (children and retired people) per working adult. In the US the ratio had been declining for decades and it is now set to start rising. (See Our Growing Inactive Population).

Turning to immigration, it is true that the US could open its doors wider to more immigration and by doing so, reach any population level that it wishes. But few commentators or politicians are advocating this approach. If we continue with the current run rate of 1 million new (legal) immigrants per year, the growth rate of the US population will continue to decline. And that would be true even if we raised annual immigration to 1.5 million newcomers.

There is nothing wrong with being too optimistic on demographics except that it could prevent policymakers from considering other steps to promote economic growth. If there is a widespread belief (as seems to be the case) that population growth will be a strong driver of the economy, we may forego some other growth-boosting measures which are in fact necessary.

In my opinion, growth for the US economy in the next few decades has to come from two main engines, first the perennial innovation engine, and second the manufacturing and export engine. The US can become once again an export powerhouse, not just in agriculture and technology, but also in other manufactured products along the entire value-added chain. Whether this requires a dramatic devaluation of the US dollar remains to be seen. If such is the case, we would not be the only country racing for a depreciated currency. Europe certainly does not want to see a stronger Euro, and if the Euro breaks up, virtually all countries except for Germany, Finland (and possibly France) will end up with currencies which are relatively weaker than the Euro. Germany may end up with a new Deutsche Mark which like the Swiss Franc will be stronger than its exporters would like to see.

Repatriating as many manufacturing jobs as possible and searching for new markets overseas are likely to be two important elements of a future growth strategy. Based purely on demographic trends, India and Sub-Saharan Africa look especially promising because improving health care and declining fertility rates (the two go hand in hand) could possibly yield the same kind of very large demographic dividend which we have seen in China and other Asian countries in recent decades.

By populyst | Also posted in Analysis and Opinion, Demographics, Dependency Ratio, Economy, Euro, Immigration, India, Sub-Saharan, United States, US Dollar, US Economy | Comments (0)

BMW, Louis Vuitton, Swatch: Can the Boom Continue?

June 18, 2012 – 1:25 pm

by SAMI KARAM

(also published at Seeking Alpha)

Diamonds are forever. What about growth in the luxury sector?

A few months after Porsche teamed up with RIM to offer the Porsche Blackberry, Tonino Lamborghini recently announced the introduction of three gold plated cell phones (priced $1,850 to $2,750) and of an Android tablet ($2,300) aimed at the Russian market. This story neatly captures the current state of play in the global luxury industry: a prestigious European brand flashing a status product at a BRIC consumer. Notwithstanding the gloom emanating from daily European headlines, the continent’s luxury sector has been riding an unprecedented expansion. With their aggregate 70% market share in global luxury goods, a slew of European companies have been living their best years ever.

The Best of Times

Sales have risen strongly at BMW. And at LVMH, the French parent of Louis Vuitton, Dom Perignon, Bulgari and Tag Heuer. And at Hermes and Burberry. And at Swatch Group, the Swiss parent of Breguet, Glashütte, Blancpain and Omega. In the two years 2010-11, BMW increased its sales by over 17% annually. LVMH increased theirs by an average 14%, Hermes by 18%, and Swatch by 22%. With record margins and cash flows, these results are oddly incongruous with a global economy limping and stumbling out of (or through, or back into) the 2008 financial crisis.

Sales Growth 2010 2011 Q1 2012
BMW 19.3% 13.8% 14.1%
Burberry 26.7% 23.7%
Hermes 18.9% 18.3% 17.6%
LVMH 13.0% 14.0% 14.0%
SwatchGroup 21.8% 21.7%
Tiffany 11.0% 18.0% 8.0%
Burberry fiscal year ends in March; FY 2011 and 2012 shown here.
Hermes, LVMH, Swatch, Tiffany: organic growth, ex- currency impact and acquisitions

The boom has been fuelled by rising demand in the BRIC countries and, to a lesser extent, in the United States. In 2011, sales in Asia (including Japan) were 28% of total revenues at BMW, 35% at LVMH, and as much as 54% at Swatch. At LVMH in 2011, sales in Asia ex-Japan and in the US grew by 27% and 18% year-on-year, respectively. For BMW, Asia represented 22.5% of unit sales in 2011, up from 10.6% in 2007.

If the rich, per F. Scott Fitzgerald, are different from you and me, then the suppliers and courtiers who pander assiduously to their vanity or sense of perfectionism, the purveyors of the finest consumer products on earth, are certainly different from the average consumer company. Whether by sheer luck or brilliant foresight, luxury goods companies now find themselves at the nexus of two main drivers of demand. First, the global rich, whose numbers have been increasing, are less sensitive to the economic cycle. They have big reserves of savings and can spend on luxury items even if their incomes falter for a year or two. Most will continue to consume luxury unless the economy is hit by a severe downturn. One of the reasons that BMW is bullish on the future is its expectation that the number of millionaires will continue to rise in developed markets as well as in the BRIC countries and Turkey and South Korea (identified as the BRIKT + China in a BMW presentation).

Second, the newly rich and middle class in emerging markets have embraced luxury products with a vengeance. Like the Japanese in the 1990s, shoppers in the BRIC countries are today’s most profligate luxury customers. Chinese buyers discovered luxury brands years ago and they have been buying with gusto. Significantly, their buying power and obsession with luxury is felt far beyond their borders. According to the Boston Consulting Group, travelers from emerging markets (tourists and business people) account for a large share of global luxury sales, even if some of these sales are recorded in Paris, New York or Tokyo. BCG says that the Chinese spend as much on luxury while away as they do at home.

Barring a global recession, these two groups, the rich everywhere and the middle class in emerging markets, will continue to spend on luxury products and, increasingly, on luxury services. These are undoubtedly the best of times for the luxury sector. The question then becomes: what will derail the boom? A shift in demographics could do it.

A Brief Digression on Demographics and Markets

In general, the world is full of coincidences but it would be foolish to accept all of them at face value. Sometimes it makes sense to ask questions to find out whether two concurrent events are really a coincidence or whether they are related. Among coincidences that we should not take at face value are important reversals in markets which occur at the same time as demographic inflection points. For example, the Japanese stock market peaked in 1990, the same year that the number of Japanese turning 40 also peaked. It could be a coincidence but then the US stock market peaked in 2000, the same year that the number of Americans turning 40 also peaked. It could be another coincidence or alternatively, there could be a poorly understood dynamic underlying the stock market, a dynamic directly linked to demographics, aging and investing etc. (The Chinese stock market peaked in 2007, one to five years after the number of Chinese turning 40 hit its own peak).

