Bob’s Journal for 1/19/22

China’s Shrinking Population Affects the Global Economy and Markets

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In 2022, the world’s most populated country had its first population decline since 1960. The United Nations recently estimated that during 2032, India will succeed China as the country with the largest population.

That probably comes as good news to Malthusians, fans of Paul Ehrlich (author of “The Population Bomb”), and others who fear the earth can’t support its current population.

But for China and much of the rest of the world, it’s bad news.

While economists disagree on many issues, they agree that a growing population generally increases economic growth while a shrinking population leads to lower growth and probably long-term negative growth.

In addition to a shrinking population, China has an aging population, perhaps the oldest population in the world. An older population lowers productivity, causing lower growth and higher inflation.

China’s younger generations are small, because it had a strict one-child-per-couple policy from 1980 through late 2015. China’s families have been slow to move past the one-child policy since it was lifted in 2015.

A shrinking population was not the only reason China’s economic growth rate declined to 3% in 2022, its lowest rate since the 1970s and below the official target of 5.5%. Lockdowns due to the zero-Covid policy were the major reason for the slow growth.

But an aging population probably kept growth from being higher in recent years, and the continued aging and shrinking of the population will keep a cap on growth.

Lower growth in China will reduce global growth because China is the world’s second-largest economy. You should expect corporate earnings and stock market returns around the globe to be lower than they would have because of the changes in China’s population.

Don’t Bet on High Profit Margins to Continue

Stock market returns exceeded overall economic growth by a wide margin over the last 10 to 20 years. Don’t count on that to continue.

Stock index returns can exceed economic growth for brief periods. But over the long term, the two rates should be similar.

One factor that pushed stock returns higher is that valuations increased. Investors were willing to pay more for each dollar of profits, cash flow, assets and other measures of corporate worth.

Investors bid up stock valuations primarily because interest rates were low. Typically, risky assets receive higher valuations when interest rates decline and lower valuations when interest rates increase.

Higher profit margins were another factor supporting stock prices and probably were a more significant factor than interest rates.

As this post points out, S&P 500 company profit margins increased dramatically over the last decade. Most of that margin growth was in the technology and communications services sectors. That caused the technology sector’s share of the S&P 500 index to increase significantly during the decade.

I’ve pointed to other measures showing that profit margins increased and were at record levels in recent years.

Profit margins can’t continue to grow at this rate, and I believe margins aren’t even likely to sustain recent levels. Global trends that aided margin growth have peaked or are fading, and counter trends are appearing.

Free trade and globalization are declining. Interest rates no longer are at record lows. The labor market favors workers more than businesses. Pro-business government policies around the world are fading as taxes and regulations increase.

These and other trends likely mean that profit margins have peaked. That’s another reason to believe stock market returns will be lower over the next decade than in the previous decade.

What You Need to Know About Annuities and Interest Rates

A classic mistake people make when considering annuities is to place too much emphasis on current interest rates, and the direction they are likely to move.

Annuities are income vehicles, so it’s natural to consider interest rates and the outlook for future rates before making a decision. But many people misunderstand the relationship between annuities and interest rates, leading them to make less-than-optimum decisions.

There are many types of annuities, but I’m talking about those that provide you with safe, guaranteed income and protect your principal.

For those looking for guaranteed lifetime income, there are single premium immediate annuities (SPIAs) and deferred income annuities (DIAs). SPIAs pay you a fixed amount of monthly income beginning within the next 12 months, and the income is guaranteed to last for as long as you live. DIAs provide fixed monthly income for as long as you live, beginning at a point you select that is two years or more in the future.

You also might consider multi-year guaranteed annuities (MYGAs). In a MYGA, you deposit money with an insurer. The insurer guarantees your principal is safe and adds interest to your account.

The interest rate might be guaranteed for only the next year, or it might be guaranteed for a longer period, depending on the annuity you purchase.

MYGAs with terms longer than one year generally pay higher yields than comparable bank certificates of deposit (CDs). Plus, taxes on the interest are deferred as long as the interest remains in the account.

Since about 2000, I’ve heard people say they’ll consider purchasing a SPIA or DIA when interest rates are higher. The statement reflects a misunderstanding of how annuities work.

With a SPIA or DIA, the insurer’s main concern when deciding how much income to guarantee is your life expectancy. It estimates how long it is likely to have to pay income to you.

Interest rates are a secondary factor. In addition, the insurer is concerned about the long term when assessing interest rates and its investment income. Near-term changes in interest rates, especially short-term rates, aren’t the insurer’s major concern. Instead, the insurer is trying to estimate the investment return over the next 10 years or longer.

Another factor that’s often misinterpreted is how you’d invest the money that you intend to put in a SPIA or DIA in the future.

If you’ve earmarked money for guaranteed lifetime income but don’t plan to buy a SPIA or DIA for a few years, you probably will invest that money very conservatively because you don’t want to put the principal at risk.

If you put the money in stocks and the stock market declines, your principal will decline. When you go to put the money in an annuity, you’ll have less money and will receive a lower lifetime income.

You’ll protect the principal by investing in a money market fund or similar conservative vehicle and will receive a low yield in return. The insurer, on the other hand, will invest for the long term. It will assume the money you deposit with it will earn a higher return than the safe investment you would buy. That higher return will be used to determine the lifetime income paid to you.

The result is that you’d probably receive a higher lifetime income by buying the SPIA or DIA now at lower interest rates than you would receive in a few years after compounding income at a low interest rate on your principal.

Another factor to consider is what the insurers call mortality credits.

An insurer will sell SPIAs and DIAs to a large number of people at a time. It estimates the average life expectancy of that group and uses that estimate to determine the lifetime income each will be paid.

