A cyclist makes their way past the Bank of Canada in Ottawa on July 11.Sean Kilpatrick/The Canadian Press
Many investors breathed a sigh of relief when the Bank of Canada chose to leave the benchmark lending rate unchanged at 5 per cent at its meeting on Sept. 6. But that hasn’t stopped the speculation as to whether the next move will be up or down, and the timing of that move.
There are essentially two camps on this topic: those who believe that the central bank has done enough to slow the economy and that it is time to cut interest rates, versus those who favour keeping interest rates higher for longer in order to ensure that inflation is truly under control.
Much of the analysis in both camps involves an in-depth scrutiny of the speeches and press releases from the Bank of Canada, along with personal opinion masquerading as fact. This may be a useful activity if you are a professional trader with a multimillion-dollar portfolio, but the rest of us need a strategic vision which is a lot less time consuming to absorb.
I am firmly in the higher-for-longer camp, and my portfolio view is based on the reversal of a long-term demographic trend known as the dependency ratio. Central bankers can tinker at the fringes of interest-rate setting, but eventually they will be overwhelmed by the tsunami of demographics.
Baby-boom investors with a good memory will recall that in the 1980s a lot of portfolio structuring was based on the theory that as the baby-boom cohort (those born 1947 through 1966) moved from infancy to old age, they would place severe pressure on various sectors of the economy. Some of these pressure points were the responsibility of governments, such as schools and colleges, but others represented opportunities for astute investors.
The dependency ratio is the statistic which best illustrates the impact of the baby boom on the domestic economy. The ratio measures that portion of the population outside the labour force age group (below 15 and over 65) as a percentage of the employable population (15 to 65).
For the purposes of Statistics Canada, those too young to work are under the age of 15 while those over 65 are supposedly retirees, leaving those 15 to 64 to carry the burden of economic output. (We can argue over the definition and the age-break points, but they follow global comparables and the trend is not materially different with minor changes.)
The accompanying graph from Statistics Canada shows the trend in the demographic dependency ratio from 1971 through June, 2022. Helpfully, it also breaks down the overall ratio into the two components; the youngsters and the oldsters. You can immediately see that back in 1971 when the dependency ratio was 60 per cent, most of it was made up of young people.
Demographic dependency ratio, Canada
Per 100 persons aged 15 to 64 years, year ending June 30
Persons aged 65 years and older
Persons aged 0-14 years
60
50
40
30
20
10
0
1971
1981
1991
2001
2011
2021
the globe and mail, Source: statistics canada
centre for demography
Demographic dependency ratio, Canada
Per 100 persons aged 15 to 64 years, year ending June 30
Persons aged 65 years and older
Persons aged 0-14 years
60
50
40
30
20
10
0
1971
1981
1991
2001
2011
2021
the globe and mail, Source: statistics canada
centre for demography
Demographic dependency ratio, Canada
Per 100 persons aged 15 to 64 years, year ending June 30
Persons aged 65 years and older
Persons aged 0-14 years
60
50
40
30
20
10
0
1971
1981
1991
2001
2011
2021
the globe and mail, Source: statistics canada centre for demography
The ratio bottomed at 44 per cent in 2008 – meaning there were relatively more people of working age – and since then it has climbed back to the current level of 52 per cent as an increasing proportion of workers have retired. It is forecast to peak in the area of 70 per cent in 2058, when the youngest baby boomers are approaching 90 years of age.
The dependency ratio calculation assumes that most people who are not of working age are consumers, rather than producers of economic output as conventionally measured. As a result, they place demand pressure on goods and services without contributing to the output. That tends to be inflationary.
Other things being equal, this inflation will inexorably lead to higher interest rates over time. The opposite was true during the downward slope in the dependency ratio. An article in the Financial Analysts Journal in 1984 (when U.S. interest rates were above 10 per cent) attempted to forecast interest rates based on these demographic trends and concluded that long-term rates would be in the 4- to 5-per-cent range by the turn of the century. They were in fact in the 5- to 6-per-cent range.
There are two possible scenarios which could reverse the inflationary impact of a rising dependency ratio.
One is to increase the number of younger, productive immigrants so that the ratio does not climb as steeply. Ottawa appears to be following this strategy.
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The other solution would be a significant increase in the productivity of the employed labour force so that fewer workers can support more dependants. This may not sit well with the work force once they calculate that their increased output is being used to support others.
Equally important, many baby boomers right now are enjoying a relatively carefree retirement and their needs are not placing much stress on the economy. As they age further, the goods and services which the very old require are hands-on and personal and not susceptible to automation or software solutions. Productivity gains in these industries are hard to achieve, so hefty wage increases may become the norm, which will fuel inflation and interest rates.
One advantage of using demographics as a portfolio strategy input is that the statistics move so slowly that you can rely on studies from the ancient past and still draw useful conclusions today. As a value investor, a 2020 book titled The Great Demographic Reversal by Charles Goodhart and Manoj Pradhan is well worth a trip to the library.
Robert Tattersall, CFA, is co-founder of the Saxon family of mutual funds and the retired chief investment officer of Mackenzie Investments.
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Robert Tattersall