Demographics are generally ignored or underestimated by market participants. They are often seen as far-removed inputs in the economy which eventually manifest themselves through other measures. For example, an investor may ignore the change in demographics in a given area or region or country, confident in the knowledge that any significant shift will eventually appear in monthly retail or housing data or other economic indicators. The only problem with this thinking is a large gap in timing. Monthly status updates from the economy are mostly embedded in market prices by the time they are released. By contrast, an analysis of demographic trends can help make a forecast several months or even years before significant changes filter through the monthly economic data.

Dependency Ratios

One demographic measure which should certainly be examined in its relation to markets is the dependency ratio which measures the number of dependents per working adult (it is the sum of people under 14 and over 65, divided by the number of people aged 15-64). The table (compiled from a UN 2010 report) shows the ratio (per 100 people) for various countries and regions. A declining ratio is generally positive for the economy because income earners have fewer dependents and can divert dollars to investing and spending.

The world’s dependency ratio which fell steadily from 1970 to 2010 will be essentially flat until 2020-30 and will start to rise beyond 2030. In the US and Europe, the ratio hit bottom around 2010 and will rise in future decades. But in Japan, it hit bottom in 1990 and has been rising ever since. Perhaps this explains in part Japan’s lost decade which turned into two lost decades.

1950 1970 1990 2000 2010 2015 2020 2030 2050
World 65 75 64 59 52 52 52 53 58
Brazil 80 85 66 54 48 45 44 46 59
Russia 54 52 50 44 39 43 48 54 67
India 68 80 72 64 55 52 50 47 48
China 63 77 51 48 38 38 40 45 64
Europe 52 56 50 48 46 50 54 61 75
Japan 68 45 43 47 56 65 70 75 96
USA 54 62 52 51 50 53 56 64 67
Africa 81 91 91 84 78 76 73 67 59

In the BRIC countries, the dependency ratio is still falling in Brazil and India, but it is near bottom and is set to rise in Russia and China. And in Africa, the ratio will continue to fall for a long time.

As the ratio rises, there will be fewer dollars to spend on discretionary items because more of these dollars will have to be redirected to taking care of dependents, whether this is done directly through assisting family members or indirectly through charities or government social programs.

Which brings us back to luxury goods, in some ways the quintessential discretionary items. Will a rise in the dependency ratio in developed countries, in Russia and in China lead to a slowdown for the sector?

Japan

Looking into the future, the case of Japan can be informative. It was not long ago that the Japanese were avid buyers of luxury goods, both at home and while traveling. But a 2009 study by McKinsey found that the Japanese appetite for luxury goods has been on the wane since 2001 (in volume terms) and it noted that their purchases started to decline (in currency terms) in mid-2006, two full years before the onset of the financial crisis.

Whether by coincidence or causality (the latter in my opinion), the demographic data fits well with this turn of events. Because of a low birth rate and an ageing population, Japan’s dependency ratio, 0.43 in 1990, rose modestly to 0.47 by 2000 and more briskly to 0.56 by 2010. It is on its way to 0.7 in 2020.

Nonetheless, heavy investing by luxury companies over several decades means that the Japanese luxury market remains the second largest in the world, after that of the United States. LVMH has 360 stores in Japan, a country 10% smaller than California, vs. 621 for all of the US.

BRICs

The dependency ratio is bottoming in Russia and China but it will only rise slowly for the next 10 to 15 years. This suggests that, barring other developments, the luxury sector could continue to do well, but its growth rate may taper off. Of all the BRIC countries, India’s ratio looks the most promising and it offers the best longer term profile if its policymakers can set the country on a path to reap the demographic dividend resulting from a decline in its fertility rate. Although luxury companies have a presence in India, their footprint is much smaller than in China and Japan. For example, Louis Vuitton has over 50 stores in Japan, 39 stores in China and 4 in India.

Into Africa

Africa will see a steady decline of its dependency ratio in the 21st century. Luxury companies have a small to nonexistent presence on the continent. Swatch Group records a minuscule 0.6% of its sales there. Louis Vuitton has three stores, of which two in South Africa and one in Morocco, but none in oil-rich Angola or Nigeria. Porsche has seven ‘Porsche Centres’ in Africa, of which three in South Africa and one each in Angola, Nigeria, Egypt and Ghana. But it has 42 ‘Centres’ in China, 23 in Russia and 8 in Brazil. Although store count is an incomplete measure (because of sales through third party outlets), a larger number of own-brand stores denotes a greater confidence in the stability and growth of a given market. If Africa is the next economic frontier, these are indeed very early days for luxury goods companies on the continent.

They should sit up and take note. A team led by Hinh T. Dinh, Chief Economist at the World Bank, recently examined Africa’s prospects as a new manufacturing hub. Dinh writes:

“The ongoing redistribution of cost advantages in labor-intensive manufacturing presents an opportunity for Sub-Saharan Africa to start producing many light manufactures, enhance private investment and create millions of jobs.

According to new evidence, feasible, low-cost, sharply focused policy initiatives aimed at enhancing private investment could launch the region on a path to becoming competitive in light manufacturing.

These initiatives would complement progress on broader investment reforms and could foster industrialization and raise the market share of domestically produced goods in rapidly growing local markets for light manufacturers.”

Rise of Experiential Luxury

In its report, BCG estimated that sales of the global luxury sector amounted to $660 billion in goods (including luxury cars) and another $770 billion in services. BCG also highlighted a gradual shift in customer preference from owning luxury (goods) to experiencing luxury (services). Experiential luxury includes spa services, safaris, luxury travel, fine dining, special art auctions and other services. BCG deems this subsector to be growing by 12% per year while the market for luxury goods grows by 3 to 7%.

A key driver of experiential luxury is the aging of the population in North America, Europe, Japan and China. As people get older, they are less interested in owning expensive watches and handbags and more interested in valuable experiences. Some luxury product companies are trying to position accordingly. In its considerable portfolio, LVMH now also counts Cheval Blanc, a high-end hotel in Courchevel. But these efforts are so far embryonic.

So can the boom last? Yes, but projecting into the future the strategy of the past ten years will not be enough. The reversal of the dependency ratio in several BRIC countries and the rise of experiential luxury in developed markets pose the biggest challenges. Luxury goods companies will have to adapt their geographic and product footprint accordingly. In the near-term, wider concerns about the global economy override demographic developments. But in the longer term, India and Africa look like promising frontiers while the rest of the world (including China) grapples with an older population and a rising number of dependents.

By populyst | Also posted in Africa, Analysis and Opinion, Asia, China, Demographics, Dependency Ratio, Economy, Emerging Markets, Europe, India, Japan, Nigeria, Russia, Sub-Saharan, United States | Comments (0)

Demographic Megatrends of the 21st Century

May 29, 2012 – 11:11 am

by SAMI KARAM

(also published at Seeking Alpha)

The world’s changing demographics will have a far-reaching impact on our economy.