About half the group will die before reaching average life expectancy. The insurer knows that from the start and uses that knowledge to determine how much income it will guarantee to each member of the group.

In other words, the deposits of the people who don’t live to average life expectancy allow the insurer to pay more lifetime income to the rest of the group. That’s known as mortality credits and increases your lifetime income if you’re one of those who live to average life expectancy or beyond.

Also, though average life expectancy in the United States decreased the last few years, that’s unlikely to continue. It is especially not likely to continue for those who don’t succumb to COVID-19 or haven’t developed substance abuse problems. Average life expectancy is likely to increase in the future.

That means if you buy a SPIA or DIA in a few years, you’re likely to receive lower mortality credits than if you buy today. It is not a major factor, but it’s something to consider.

With MYGAs, the yield on your account does change with market interest rates. But you probably can’t time interest rate changes. If you could, you should be trading interest rate futures or options contracts.

A MYGA is to lock in a guaranteed yield while protecting your principal. If you are worried that you might lock in a yield for several years today only to see interest rates rise higher in six to 12 months, then don’t put all your money in one MYGA.

Instead, create a MYGA ladder. Spread your money among MYGA contracts with different terms. Put one-third in a one-year MYGA, one-third in a three-year MYGA, and one-third in a five-year MYGA, as one example. When the one-year MYGA matures, roll it over to a three-year or five-year MYGA. With the ladder, you capture today’s relatively high yields and upgrade to higher yields if interest rates increase.

The important point is your reasons for buying an annuity aren’t likely to be to time interest rate changes. You buy an annuity to create guaranteed lifetime income or to protect your principal while earning a guaranteed interest rate or both. If you want to time interest rates, consider trading options, futures, or long-term bonds.

Interest rates changed dramatically in 2022. By some measures, they rose faster in 2022 than any year in the previous 40 years.

How did that affect annuity payouts?

SPIA payouts increased 11% for men over the course of the year and 13% for women, according to Insurance NewsNet. Payouts on DIAs increased on average by about 42%.

You can see more details about how annuity payout rates have changed here.

The change in SPIAs was not as dramatic as the change in interest rates or the returns on bonds. The change in DIAs was more dramatic, indicating it might be better to have the insurance company invest your money and take advantage of the mortality credits instead of investing the money yourself and waiting to buy a SPIA in a few years.

The Data

Retail sales declined 1.1% in December. A significant part of the decline was a 4.6% decrease in sales at gas stations due to lower gasoline prices and reduced overall prices in goods. The monthly retail sales data aren’t adjusted for inflation or price changes.

But after excluding sales at gasoline stations, retail sales declined 0.8%.

Over 12 months, retail sales increased 6% at the end of December, the same number as at the end of November.

The Consumer Price Index (CPI) decreased by 0.1% in December, the first monthly decline since May 2020. Gasoline and food prices were the major reasons for the dip.

Over 12 months, the CPI increased 6.5% through December, down from 7.1% in November.

Excluding food and energy, the core CPI increased 0.3% in December, higher than the 0.2% recorded in November. Over 12 months, the core CPI increased 5.7%, down from 6.0% in November.

The Producer Price Index (PPI) declined 0.5% in December, following a 0.2% increase in November.

The core PPI, which excludes food and energy, increased 0.1% in December after rising 0.2% in November.

Over 12 months, the PPI increased 6.2% as of December (compared to 7.3% in November), and the core PPI increased 5.5% as of December (compared to 6.2% in November).

Industrial production declined 0.7% in December and increased 1.6% over 12 months.

There was a small improvement in the new home market. The Housing Market Index for the National Association of Home Builders (NAHB) increased to 35 in January from 31 in December. The December number was the lowest since 2012, excluding the early months of the pandemic.

The Consumer Sentiment Index from the University of Michigan was 64.6 in mid-January, up from 59.7 at the end of December. This is the highest level since April.

There was a significant increase in the Current Conditions segment of the index and a lesser increase in the Expectations component.

The Empire State Manufacturing Index declined dramatically in January to negative 32.9 from negative 11.2 in December.

That’s the lowest level since May 2020. The decline from December to January was the fifth largest in the history of the index.

New unemployment claims declined by 1,000 to 205,000 in the latest week. That is the lowest level in three months.

Continuing claims increased to 1.634 million from 1.697 million.

The Markets

The S&P 500 rose 1.84% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.57%. The Russell 2000 increased 3.50%. The All-Country World Index (excluding U.S. stocks) added 2.53%. Emerging market equities climbed 1.01%.

Long-term treasuries gained 1.99% for the week. Investment-grade bonds increased 1.30%. Treasury Inflation-Protected Securities (TIPS) added 0.14%. High-yield bonds gained 0.88%.

In the currency arena, the U.S. dollar declined 0.72%.

Energy-based commodities increased 5.74%. Broader-based commodities rose 3.99%. Gold gained 1.66%.

Bob’s News & Updates

My next book will be “Retirement Watch: The Essential Guide to Retiring in the 2020s.” The official publication date is Jan. 3, 2023. You can make a pre-publication order or learn more about the book by clicking here and here, respectively.

My latest book is “Where’s My Money: Secrets to Getting the Most out of Your Social Security.” It has received mostly five-star reviews on Amazon for telling you clearly what your benefit options are in different situations and how to determine the best choice for you. You can find it on Amazon.com or Regnery.com.

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A recent five-star review of my book, “The New Rules of Retirement” on Amazon.com said, “A complete retirement guide! One of the best books on this topic!” Click for more details about the revised edition of “The New Rules of Retirement.”

If you’re interested in my books, check my Amazon.com author’s page.

I’m a senior contributor to the Forbes.com blog. You can view my contributor page here.