New UBS Research Report Focused on Demographics: a Coming of Age

The world's population is aging. Families are havingfewer children, medical science is extending people's lives, and thebaby boom generation is entering retirement. These trends are not new.They have already been discussed in numerous studies, which, indeed,often arrive at quite somber conclusions. UBS Wealth ManagementResearch projects, however, that countervailing forces will mitigatethe negative impact of population aging on overall economic growth percapita. Even a rising transfer to older generations will leave the percapita income growth rate of the working age population at asurprisingly solid level. Demographics will also have only a mildimpact on financial markets - fundamentals matter more. But thewidespread demographic change through the middle of this century willhave a profound impact on the products and services people demand andconsequently the health and prosperity of the industries affected andtheir attractiveness for financial investments.

A new report released by UBS Wealth Management Research analyzeshow the aging of the population in developed countries will impacteconomic growth projections, financial market performance, andindustry trends.

In particular, the new report highlights the following:

-- Trend rate of global economic growth to slow; income distribution more important as countries age

-- Mild, yet mixed, impact on financial markets; outcome depends on pensions and regional exposure

-- Building demand for new tailor-made products; projected industry innovation and evolution

Trend rate of global economic growth to slow

One of the consequences of aging is that fewer people will enterthe labor force, while at the same time, more people will enter theirretirement years. This creates two potential economic challenges,according to UBS. The first result is that a shrinking labor force andlower rates of saving will slow the trend rate of economic growth inseveral developed countries. Increasing workforce participation rates,the retirement age, hours worked, and immigration may help to mitigatethe growth slowdown, but are unlikely to fully remediate the effect ofaging on developed country economies.

Secondly, countries will have to distribute economic output, orincome, among a larger group of people who are retired and a smallergroup of people who are working. Certain government policies, such asthe provision of healthcare and public pension programs, for example,will act to redistribute income between age groups. However, even themost ingenious financing schemes cannot bypass the fact that we canonly consume what is produced. This report shows that countries mostaffected by aging demographics will need to find ways to transfereconomic production from workers to elderly generations in order toprevent an absolute decline in the living standards of the elderly.Even if transfers are large enough to keep the per capital incomegrowth of the elderly constant at 1.0% per annum, the income growth ofthe working age population in developed countries would still risebetween 1.1% per annum in Switzerland and 1.8% in Japan.

Demographic projections point to continued growth in the workingage populations of many developing countries, as fertility ratesremain well above the replacement rate. The UBS report shows that thisdemographic trend should continue to support economic growth rates indeveloping countries when accompanied by important institutionalreforms, improvements in productivity, and greater participation inthe world's economic system.

A mild, yet mixed, financial market impact

Slower economic growth rates and lower savings rates in developedcountries, brought about by an aging population, do not automaticallytranslate into weaker financial market conditions, according to thenew report from UBS. Demographic shifts will likely be overshadowed byother fundamental trends, such as the geographic diversity ofearnings, the integration of global capital markets, and shifts ininstitutional pension plan holdings. On the earnings side, ascorporations invest abroad and increase the geographic diversity oftheir sales and cost structure, earnings will increasingly decouplefrom home country economic growth rates.

Meanwhile, real interest rates (i.e., inflation adjusted) willincreasingly be set by the global interplay between the demand forinvestment and the supply of savings. In industrial countries, anyreduction in saving brought about by the drawdown in financial wealthduring retirement should exert upward pressure on real rates, whilethe opposite should occur in developing countries. However,increasingly integrated bond markets will ensure that these effectsare limited. In particular, capital flows from thrifty emergingmarkets into low-saving developed countries will likely constrainupside pressure on real rates in developed countries.

Where the impact of demographic trends on financial markets may bemore apparent is through shifts in pension plan holdings. Under areduced investment horizon, pension plans will likely seek to shifttheir asset allocation toward bonds and away from equities, and mayeven begin to shift their debt holdings to shorter-maturity bonds asplan participants age. Overall, the described shift in portfoliocomposition should negatively affect equities and support bonds (i.e.,help maintain low bond yields).

However, as this effect is expected to originate from pensionplans rather than from individual investors, we expect it to be mostnoticeable in countries with a well-developed pension system. Primeexamples are the Netherlands, the UK, the US and, to a somewhat lesserextent, Switzerland. In some rapidly aging countries that heavily relyon pay-as-you-go public pension programs, forces will be at work thatshould provide support to financial market performance. The resultwill be a strengthening of the equity culture, a deepening offinancial markets, and a greater demand for financial assets.Countries that are the most likely to experience this effect includeGermany, France, and Italy.

Building demand for new tailor-made products

Finally, the report identifies shifts in demand for products andservices as a result of aging, both positive and negative, as well ashow labor shortages can impact selected industries. Specifically, UBSdiscusses the effect of the aging demographic trend on the healthcare,consumer cyclical & consumer discretionary, technology, and financialindustry sectors. According to UBS, the impact of demographic changeon industries and companies will be far-reaching, requiring a thoroughunderstanding of the key issues facing each particular sector. In somesectors, such as food manufacturing and auto assembly, productioncenters will likely shift to regions with less expensive labor. Inothers, such as orthopedics and banking, products and services willchange to meet the demands of an aging customer base. New industries,such as robotics and household medical equipment devices, will emergeto address labor shortages and meet the needs of elderly consumers.

UBS

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