Context, as we know, can be very important in economics and in investing.  Some of the most successful investors of our time might have been unknown humble laborers if they had instead been born in a poor country far away or born in this country at a less propitious time. Context is made of several components including, among others, political risk, the rate of innovation, fiscal and monetary policy, and of course demographics.  Some or all of these components can remain unchanged for years or even decades, which may lead a majority of economists and investors to mistakenly view them as permanently fixed. Yet each inevitably comes to an inflection point which destabilizes economic or investment projections built on assumptions derived from the old paradigm.

In the case of demographics, they have acted for decades as sustained tailwinds for the US and global economies. The main drivers of these tailwinds were 1) the rise of the baby boomers and 2) the subsequent decline in the birth rate in North America, Asia and Europe, which resulted in a fall of the dependency ratio (number of dependents per working adult). Because these tailwinds have now largely died down (except in India and other parts of Asia), demographics can no longer be seen as a fixed component of the economic or investment context.  What was true for decades is no longer true because we have recently passed an inflection point in demographics.

Going forward, changes in the populations of North America, Europe, Asia and Sub-Saharan Africa will likely undermine economic projections derived from the habits and assumptions of an obsolete context.  Unlike the past few decades, demographics should now be considered as a moving variable which may be supportive or adverse to one’s economic or investment thesis. (In my view, every investment portfolio should be subjected to a ‘demographic audit’ which incorporates the impending changes).

Some demographic megatrends were quantified in 2010 by a United Nations report, World Population Prospects, and are summarized in the table below.  Forecasting is a difficult endeavor and the UN tries to mitigate the uncertainty by creating four different scenarios, or ‘variants’ of the Total Fertility Rate (TFR), for population projections: constant-fertility, high, medium and low. The constant-fertility variant assumes that the fertility rate (the number of children per woman) in each country and region of the world remains at the same level as it was in 2005-10.  This variant shows a shocking increase in the world population to levels which are probably unmanageable, from 7 billion today to 11 billion in 2050 to 27 billion in 2100.  It is highly unlikely therefore that fertility rates will remain unchanged. They are today exceedingly high in Sub-Saharan Africa and exceedingly low in Russia, Germany and Japan.  The three other variants all result in lower population counts for 2050 and 2100.  I use the medium variant below and all figures are UN estimates, not my own (for more detail on fertility assumptions of the four variants, see pages 27-35 of the UN report).

The key points are as follows:

The population in each of the more advanced economies of North America, Europe and Oceania will either grow slowly, stagnate or fall precipitously.  In the US and Canada, it will grow slowly. In a large majority of European countries, it will stagnate or shrink moderately. And in Russia, Japan and Italy, it will fall or fall precipitously.

Europe

Europe faces a significant demographic challenge.  It is in its causes and chronology similar to the challenge we face in the United States but it is more severe because Europe has a lower fertility rate. How do you keep the economy growing when the size of the population and its age distribution are no longer working in the direction of growth? It can be done but it is certainly more difficult. And how do you maintain Europe’s cherished social programs when the number of workers stagnates or declines and the number of retirees increases?

Europe’s population is expected to fall from 738 million in 2010, to 719m in 2050 to 675m in 2100. Because of some growth in Ireland, France and the United Kingdom, the population of Northern Europe would maintain itself or grow modestly. But it will decline in Southern Europe in large part because of Italy, Portugal and Serbia. On medium variant estimates, the number of Italians would shrink from 61m in 2010 to 59m in 2050 to 56m in 2100.  Germans would also be fewer, from 82m to 75m to 70m. Eastern Europe (including Russia) would shrink from 295m to 257m to 222m, with every state except the Czech Republic, Hungary and Slovakia losing 20 to 30% of its population count by 2100.

The UN report projects that, at constant-fertility rates, the population of Russia would fall from 142 million in 2010 to 114m in 2050 to 67m in 2100. The more probable medium variant predicts a Russian population of 126m in 2050 and 111m in 2100, still a decline of 31m by the end of the century. Russia suffers from a low fertility rate and a low life expectancy, two factors which are likely to improve in coming years.

Africa

Africa presents the opposite profile with the population of Sub-Saharan Africa continuing to grow rapidly.  In 2010, the fertility rate in Africa was 4.37 children per woman (5.43 in Nigeria) compared to 1.59 in Europe and 2.08 in the United States.  Although fertility rates are expected to fall dramatically, the population of Africa will first grow from 1.02 billion in 2010 to 2.19b in 2050 to 3.57b in 2100 (again, using the UN’s median variant). Of these numbers, Sub-Saharan Africa which has 856 million people today will total 1.96b and 3.36b. Given that the world population is expected to grow from 6.9 billion in 2010 to 9.3b in 2050 to 10.1b in 2100, it is easy to see that a huge part of this growth, 77%, will be coming from Sub-Saharan Africa.

If these numbers are surprising, consider that the world fertility rate stands today at 2.45 children per woman but that it is 4.78 in Sub-Saharan Africa.  And while the Sub-Saharan rate is expected to decline to 2.85 by 2050 and 2.14 by 2100, it will not decline fast enough to avert the incoming boom. Indeed, the numbers above already assume such a decline. A fall in the fertility rate usually follows an improvement in health care and a fall in the mortality rate. There is excellent news on this front. As recently reported by the Economist, “16 of the 20 African countries which have had detailed surveys of living conditions since 2005 reported falls in their child-mortality rates”.  The World Bank calls this “a tremendous success story that has only barely been recognised”.

China, India and Japan

China was the most populous nation in 2010 with 1.35 billion people but it will be overtaken by India around 2020 when both countries will have 1.39 billion. The impact of China’s one-child policy means that its population count will fade to 1.3b by 2050 and 952 million by 2100, while India continues to grow to 1.69b by 2050 before it also fades to 1.55b in 2100. The assumptions built into these numbers are not extreme. Starting at 1.56 in 2010 (well below the world average), China’s fertility rate would rise to 1.81 by 2050 and 2.01 by 2100.  India’s TFR now 2.54 (slightly higher than the world average) would fall to 1.84 by 2050 and tick up to 1.88 by 2100.

Like Europe, Japan’s population will fall by a large percentage.  Japan’s fertility rate of 1.42 was in 2010 one of the lowest in the world, but the UN is expecting it to recover to 2.04 by the end of the century. This will not be soon enough to avert a precipitous decline from 126m Japanese in 2010 to 109m in 2050 to 91m in 2100.

North America

The UN expects the population of North America to grow from 344 million in 2010 to 447m in 2050 to 526m in 2100 with nearly all of this growth taking place in the United States (respectively at 310m, 403m, 478m). My own estimate of the US population, published in America Heading for Zero Population Growth?, is lower.  Without new immigration, I found that the US population would not grow at all in the 2030s and 2040s.  The difference between my estimate and the UN estimate is of the order of 25 to 35 million Americans by 2050, which is significant for the US, but not so significant in the context of global demographics where the numbers are much larger.

