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Investments Inc.

spacer January 2003
Commentary

"Tell me when you were born, and I will tell you your future."

That may sound like a come-on line from your friendly neighbourhood astrologer, but there is a branch of the social sciences that makes a similar claim.

Those gurus of the Baby Boom at "Demographics R Us" think they can read your stars, too. By knowing the year of your birth, they can predict when you will bid farewell to diapers, go to primary school, rent your first apartment, have kids of your own, need bifocals, and develop that midlife craving for a sports car. Heck, they believe they can even approximate the time of your funeral.

Each of these stages of life creates demand for specific products and services, so by studying population trends, demographers hope to forecast these wants and needs.

In the early days, the study of birth and death records and distribution of population was linked with such bread-and-butter issues as the future availability of young men for the military and the calculation of actuarial tables for the budding life insurance industry. In the days before computers, these calculations were tedious in the extreme, and the study of demographics was dominated by mathematicians and astronomers.

In the last century, the study of national populations became institutionalized, as a growing range of social scientists began to urge that demographics be considered in the development of public policy, primarily to extend government planning horizons beyond the typical four- or five-year lifespan of a legislature.

But then a major glaring weakness inherent in the young science was exposed: it could only extrapolate from current and historical tendencies, and could not anticipate change. When new trends emerge, projections based on old data turn out to be wrong.

It is ironic that the very group that has contributed so much to the mainstream popularity of demographics -- the Baby Boomers -- were responsible for illustrating this shortcoming. You see, they weren't supposed to exist! There had been increases in the birth rate before, when randy soldiers returned home after war, but demographers in the 1940s had no way of anticipating the amazing and sustained upsurge of fecundity that followed World War II. Projections for population growth in the 1950s and 1960s turned out to be pitifully inaccurate.

For many Canadians, demographics became a household word with the publication of the bestselling book Boom, Bust & Echo in 1996. Author David Foot, the gregarious Harvard-educated economist, began commanding five-figure appearance fees to supplement his steady gig at the University of Toronto.

In the introduction to his book, Foot explained that the aging of the Boomers made the waning of the tennis boom during the 1990s "predictable and inevitable." Elsewhere he stated, "The Canadian real estate boom [of the 1980s] was not only predictable, it was inevitable."

It is the immutability of these demographic prophecies that explains their enormous appeal to the investing public. What a lovely way to reduce risk: simply pay attention to population trends and buy those firms that will predictably and inevitably profit from a growth in the number of customers.

Foot does allow that such pesky details as government intervention and recessions do have an effect, but he reckons that demographics is "two-thirds of everything."

But while Foot's advice on investing was somewhat fuzzy -- aside from the point that Boomers would likely stuff their savings into quality stocks -- another Harvard man, the economist and business consultant Harry Dent, took on the task of forging demographics into a tool for investment selection head-on.

In his first book, The Great Boom Ahead (published in 1993), he foresaw a period of deflation that would last until 1997, during which long-term bonds would be a good choice, followed by a period from 1998 until 2006 when quality stocks would excel.

The end of this latter period would see the Dow peak at 8,500. After 2006, he recommended a gradual shift back into safe government securities because the "Mother of all Depressions" would arrive by 2010, ushering in a 15-year era that coincided with the Boomers' retirement.

Though he was wrong about deflation, and how high the Dow would go, inflation certainly decelerated far faster than most had guessed, and his advice for the 1990s was remarkably effective, at least judged from the perspective of 1998.

The bull market for bonds in the mid 1990s was one of the strongest ever as long-term interest rates careened downward. Dent predicted that the Boomers would fill the government's coffers, a notion that seemed far-fetched at a time when the U.S. was running a $290 billion deficit. If it turned out that he was a bit late in switching into stocks, few found fault.

It seems strange now, but a prediction of a Dow at 8,500 seemed Pollyanna-ish when it was trading around 3,000 -- especially to investors still rattled from the combination of the 1987 crash and the vicious 1990-91 recession. And his advice to choose such demographically favourable sectors as technology and financial services, while eschewing real estate, commodities and utilities, was right on the mark.

His credibility with professional money managers thus assured, Dent was ready to take centre stage. Any movement needs strong leaders to provide direction and morale, and the mutual fund industry was no different. Folks like Abby Joseph Cohen used the prestige of leading broker Goldman Sachs to become spokesperson for "The Street." George Gilder was the techno wizard par excellence, explaining the guts of the New Economy, and how to profit from it, in mind-boggling detail.

Dent added intellectual firepower, showing that a monstrous bull market until at least 2008 (adding a couple of years onto his earlier prediction) was a foregone conclusion, a demographic inevitability that investors could saddle with serene certainty.

