Got Demographics?

“I figure lots of predictions is best. People will forget the ones I get wrong and marvel over the rest.”– Alan Cox

Since the year 2000, Americans have suffered through one of the worst bear markets in history … a disputed presidential election … the worst terrorist attack in the country’s history … two subsequent wars in Afghanistan and Iraq … and a massive oil bubble. Yet, despite the chaos, consumer spending has actually risen every quarter. It appears that even calamities of biblical proportions cannot stop the American consumer.

Are Americans blind to the world around them? Of course not. At worst, they can be accused of being a little stubborn. Americans will do anything in their power to maintain their standard of living, even if it means taking on more debt than they should.

The typical American dad doesn’t consider the trade deficit or the price/earnings ratio of the S&P 500 when Junior grows an inch and needs a new pair of jeans. Instead, Dad just buys the jeans and figures out how to pay for them later. As a general rule, people simply do not consider the macro economy when making household decisions. They may fret about it, but at the end of the day they still buy that big, gas-guzzling SUV for Mom to carpool to soccer practice.

On the average, people progress through a series of very predictable stages – marrying, having children, purchasing homes, and finally retiring. Understanding that this life cycle exists, and then seeing how it can be forecast, is the key to understanding the economy and the stock markets.

By studying consumer purchasing data compiled by the U.S. Bureau of Labor Statistics, we can forecast demand for hundreds of goods and services, including things as simple as potato chips. From this wealth of data, we know that the average American’s spending on potato chips peaks at age 42. This can be expected, given that the average American marries at about age 26, has a child at about age 28, and 14 years later that child is eating everything in sight.

Just as this type of forecasting can be done for individual products and services, it can also be done for aggregate household spending. Total household consumer spending tops out when the average breadwinner hits age 48, just as the average kid is leaving home.

The good news is that the largest segment of the baby-boomer generation is quickly approaching its peak spending years, which will shift our economy into another bubble boom. The bad news is that once this mass of boomers passes that threshold, consumer spending will progressively slow down for over a decade. When it does, our economy and stock markets will suffer.

And unlike recent recessions, where an accommodative Federal Reserve and free-spending Congress were able to muster enough demand to produce a relatively quick recovery, this time no amount of government stimulus will compensate for the loss of spending.

For an idea of what to expect, look east.

Japan’s rise from the ashes of World War II was truly meteoric. No country in history could match Japan’s growth rates from the 1950s through the 1970s. In just two decades, Japan evolved from a largely agrarian country to an industrial giant that rivaled the U.S. and Europe. By the 1980s, American companies found themselves struggling to compete with Japanese manufacturers in steel, autos, and consumer electronics. Business schools began teaching classes on Japanese management techniques, and American workers looked on in fear as their bosses were replaced with Japanese managers.

The Japanese stock market played its part too. After putting up good returns throughout the 1960s and 1970s, shares shot through the roof in the 1980s – and by the middle of the decade, Japanese stocks were in a full-blown bubble. Between 1985 and 1990, the Nikkei tripled, hitting a high just shy of 40,000 in December of 1989.

Today, we see a very different Japan. The present rally notwithstanding, the Nikkei is still down over 60 percent from its top – more than 15 years later! Japan has spent the last 15 years in and out of recession, never able to get any real momentum.

So what caused Japan to fall into this hibernation? The falling desire of Japanese consumers. Low consumer demand due to the aging of the population meant low profits for Japanese companies. And that, in turn, led to decreased hiring and even lower demand. A vicious cycle developed with no way out. This cycle – lower demand, lower profits, lower production, etc. – is exactly what we see in our future.

The Japanese consumer got old. As he slowed his purchases in the early 1990s, the economic bubble burst despite all efforts to keep it inflated. The Bank of Japan cut interest rates from 6 percent to zero, essentially giving money away in the hopes that someone would spend it to build a factory, increase production, or consume.

In the standard formula, lowering rates spurs consumption and investment. As the reward for saving money gets smaller, the incentive to spend it gets bigger. But an odd thing happened in Japan: Interest rates dropped, but savings rates remained high. Consumer spending stayed flat and then fell. New investment in productive assets stalled, because Japanese business already had more than enough capacity.

The United States will start “turning Japanese” around mid to late 2010. The demographic trends that have powered the economy since the early 1980s will peak at that time and finally reverse as the baby boomers begin to save every dollar they can spare for their impending old age. Demographically, we will be in the same place as the Japanese were when they began their slow, grinding decline in 1990. And when consumer demand falls, American businesses will have a hard time turning a profit. Stocks will likely enter a long bear market, and investor portfolios will be ravaged.

Our policymakers will follow the example of the Japanese, because it is the only model they can reasonably be expected to follow. And, as in Japan, the policies used will ease the pain a little but will certainly not cure the disease. Americans, long scolded by the rest of the world as being spendthrifts, will suddenly start to resemble their Asian counterparts in their saving habits. Consumer spending will drop, and the economy will scratch and claw frantically just to avoid falling into the abyss of deflation, the likes of which haven’t been seen on American shores since the 1930s.

The moral of the story? Save and invest as much money as you can in the next five years, and tilt your portfolio toward growth stocks. Enjoy the grand finale of the greatest boom in history! But as we get closer to the demographic turning point, you need to get conservative. You’ll need to start “acting Japanese.”

[Ed. Note: Harry S. Dent Jr. is a noted financial author and speaker whose articles have appeared in publications such as US News & World Report, The Wall Street Journal, and the Daily Reckoning. For more information on Mr. Dent’s research on demographics and the economy, please visit]