On the Demographic Dividend

The demographic dividend is an economic benefit which can occur after mortality and fertility rates decline in a given country.  A decline in the mortality rate is generally followed by a decline in the fertility rate, as more women gain access to better health care and to some form of birth control. Over a period of decades, each adult and each working person will have fewer dependents to support. In the right context and with the right policies, this decline in the dependency ratio will yield a demographic dividend.  The best examples of the demographic dividend are found in East Asia, and in developed countries.  The demographic dividend in the US has largely been reaped and it now threatens to turn into a liability unless we enact the policies needed to deal with its aftermath. I wrote in Our Growing Inactive Population that the dependency ratio is about to reverse unless the retirement age is raised to 70 years.

In theory, Africa could be the next place to benefit from a demographic dividend. This would require not only a big decline in mortality and fertility rates, but also the adoption of government policies which foster political stability and encourage economic development. As to timing, it may be decades before the dividend appears, if at all. Outside of Africa, India could also reap a large demographic dividend.

Other Considerations

Outside of the sheer numbers which are startling enough, there are other considerations which flow from the age distributions and economic conditions in various countries.  The challenges posed by aging populations on developed economies and their government social programs are well known and documented.  It is enough to say that the status quo is untenable since it would lead inevitably to an explosion in government liabilities and to a severe deterioration of the economy. This statement applies easily to North America, Europe and Japan.

Less known are the demographic issues facing developing nations.  Nicholas Eberstadt of the American Enterprise Institute described them in a 2011 working paper:

On China:

“China is confronting the demographic version of “the perfect storm” and these new demographic realities may ultimately force us to revise today‘s received wisdom about “China‘s rise”.”

“China‘s future demographic profile will differ substantially from its current population situation, mainly because of the country‘s low levels of fertility. Although there are some inconsistencies and problems in official Chinese population data, population specialists believe that China became a sub-replacement fertility society about two decades ago—and that birth rates have fallen far below the replacement level since then.”

“In the decades immediately ahead, China will see the emergence of a growing host of essentially unmarriageable young men. This outcome will be the all but inescapable arithmetic consequence of the gender imbalance that has accompanied the country‘s “One Child Policy” – while ordinary human populations regularly and predictably report 103 to 105 baby boys for every 100 baby girls, China‘s officially reported sex ratio at birth (or SRB) was almost 120 boys for every 100 girls in 2005. This imbalance between the numbers of little boys and little girls in China sets the stage for a “marriage squeeze” of monumental proportions in the decades just ahead.”

In India, Eberstadt sees a significant North-South divide correlating the birth rate with education and economic opportunity:

“[India's] dilemma can be highlighted by contrasting the prospective educational profiles of Kerala (which is now one of India‘s most prosperous states) and Bihar (one of its poorest). In just over a decade and a half, Kerala‘s working-age population will be on the brink of stagnation—but the state‘s working age manpower will be fairly well trained (roughly half of Keralites aged 15-64 would have high school education or better). By contrast, Bihar‘s working-age manpower will still be growing briskly—but as 2030 approaches, these projections suggest that well over half of working-age Biharis will have received no more than some primary schooling, and nearly a third of the state‘s working age manpower will have no formal education at all.”

Globally, Eberstadt sees a slowdown in the growth of the working-age population:

“By the reckoning of the UN Population Division, the world‘s population of “working age” (conventionally, albeit somewhat imperfectly, defined as men and women 15-64 years of age) grew by 1.3 billion, or about 40%, between 1990 and 2010: a pace averaging about 1.7% a year. Given the pronounced global fall-off in fertility over the recent past, however, the world‘s manpower of economically-active ages is set to grow much more slowly between now and the year 2030. By the Census Bureau‘s projections, the absolute increase in the world‘s working age population for 2010-2030 would be around 900 million—400 million fewer than over the past two decades—and the projected average rate of global manpower growth for the coming decades is 0.9% per annum—that is to say, only just over half the tempo for 1990-2010.”

Demographics are not the be all and end all of economics but they are one important factor among many important factors.  They open or close a window of opportunity. There is always a risk in extrapolating the present to predict the future and we should view these figures with some skepticism. However the trends outlined above are undeniable, even if their magnitude turns out to be greater or smaller than the figures suggest.

By populyst | Also posted in Africa, Analysis and Opinion, Asia, China, Demographics, Economy, Emerging Markets, Europe, European Union, France, Germany, India, Italy, Japan, Nigeria, Russia, Sub-Saharan, United Kingdom, United States, US Economy, US Federal Budget | Comments (0)

Boeing vs. Airbus: Orders and Profits

May 15, 2012 – 12:27 pm

by SAMI KARAM

(also published at Seeking Alpha)

Boeing has a better product lineup and is more profitable but Airbus has more room for improvement.

The rising tide of globalization has boosted growth prospects for the airline industry all over the world, and in particular in emerging markets such as China and India.  As air travel has become more accessible to hundreds of millions of people, airplane orders and deliveries have boomed. We examine the evolution of orders and profits at Boeing and Airbus.

Airbus Market Share Strategy

Given the Boeing – Airbus duopoly and buoyant demand markets, both manufacturers should now be highly profitable but this is only true of Boeing.  Airbus made some strategic decisions in the late 1990s and early 2000s which continue to depress its profitability, namely the development of the super jumbo A380 which is still loss-making, and the sale of planes below cost or at razor-thin margins in the early 2000s in a drive for market share.

If Airbus’s main mission has been to gain market share, one has to recognize that this mission has so far been highly successful.  In the year 2000, Airbus delivered 311 planes to airlines and Boeing delivered 489.  Eleven years later in 2011, Airbus delivered 534 planes and Boeing 477.  As important, the backlog at EADS (European Aeronautic Defence and Space Company, the parent of Airbus), including non-Airbus divisions, grew from €132 billion in 2000, the equivalent of 5 years of revenues, to €541 billion in 2011, the equivalent of 11 years of revenues.  Boeing’s comparable backlog grew from $153 billion in 2000, 3 years of revenues, to $355 billion in 2011, 5 years of revenues.  Because the Euro has appreciated against the dollar in that decade, these figures actually underestimate the scale of the shift in favor of EADS/Airbus.  In dollar terms, EADS’s backlog has grown from $124 billion in 2000 to $700 billion in 2011, a near six-fold increase.

But Boeing has been more profitable.  In 2011, its EBIT margin in commercial planes was 9.7% vs. 1.7% at Airbus. This dichotomy between one party’s push for market share gains and the other’s focus on profitable orders has defined the relationship between the two competitors for over a decade.