His books were runaway bestsellers, and mutual fund companies were only too happy to shell out $50,000 for a lecture from the seer, who clocked more than 200 appearances a year. This guy could sell!

Mutual fund giant AIM Investments took a shot at destiny and started the AIM Dent Demographic Trends Fund, drawing stock-picking advice from Dent's research arm, H.S. Dent Advisors Inc., in June 1999. The fund was a hit, as well over a billion dollars poured in at a fantastic rate from eager investors.

Time for a reality check. Here are the fund's performance numbers over the past three years:

2002-32.68%
2001-32.06%
2000-17.22%

Oops. That's a three-year performance of -29 percent, a full 10 percentage points worse than the S&P 500. AIM's disclaimer rings loud and clear: "Unforeseen events -- such as rising inflation, declining productivity, irregular spending and savings patterns, and other social, political and economic uncertainty -- could impact the direction of corporate earnings and the stock market, negatively altering Dent's view."

Talk about stating the obvious! However, even in a bear market in which all of these ills might manifest themselves -- and they didn't -- that's a truly horrendous performance. Morningstar ranks the fund 82nd out of 85 in its category.

So, is the entire field of demographics a load of bunk, or just Dent's version of it? To answer that question, we need to take a closer look at how he created his forecasts.

Dent's epiphany came when he detected a particular connection between the stock market and population trends. When he overlaid graphs of the number of 47-to-49-year-olds in the population and the stock market indices (adjusted for inflation), he found a strong correlation.

He concluded that, in order to generate long-range predictions regarding the economy and the stock market, "You simply project the cycles of birth rates 49 years ahead, when the generation is in its peak spending years."

Now, something strange happened when Dent published The Roaring 2000s Investor in 1999. The Dow had already blown through his 8,500 target with ease. Did he therefore conclude that the market was in a speculative phase and due for a nasty revision -- just the sort of explanation he had proffered for the 1987 crash in his earlier book, when stocks had temporarily diverged on the upside from his demographic chart?

Far from it. Instead, there are the same overlaid charts, still apparently matching up smartly -- but the vertical axis denoting the Dow has changed from a linear to a logarithmic scale.

Well, hello and get happy! The new math projects that the Dow will reach a cool 41,000 by 2008. No explanation is given for this fascinating transformation, but if you were advertising a new mutual fund, and millions of dollars in licence fees were in the balance, which version of the chart would you choose?

It has become fashionable for politicians to rail against a "culture of greed" to explain the stock market collapse. There's a grain of truth to that -- nefarious schemes did blow up and wipe out many firms -- but this perspective is basically ass-backward. It was the success of the bull market in the 1990s that caused this behaviour to manifest itself.

While demographic predictions may not be as inevitable as practitioners suggest, it is a rock-solid truth that sudden success and wealth breed greed, overconfidence and a sense of entitlement. That's not based on any of the last century's economic doctrines, but on the essence of human nature, a theme that has been repeated in the classics for thousands of years.

Speaking of overconfidence, might the Contra Guys be getting a bit cocky after rolling up a couple of hot years while the general market rotted? It's tempting to do so, but forewarned is forearmed, and something that keeps us humble is a copy of a beautiful, but worthless, certificate for a stock that once seemed like a brilliant selection. We keep it close at hand. Plus, as "back-end Boomers" we can't afford to be smug -- not as long as the front-enders are apparently clogging the rungs to success.

As far as using demographics to pick stocks is concerned, we will continue to set aside a point for this category on our tally sheet. Given that a typical Contra pick receives 10-14 points, a single point for favourable demographics hardly represents "two-thirds of everything."

Like the daily horoscope, it is easy to read more into demographic trends than what is actually there. Ultimately, it is the way one comprehends and uses the information that is critical.

If demographics, with its confident assertions on what consumers should want, has the lilt of Soviet-era planning about it, that's because it is based on a brand of academic logic that fails to anticipate social behaviour.

Sure, it makes sense to save jobs for the overcrowded Boomer labour force by reducing overtime and introducing job sharing, but trying to pry an hour of overtime away from a union labourer is about as easy as asking a university professor to give up her tenure. It may be logical, now that families are smaller, for North Americans to live in smaller houses than previous generations dwelled in, but any real estate agent will tell you that bigger is better.

Back in 1775, Edmund Burke said, "But our misfortune is, we are too acute, we are too exquisite in our conjectures of the future." He was trying to convince the British Parliament that their policies regarding the American colonies would have some unanticipated consequences.

It's good advice for anybody who thinks that a good crystal ball ensures that the universe will unfold as it should. Sorry, Nostradamus, but the world is just a bit more complicated.

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