What Demographics Say About Japan's Problems, Spain And Ireland's Future

Includes: EIRL, EWJ, EWP
by: Simon Moore, CFA

Even though demographics are slowly changing, they are relatively easy to predict and a powerful force. An examination of current trends shows that Japan looks unattractive for the long run. Interestingly though, some of the European countries most impacted by the sovereign debt crisis might also be reasonably well positioned, based on demographics.

Why Demographics Matter

Demographics matter a great deal for growth, and by extension, for asset pricing. Demographic trends also have the advantage of being far easier to predict than other economic factors. It is a fair bet that if you are 20 years old in 2012, you'll be 21 years old in 2013. At the country-wide level, given the law of large numbers, these forecasts can be relatively very accurate. Particularly when compared to the level of accuracy we achieve in many other areas of forecasting.

To give an indication of the significance of demographics: In 2010, world population growth was 1.1% and world GDP growth was 4.2%. So population growth can contribute in the region of 25% to GDP growth. Not completely deterministic, but a significant contributing factor, especially over the long run.

How Demographic Factors Work

Demographics impact an economy in many ways, but two of the main ones are:

  1. The age structure of an economy has implications for its growth rate. A high ratio of those of working age relative to those who are not is positive for an economy. More people are economically productive and economic growth is higher as a result.

  2. Growth in population, all else equal, contributes to GDP growth. This is basically saying if you have a larger population, your economy will be larger too. Population growth contributes to GDP growth.

Recent Paper In The Financial Analysts Journal

Robert Arnott and Denis Chaves of Research Affiliates recently published a working paper on demographics, which was subsequently published in the Financial Analysts' Journal, unfortunately there's no free access to the journal article unless you are a member of the CFA Institute, but the working paper is here, which has similar content.

Demographic insights

Looking at demographics from 2011 to 2020, a few things are clear:

Weak outlook for Japan

From this perspective Japan is in trouble, the population is aging and the birth rate is low. However you slice demographic data, Japan is poorly positioned relative to most other countries. The implication is decline both for GDP and the bond and equity markets.

Middle East does well

The Middle East and Northern Africa does generally well on this analysis. But given less well developed bond and equity markets in these regions- at least for U.S. investors- this is difficult to implement.

An optimistic take on Europe

One outcome of demographic analysis is that some of the more troubled countries in Europe also tend to have a positive outlook from a demographic perspective. Ireland and Spain particularly are strong performers from a valuation perspective as we look forward to 2020.

The numbers

Here are some of the figures for the countries, I have just mentioned, using the U.S. as a benchmark.

Country 10 Year Bond Yield Debt/GDP Population Growth 2015-2020 Dependency Ratio (2010)*
Spain 4.97% 60% +0.37% 47
Ireland 8.21% 96% +0.97% 49
Japan 0.97% 220% -0.37% 56
US 1.89% 93% +0.79% 50

debt/GDP source; 10 year bond source; population growth data; dependency ratio data

* dependency ratio = population under 15 or over 64 / population 15-64 x 100

Context - generally, population growth helps economic growth, so more is better. A low dependency ratio is better than a high one.

We can see that Japan is bad on all metrics. Population growth is negative and the dependency ratio is high. In addition, the debt burden is very high. Conversely, Spain and Ireland do very well on dependency ratios and Ireland particularly has strong population growth. For the U.S., things are bit more mixed. The dependency ratio is larger than ideal, but population growth is good.


This article doesn't examine the sovereign debt crisis in sufficient detail to merit a long position in Spain or Ireland, but the demographic factors in those countries mean the long-term outlook may be rosier than looking at debt issues alone would suggest. However, it does seem clear that Japan is an unattractive market on a 10 year view and exposure to stocks with heavy exposure to the Japanese economy should be avoided. For example, the Japanese ETF EWJ appears unattractive on this analysis, and specifically Japanese companies without a strong export focus. Alternatively, similar ETF exposure to Spain (NYSEARCA:EWP) and Ireland (NYSEARCA:EIRL) is worthy of further consideration. However, I hold back from a fully positive recommendation there, because macroeconomic issues beyond long-term demographics will drive those countries in the short term.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.