In a decade of astounding revenue and order growth, Airbus has not improved its profitability.  In fact, its operating income (EBIT) was negative in three of the last six years (2006-2011) despite healthy revenues and deliveries.  Boeing has remained profitable but its commercial airplane sales and operating income have been range-bound for a decade.  From 2000 to 2011, Boeing sales grew at a small 1.4% annualized rate and EBIT at only 2.3%.  At Airbus, sales have grown at a 7.6% annual rate (11% in dollar terms) but EBIT has nosedived into the red for the past six years.  Boeing’s commercial plane division accounted for 66% of its group sales in 1999 and now accounts for 52%.  Airbus sales have remained consistently above 60% of EADS group sales and reached a new high of 67% in 2011.  Airbus’s drive for market share at the expense of profits has had a very measurable impact: its revenues are up, its profits are down, and Boeing’s airplane sales and earnings have flatlined.

EADS went public in July 2000 at €19 per share and ended 2011 near €24, a subdued performance for an 11-year period in which sales more than doubled. In January 2012, Airbus promised better returns for its shareholders for the years ahead and the share responded by rising to €31 in March (it recently traded at €28.8). EADS’s reasons for optimism are a decline of the Euro vs. the US dollar and a long-awaited improvement in operating margins for its superjumbo A380.

Prospects

Long-term headline prospects look nominally encouraging. Airbus and Boeing estimate that 25,000 to 33,500 new planes (including both passenger and cargo) will be delivered to airlines in the next twenty years.  However, according to Boeing, single-aisle aircraft (the A320 for Airbus, the 737 for Boeing, and their successors) will account for two thirds of units sold and for half of the value.  And as many as one third of new planes will be sold in the Asia-Pacific region.

As a market segment, ‘single-aisle in Asia-Pacific’ is not the ideal sweet spot for profit growth because smaller planes have lower margins and because Airbus and Boeing face new entrants in the single-aisle category, notably from China’s COMAC C919 and from Russia’s Sukhoi Superjet 100. The COMAC C919 seats 165 to 190 passengers and is therefore directly positioned against the larger versions of the A320 and the 737. It already has 175 orders, nearly all from Chinese airlines, and it plans to start deliveries in 2016.  Note in passing that Airbus is now assembling some of its own A320s in Tianjin, China, with a target production rate of four per month in 2012. It says on its web page Airbus in China that it ”has several major technology transfer programmes underway” some of which have ostensibly already been filtered to COMAC.

The Superjet 100 is smaller than the C919 at 75 to 95 passengers and is positioned against the smallest versions of the A320 and 737 and against Brazil’s Embraer and Canada’s Bombardier. Although it has 240 orders, there are only eight in service now, seven of them with the Russian carrier Aeroflot. Last week’s tragic crash in Indonesia raises fresh safety concerns about Russian aviation just as it tries to rebound from its accident-prone Soviet legacy.

Turning to recent orders, we see that as of the end of April, Boeing had received 415 new plane orders in 2012 and Airbus 95. This huge lead in favor of the American is a temporary anomaly because most of it comes from orders for the new Boeing 737MAX which came on line about 12 months after the competing Airbus 320NEO.  If 2012 is the year of the MAX, 2011 was the year of the NEO with Airbus logging a commanding 1419 total orders (of which 1226 for the NEO) against 805 at Boeing (of which 150 for the MAX).

Wide-bodies

Looking at wide-body categories, the Airbus lineup includes the A330, the A340, the perennially loss-making superjumbo A380, and the A350 still under development.  Boeing’s competing lineup includes the aging but ever-updated 747, the 767, the new 787 ‘Dreamliner’, and most importantly today, the hugely successful 777. Stripping out single-aisle aircraft from 2011 orders, we see that Boeing secured 254 orders for wide-bodies and Airbus 193.

The 777 in particular now enjoys a quasi-monopoly in some segments, vindicating Boeing’s decision to develop this plane while Airbus exhausted itself on the prestige-minded A380 double-decker. Boeing delivered its 1,000th 777 to Emirates in March.  Airbus has positioned different versions of the upcoming A350 against both the 777 and the 787 Dreamliner. The A350 is years away from service but it now has a total of 548 orders. Recent cancellations by Abu Dhabi-based Etihad Airways have slowed down the momentum for the largest version A350-1000 which competes with the 777-300ER.

Airbus still loses an estimated €30+ million on each A380 that it builds but it expects the program to break even in 2014-15 on an EBIT pre R&D level, which is break-even on an operating level, ignoring much of the upfront investment.  That would place the EBIT break-even point somewhere between 200 and 250 unit deliveries (so far 72 A380s have been delivered).  In 2005, Airbus estimated the program would break even on an IRR basis at 270 units.  But in 2006, it revised the break-even point to at least 420 units.  The A380 now has 253 orders, two thirds of which have come from airlines based in emerging markets. And one airline, Dubai-based Emirates, accounts for 90 orders.

Airbus sees a total market of over 1,200 units for the A380 (all versions) in the next 20 years, but Boeing believes the potential market is only 325 units. Depending on where one stands on either end of this range, the A380 will either be handsomely profitable in a few years or one of the most visible financial failures in modern industry. For context, consider that in the 42 years since the introduction of the Boeing 747 in 1970, Boeing has sold nearly 1,500 versions of the plane.  With its A380 projections, Airbus is hoping to sell 80% as many units in as few as 20 to 25 years. It is true that the overall market is much bigger today but it is also true that airlines seem more interested in smaller planes. Rising world demographics do not necessarily create a correspondingly large demand for jumbo planes, as much as they do for a larger number of destinations and higher frequency of flights serviced by smaller aircraft.

It would be beneficial for both manufacturers if the A380 turned a profit (at least at EBIT level).  The plane has a list price of $375 million but list prices are generally above contracted prices.  Boeing’s revamped 747, the 747-8 Intercontinental, has a list price of $318 million. If the A380 stays in the red, the question becomes how long will Airbus continue to build it at a loss? Thousands of European jobs depend on the plane and Airbus will probably keep the program for as long as possible. Selling the A380 at a loss for an indefinite period would be detrimental to the Boeing 747-8′s own profitability if Airbus has to offer greater and greater discounts in order to keep the program alive.

It is still early in 2012 but both manufacturers have had difficulty selling wide-body aircraft this year.  Of Boeing’s 415 net orders, only 2 were for wide-bodies (there were 8 new orders and 6 cancellations). Of Airbus’ 95 net orders, only 6 were for wide-bodies (there were 22 new orders and 16 cancellations). The A350 has lost a net 7 orders in 2012. Boeing’s newest plane, the 787 Dreamliner lost a net 6 orders. However, both manufacturers have large backlogs, equivalent to 5 years of 2011 revenues at Boeing and to 11 years at Airbus, which should keep their factories humming in any downturn, barring large cancellations.

