Middle Kingdom at Middle Age

At the end of last year, we looked closely at the aging of the United States. Now is a good time to take a look at China’s demographics, and how the aging of that country feeds into the growth slowdown that appears to be swallowing the world.

My guide for this view is Nicholas Colas of the brokerage Convergex. He has unearthed quite a number of compelling data points and anecdotal evidence that explains why China will not be the engine of growth going forward that it was over the past 15 years.

Here is a lightly edited recounting of Colas’ view:

— “China surprisingly shares one key problem with many developed economies: demographics. Issue #1: China’s population is growing more slowly than the United States, India or Nigeria.

— “Issue #2: The average age of a Chinese citizen is climbing quickly.

— “Issue #3: The cause of China’s slow population growth and aging demographic profile is declining fertility rates, or the number of children born to women in the country.

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— “Issue #4: China has a notable mismatch in the ratio of men to women, and this is most noticeable in live births in the last decade.

— “The upshot of all this data seems clear: China may be a growth economy, but it is not a particularly fast growing country. It faces a fast aging population without social benefits like Social Security or Medicare. Even with the recent scrapping of the one-child policy, it faces an uphill climb to get back to a fertility rate of 2.0, the required pace to stabilize the size of the population. Younger people, and the society as a whole, will face a greater challenge in tending to their elders than many developed countries better known for an aging population.

— “Much of the Western narrative related to China’s need for economic growth revolves around social stability. Citizens endure pollution, corruption, autocratic rule and more recently stock market volatility because there is an implicit social contract: increased living standards in return for all those challenges. And no doubt that the government has largely made good on its end of the bargain. China has lifted more people out of poverty in the last generation than any country in history.

— “Capital markets, however, only care about the future. The China economic story is more challenging than before because of the demographic profile outlined here. An aging and very slow growth population is a clear headwind. Also, older citizens demand a different social contract from the one they thought valuable when they were younger.

— “Westerners believe that ‘May you live in interesting times’ is an old Chinese curse; there is apparently no direct quote in China’s literature, however. Perhaps the country’s demographic challenges will eventually make it popular there.”

Bottom line for me: China needs to start occupying a different place in your mind as an investor than it did 20 years ago. Make sure to keep up with the reality, not just what you remember.

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Panic at the Disco

The database hounds that I like to quote for perspective are having a field day with the latest rout. Let’s see what we can glean.

Bespoke Investment Group reported that in the last two weeks of trading prior to Jan. 14, the S&P 500 has fallen 9%, capped with a 2.5% swan dive on Jan. 13. The analysts wanted to see how the market has performed in the past when it has experienced an extreme two-week drop that was capped off with a belly flop on the last day.

Above, they highlight two-week (10 trading day) periods since 1990 in which the S&P 500 fell 8%+ with a drop of 2%+ on the 10th day. As shown in the table, the S&P 500 has more often than not bounced following these nasty two-week periods. Specifically, it’s averaged a gain of 1.5% over the following week, and a gain of 2.3% over the following month. The latest was Aug. 24, and the one prior was October 2011, which launched a big rally. Most years featured rebounds, but don’t ignore the clunkers.

The 3.3% collapse on Jan. 13 pushed the Russell 2000 into an official bear market, which is a 20% decline from the prior peak. That ended the fourth strongest and third longest bull market for small-caps in the index’s six-decade existence.

The Bespoke table above lists every bear market for the Russell 2000 since 1980. For each, you can also see the length and amplitude. Of the 15 prior bear markets for the Russell 2000, the analyst reports that the average decline was 30.9% over an average of 191 calendar days. With the current bear market already clocking in at 204 days, Bespoke reports that it is not only already longer than average, but it already ranks as the sixth longest in the index’s history.

In terms of magnitude, if this bear market sees just an average decline from its high, that would translate to a downside target of 895, or 12% down from current levels, Bespoke notes. This is one reason why bears will continue to hover around the small-caps.

Best wishes,

Jon Markman

P.S. We are on the cusp of the most profitable bull market of our lifetime. Stocks will be driven higher by powerful global undercurrents that Wall Street will either ignore or fail to understand. As the Dow doubles, some stocks will see explosive gains of 300%, 400%, 500% and more. Savvy investors who make the right moves will become very rich!

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