I just received a note from the desk of the Chief Investment Officer of Wasmer, Schroeder & Company, Michael J. Schroeder, entitled “Has the Fed Become Irrelevant?” Mr. Schroeder’s firm specializes in fixed income and we got to know their portfolio managers because we had offices on the same floor of the Eaton Building downtown. Wasmer, Schroeder & Company has been advocating fixed income products for a long time under the theory that the United States is in the middle of a long-term trend of low inflation and low interest rates. In his September letter Mr. Schroeder had a few observations that I find different and appealing:
“There are also several broad, secular forces at work that are keeping the Fed up at night, including:
- Demographics that are limiting growth rates in most developed economies.
- Lower labor participation rates.
- The evolution of the makeup of the job market and the application of technology versus labor is keeping wages in check.
Inflation continues to be a story dominated by the fact that developing economies and China are producing goods at lower effective prices and exporting them to developed economies, keeping prices from rising. In exchange, developed economies are exporting their higher standard of living to these countries. While at some point there will be equilibrium, we are not near that point.”
The Concept of Home Is Changing
Mr. Schroeder talks about demographics. Unlike the Wall Street folks who are advocates for high growth and sustainable PE ratios, the demographic variable bears some thought. As the citizens of the United States, Europe and Japan get older, their preferences and priorities will change. I am observing many of my Cleveland friends downsizing, uncluttering, simplifying and conserving. Almost universally they are selling their cold weather home where they raised their family, spent their careers and made their lifelong friendships. They want a lifeline back to their roots and plan to stay connected, but are opting out of ownership and opting into rentals. At the extreme, one couple is going to spend their Cleveland summers at a Residence Inn. The concept of “home” is changing.
Those retirees are also moving closer to their children and grandchildren. One couple has completely left Cleveland for the Boston area where all of their kids and grandkids reside. They understand that long-term they will need medical and other types of supervision and do not expect their children to come to them.
Check Your Refrigerator
It is hard to believe in a consumer growth case without a money multiplier like we had in 2005-2007 where debt origination was multiplied many times by a combination of accommodative central bank policy, derivatives, conduits and Fannie Mae & Freddie Mac. Even with a multiplier it is hard for me to envision that the Baby Boomers are going to be big consumers. Just look in our refrigerators! Except for time challenged milk and multiple containers of leftovers, there is not much food! My fridge is starting to remind me of my grandparents’ “ice box”. It is also hard to believe that the historic growth rates for outboard motors, chain saws, lawn tractors, snow blowers, and power tools can be sustained. While I am never going to surrender my 1985 Homelite chainsaw, I am certainly not going to buy a new one. I might reconsider if I could remember the right oil to gas mixture and if my rotator cuff could handle the 57 “dry pulls” before a start. The same is true for work clothes, sports equipment, and jewelry not to mention camping equipment and log splitters.
The Great Uncluttering Has Begun
There is a whole storage industry built around maintaining Baby Boom clutter. If our Cleveland friends are any indication, the “PODS” movement will be mostly in reverse as the great uncluttering begins. I also cannot see the Baby Boomers keeping their Costco memberships either. Who needs a pallet of water bottles, 40 rolls of toilet paper, 20 rolls of paper towels or a dozen strip steaks when you are living at a Residence Inn? After all, you can still shop on your kids’ membership card at Costco and unbundle the one strip steak you are allowed each month. This is bad news for Costco because almost 90% of their profit is membership fees.
The demographic facts are pretty startling. According to United Nations predictions, from 2000 to 2050 the percentage of people over 65 years old will have moved from 12%, 17% and 16% for the U.S., Europe and Japan respectively to 21%, 30% and 28%. That is a pretty big migration from producers and consumers to dependency. Those same Boomers who fueled a long term consumer growth trend starting in the 1990’s may be leading a quick retreat.
Investment Thesis for All Asset Classes In Flux
The investment thesis for every asset class has to include a sober analysis of how valuations may be affected by these demographic trends. For example, looking at historic PE multiples for common stocks may not make much sense when growth rates are slowing down? Dumping fixed income because there is an impending interest rate “bubble” may be a premature call? Predicting an end to the rally in multi-family rental properties may likewise be premature given the move from ownership to rentals?
This may also suggest that Private Equity Valuations will have to reflect more realistic growth rates for the underlying businesses. It is hard to pay 8-10x EBITDA without a credible thesis about sustained revenue growth.
Finally, all retirement plans, public and private, are challenged by demographics and a slow growth scenario. A 7-8% pension growth model seems pretty silly when the U.S. economy is growing at 1-2%. Past performance of almost every asset class comprising the mix for pension plans most certainly is not an indicator of future performance. This may not be the news you hear from your political leaders, but it is most likely the truth.
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