Profitability

Airbus is trying to improve its poor profitability.  Its EBIT margin in 2011 was a dismal 1.7% vs. 9.7% at Boeing’s Commercial Airplanes division. Airbus management is targetting an EBIT margin of 10% for 2015, a level last reached in 2005. The margin is expected to start expanding in 2012 as A380 losses subside and low-margin orders from the early 2000s are finally phased out.

By contrast, there may not be a lot of room for margin improvement at Boeing. Its group EBIT margin was 8.5% in 2011 and its margin in commercial planes was 9.7%.

Long-term expectations remain high and both manufacturers are likely to add more capacity in coming years. Because these expectations are predicated on continued growth in emerging markets, a cyclical downturn in these markets will depress utilization rates and put pressure on pricing at the same time that new competitors enter the lower end of the market. On the other hand, continued expansion of emerging market airlines and operational improvements at Airbus could result in better pricing power unless COMAC manages to gain significant market share.

In conclusion, both companies stand to benefit or suffer from emerging market developments. Operationally, Airbus has more room to improve. If it can narrow the margin gap with Boeing, EADS’s EV/Sales and stock should rise correspondingly. But its manufacturing location in Europe may make it difficult to reach its stated margin targets.

By populyst | Also posted in Aerospace, Airbus, Airlines, Analysis and Opinion, Asia, Aviation, Boeing, China, Economy, Emerging Markets, Europe, European Union, France, Germany, India, United States, US Economy | Comments (0)

US Demographics and Housing

May 15, 2012 – 10:54 am

by SAMI KARAM

(also published at Seeking Alpha)

Expectations of a robust housing recovery are not well supported by US demographics.

From Bloomberg News (February 8, 2012): Chief Executive Officer Jamie Dimon told investors and analysts in a January conference call that housing is “getting closer” to a bottom. “We’re going to add 3 million Americans every year for the next 10 years. That’s 30 million Americans who need 13 million dwellings,” he said.

Mr. Dimon’s estimate looks too optimistic on two accounts.  First, the US population will more likely grow by 23 to 26 million in the next 10 years.  And second, the demographic bracket which includes over 80% of home buyers will grow at a much lower rate.

The US population grew by 2.8 million people in the sixteen months from April 2010 to July 2011, but over 700,000 of these 2.8 million were new immigrants.  In the remainder of this decade, the population will grow by an average of 2.6 million people a year, assuming a more typical 1 million new immigrants per year.  My estimates are derived from data compiled by the Center for Disease Control (which tracks life expectancy among other things) and by the US Census. In the next decade 2020-29, the population will grow by an average 2.3 million per year and in the following decade by 0.9 million per year, again assuming 1 million new immigrants per year.  Note that without immigration, the population would shrink in 2030-39 and in 2040-49, as I argued in America Heading Towards Zero Population Growth?.

It is not enough to tabulate the number of new Americans (newborns or immigrants) to estimate the likely impact on housing.  We have to also look at the likelihood that they are in an age segment and in an economic bracket that will lead them to spend a fair amount of money on a home, regardless of whether they are renting or buying.  An ideal scenario would be a large increase in the population segment of young and middle-aged Americans who can be characterized as middle-class or richer.  But this scenario is unlikely in the next decade.

Of the 2.6 million annual addition to the population in the present decade, 4.2 million will be from new births and 1 million from new immigrants.  And because there will be 2.6 million deaths, the sum total of these three figures comes to a 2.6 million (4.2 + 1 – 2.6 = 2.6) addition.

The US Census recently disclosed that foreign-born households are made up on average of 3.4 people, more than the 2.5 people average for native-born households. Assuming new immigrants are in similarly-sized households, one million immigrants would absorb about 294,000 dwellings per year. Incidentally, there were only 700,000 immigrants in 2011, equivalent to a demand for 206,000 units.

Outside of immigration, the annual growth in population in the present decade will be 1.6 million.  Babies don’t buy homes but growing families with new babies may do so because they need more space.  In this case however, they are vacating one home and moving into another, resulting in a net demand of zero in terms of units (say trading a 3 bedroom for a 4 bedroom home) and a subdued net positive demand in dollar terms (say trading a $250,000 home for a $300,000 home).  At the other end of the age spectrum, older people who pass away often leave a home vacant, adding to the supply of existing homes for sale.  The demand for upgrades is debatable but the supply from deaths is certain, resulting in a murky overall supply-demand situation.

A better way to look at the demand is to estimate the size of the population of people who are likely home buyers.  75% to 80% of home buyers are in the 30 to 60 age bracket (see footnote). The remaining 20% to 25% of home buyers are aged less than 30 or more than 60 and are generally buyers of smaller homes. In terms of dollar value, the 30-60 bracket could therefore represent as much as 90%+ of the residential real estate market. This bracket now has about 125 million people but it has stopped growing (excluding new immigration) in 2005 and will not resume its growth until after 2020.  If the overall pool of likely home buyers is not growing, then people are just trading homes amongst themselves without any significant net gain in overall demand for new homes. Upsizing by growing families could be largely matched by downsizing from older couples whose children have left home.

Therefore if you assume no demand from existing residents and demand of 294,000 homes from new immigrants, the total net demand in the next ten years would be around 3 million units, far fewer than the 13 million estimated by Mr. Dimon. Total home construction will probably exceed this 3 million figure because of some demolition of older homes and because supply and demand are often not in the same location.  Florida or Texas may see net demand while some other regions see net supply.

Some attention has been given to other measures of demand such as housing affordability and the rate of household formation. The National Association of Realtors said in March that the housing affordability index rose above 200 for the first time since recordkeeping began in 1970. An elevated index is an indication of high affordability.  But in any transaction, there is the ability to buy and the need or desire to buy. The affordability index shows that the ability to buy is strong but it is not indicative of the need to buy. If people are already in homes and there are few incremental buyers, housing affordability is not an indication that demand will soon return. If the index is high because demand is muted and interest rates are low, it does not follow that greater demand will inevitably return. That would only be true in the context of favorable demographics such as we have had in previous recoveries.

As to household formation, it is still low but seems to have bounced in the first quarter.  It declined after 2007 because of a fall in the divorce rate and because more young people stayed under their parents’ roofs.  The youth unemployment rate has recently been improving, raising expectations that household formation will also recover. But even during the good times, the young demographic contributes a relatively small demand in terms of units and an even smaller demand in terms of value (since they tend to live in smaller and less expensive housing). Furthermore, counting the young people who enter the house-buying age bracket and neglecting to count the older people who simultaneously leave this bracket only presents half of a full picture.

Outside new immigration, there will be little demand for housing from demographics until the end of this decade.  When the 30-60 age bracket starts growing again in the 2020s, housing demand will grow again but it will be weaker than in 1985-2005 and will have to contend with the new supply of homes vacated by rising numbers of dying or downsizing baby boomers.

As to the exchange-listed home builders, two factors may work in their favor despite the poor demographic backdrop. One is that real estate is famously local, which means that, with sufficient research, they may be able to focus on areas of the country which are growing even in a time when the overall market is not.  For example, some parts of Florida or Texas may see more demand than supply while some regions in the Midwest or Northeast see more supply than demand. The second factor is the trend towards urbanization with more people choosing to live in cities instead of suburbs. In this vein, several home builders are shifting some of their focus to multi-family developments.

The main risk to these forecasts arises from the difficulty in assessing the impact of illegal immigration. It clearly contributes to some incremental demand, perhaps not in the early years after a person’s arrival, but certainly after a few years. But here again, the data is mixed because, as noted by the Pew Research Center, the inflow from Mexico has recently reversed for the first time.

Footnote: The National Association of Realtors publishes every year a Profile of Home Buyers and Sellers. The Profile is compiled from responses to a survey which the NAR mails to tens of thousands of consumers who purchased a home during the period under study, usually July to June.  For 2010, the NAR mailed 111,004 surveys and received 8,449 responses, or 7.9%, and for 2011, it mailed 80,099 surveys and received 5,708 responses, or 7.3%. It is not clear whether these samples are large and diverse enough to be representative of all home buyers. It is possible, or perhaps even probable, that the profile of survey respondents differs markedly from that of home buyers in general. Notwithstanding the methodology, the 2011 Profile shows a marked jump in the average age of home buyers from 39 in 2010 to 45 in 2011.  This jump is directly related to the expiration of the first-time home buyer tax credit which was still on offer in 2010 (and 2008-09) but not in 2011.  Although the age distribution of buyers in 2010 showed a large percentage in their twenties, we view this as a discrepancy caused by the tax credit. In addition, it is very likely that the current historically very low mortgage rates have skewed the age distribution towards younger age groups.  We are comfortable with our estimate that, under normalized circumstances, 75 to 80% of home buyers are in the 30 to 60 age bracket.

By populyst | Also posted in Analysis and Opinion, Demographics, Housing, Immigration, United States, US Economy | Comments (0)

Can ‘Occupy Wall Street’ Make a Comeback?

May 1, 2012 – 5:00 am

by SAMI KARAM

The young alone lack the demographic firepower to mobilize an effective protest movement.

With the return of warm weather, the ‘Occupy Wall Street’ movement is staging a series of protests in the hope of making a comeback after last fall’s dismal showing. Whether it succeeds in turning itself into an enduring force for change or whether it fizzles out as it did in November will depend in some measure on its ability to overcome some demographic odds which are stacked against it.  Because the percentage of young people in this country is now relatively low (compared to the 1960s and 1970s), the movement will likely gain more traction only if it succeeds in drawing into its ranks greater numbers of Americans aged 30 or more.

The hypothesis is that the young population (under 30) must be of a certain critical size as a percentage of the total population in order for a small protest to gel into something bigger.  And in America today, the young lack sufficient numbers to reach that level.  It would take a stronger demographic, equivalent to 20 to 30 million additional Americans aged 16 to 30, in order for a certain number of them to bring about significant change through street demonstrations. This hypothesis is borne out by the demographic dynamics of the 1960s protests in America and of protests in the Arab world in the past 15 months.

Source: adapted and compiled from US Census data

The adjoining chart shows the annual number of Americans who reached the age of sixteen, as a percent of the total population, between 1930 and 2010.  Note how it rises for nearly two decades from a low of 1.49% in 1955 to a high of 2.03% in 1973.  With the Vietnam War and the charged climate of the civil rights movement, there was plenty in the 1960s for young people to want to change.  And they clearly had the numbers to push for change.

When we were young. (photo: wikipedia)

But the picture today is quite different.  In America today, the percentage of people becoming young adults every year is only 1.3% and it is trending down towards the all-time low of 1.2% reached in 1992.  This decline is explained by the fall in the birth rate (the numerator) and by the aging of baby boomers (the denominator).  The deviation from the past may appear small but the 0.7% differential between the 1973 and 2010 figures is in fact equivalent to 2.2 million fewer young people per year, or 11 million over five years (the 16 to 20 bracket) or 22 million over ten years (the 16 to 25 bracket), than there would be in the US had the ratio remained at the 1973 level.

Consider for comparison the corresponding numbers in the Arab world.  The number of teenagers turning 16 every year, as % of the population, is 1.9% in Egypt, 1.8% in Libya, 1.7% in Tunisia, 2.2% in Syria and 2.3% in Yemen.  If there is a ‘tipping point’ in youth demographics beyond which a revolt can sustain itself, it can perhaps be derived from these ratios. A tipping point is likely to be at 1.7% or higher.

A rise in a country’s median age is another noteworthy measure.  The median age in America is 37 years but it is 24 in Egypt, 25 in Libya, 30 in Tunisia, 22 in Syria and 18 in Yemen.

This time around, ‘Occupy Wall Street’ may grow to become more significant, but only if it can attract older demographic segments in much larger numbers than it did in the fall.

(also featured at Urban Times)

By populyst | Also posted in Analysis and Opinion, Demographics, US Economy, Wall Street | Comments (0)

Germany Reaps the Benefits of a Weak Euro

April 16, 2012 – 10:18 am

by SAMI KARAM

Germany is looking increasingly like the sole beneficiary of the Euro currency.

Since the introduction of the Euro in the late 1990s, Euro countries have greatly benefited from the convergence of interest rates towards German levels.  This trend cut the cost of funding for governments, corporations and individuals.  Some will argue that it also created the financial laxity which eventually led to the present-day crisis.  With the unfailing clarity of hindsight, it is now obvious that Greek borrowers should have paid a lot more in interest than German ones. For Greece and most Euro countries, the party lasted for several years but the brutal hangover has now set in.  Not so for Germany which has emerged in the last two years not just as a beneficiary of the Euro, but arguably as the sole beneficiary.

As The Economist pointed out recently, the German economy is booming:

“Its (Germany’s) GDP per head has risen by more than any other G7 country’s over the past decade. Unemployment in the troubled euro zone is at its highest since the single currency’s birth; in Germany it is at a record low. In most rich countries manufacturing exports have been hammered by foreign competition; in Germany they remain powerful drivers of growth.”

The Economist identifies several factors in Germany’s success, notably the resilience of Mittelstand manufacturers and the system of apprenticeships and vocational training, but it overlooks the most important factor:  German exports have boomed because the Euro is significantly weaker than the Deutsche Mark would have been.  If the Euro zone was disbanded and the strong Deutsche Mark returned, the competitiveness of German manufacturers and exporters would be adversely impacted.  In a strange irony amid the current turmoil, Germany can find solace in Greece being Greece, and Italy and Portugal, since the inclusion of these countries in the Euro zone has weakened the Euro vs. other leading currencies.

By contrast, the Euro has been too strong for Greece, Portugal and Italy, making their exporters less competitive with foreign counterparts.  Unlike Germany, these countries lack the skill, technology or competitiveness to produce the cutting edge industrial products which are now in high demand in the developing world.

The Economist recognizes that Germany has a serious demographic problem.  As for most European countries, its population is expected to shrink.  Domestic consumption, unlike in the US, has always been moribund, but if the export machine weakens due to a stronger currency or other reasons, there is little hope that the domestic economy can pick up the slack. The structural strengths of the German economy, real or imagined, will then appear of secondary importance.

See also The Economist’s interactive guide to diverging conditions in various European countries.

By populyst | Also posted in Analysis and Opinion, Demographics, Economy, Euro, Europe, Germany | Comments (0)

America Heading Towards Zero Population Growth?

April 5, 2012 – 2:33 pm

by SAMI KARAM

(also published at Seeking Alpha)

The US population is growing at a declining rate and, without immigration, it will not grow at all in the 2030s and 2040s.

In the years following WW2 and until the mid 1960s, the US population grew by an average 1.6% per year.  From the late 60s to 2007, it grew by an average of 1% per year.  Since then, the growth rate has fallen under 1%. On my calculations, it will remain below 1% for several decades and will fall well below 0.5% in the 2030s and 2040s.  Without immigration, the size of the total population would flatline or shrink moderately in those decades.

Many, or possibly most, commentators mistakenly believe that US demographic growth will be robust for decades to come. This misconception is due in part to the fact that Europe and Japan have very poor demographics in comparison to the US. The number of Europeans and Japanese is indeed expected to decline while the American population continues to grow. But the rate of US population growth will also be declining for the next several decades.

It is widely known that immigration has been and will continue to be a key component of growth for the US population, but immigration is seen by many as an addition to the organic growth of the existing population, when in reality it will be the only source of growth in the 2030s and 2040s when organic growth will be flat or negative.

A recent report by the Census Bureau stated that the US population grew in 2011 at the lowest rate since 1940. It is a headline which will appear frequently in the future. The reason for this unusual phenomenon is quite simple. Due to the baby boomers’ passing and a relatively lower birth rate in recent decades, the number of deaths will rise quickly while the number of births rises slowly.

The annual net addition to the population is the number of births minus the number of deaths plus the number of new immigrants. Every year, legal immigration adds about 1 to 1.1 million people to the US population. In the 2030-39 decade, on current trends, the number of births will match or fall slightly short of the number of deaths and the population will grow only due to immigration.

In order to quantify the growth of the population, we need to consider two main factors: First, how many births are likely in the coming years? Assuming the birth rate remains steady at 11 children per 100 women aged 20-40, there will be 4.2 million new babies in 2015, rising to 4.3 million in 2020, 4.4 million in 2030, 4.6 million in 2040 and 4.7 million in 2050.

Second, how many deaths will take place every year? This is a bit more difficult to predict because we need to quantify the number of Americans in each age segment today and to estimate the years of their deaths based on the life expectancy of each age. How many 40-year olds are alive today and what is the likely year of their passing? How many 41-year olds, 42 year-olds etc? For example, we estimate from US Census data that there are today 4.5 million Americans aged 50. Their life expectancy according to the Center for Disease Control is 31 years. A crude conclusion therefore would be to estimate that there will be 4.5 million deaths in 2043, excluding any deaths in that year of immigrants and their children who will have come to the US in the intervening years 2012-2043. (Obviously, not all people aged 50 today will pass in 2043, but there will be in that year additional deaths from people who are now in their 40s or 50s.)

Using this approach for every age, we estimate that the number of annual births in 2015-19 will approximate 4.2 million and the number of deaths 2.6 million, yielding an annual addition of 1.6 million to the US population. Adding 1 million more people to account for new immigrants yields a net annual addition of 2.6 million, a number which is consistent with the 2.8 million addition just announced by the Census Bureau for the period from April 2010 to July 2011. Immigration only added 703,000 people in 2011 because of the sluggish economy. A 1 million annual addition from immigration is therefore predicated on a stronger economic recovery.

The number of births fell steadily between 1921 and 1933 and did not fully recover until 1943. The dip in the 1920s and early 30s explains why the number of deaths has stagnated at around 2.4 million annually in the decade since 2000. But the subsequent recovery in births in the late 30s and in the baby boom years means that the number of annual deaths will also pick up in the remainder of this decade and in the 2020s.

Absent major changes in life expectancy and without the effect of future immigration, we estimate that there will be 31 million US deaths in the 2020-29 decade or 3.1 million per year, 46 million deaths in the 2030-39 decade or 4.6 million per year, and 48 million deaths in the 2040-49 decade or 4.8 million per year. Because the number of births will grow more slowly, the net annual additions to the population will fall from 2.6 million in 2015-19 (including immigration), to 2.3 million per year in 2020-29, to 0.9 million in 2030-39, to 0.8 million in 2040-49. In these last two decades, the number of births will be less than the number of deaths, which means that all of the US population growth will come from immigration. This analysis assumes no major changes in life expectancy, a stable birth rate, and annual immigration of 1 million newcomers.

Illegal immigration is not factored in any of these figures, but its impact is likely to be negligible unless the numbers turn out to be greater than currently estimated.

The economic consequences of declining population growth are likely to be far reaching. Many sectors of the economy which have been conditioned to expect higher population growth will be negatively impacted. These include housing, retail, travel and a host of others which have benefited for years from annual population growth of 1% or more and which will have to adapt to growth of less than 0.5% for a couple of decades. Some sectors may experience additional pressures from even lower (or even negative) growth in their target demographic segments. Manufacturers of finished goods should fare better since they can make up the slack in domestic demand by selling more abroad.

Risk factors to this thesis:

It is always risky to extrapolate current trends in a linear way. Many factors could intervene to mitigate or disprove the thesis here. For example, America could have another baby boom which would raise the birth rate from 11 children per 100 women aged 20-40 (assumed here) to 15. That alone would add 1.5 million annual births. But note that even in this extreme case, population growth would still be below 1% in the 2030s and 2040s. Another possibility is a big leap in life expectancy. Yet another is a greater number of immigrants in future decades after the economy recovers. Although any of these are possible, they are in my view less likely than the base case I presented above.

By populyst | Also posted in Analysis and Opinion, Demographics, US Economy | Comments (0)