Equity markets were mixed in May. In the US, the S&P 500 rose +0.3%, the Nasdaq rebounded sharply +5.8%, whilst in the UK, the FTSE 100 declined by -5.4%. In Australia, the All Ordinaries Accumulation index fell -2.6%, driven by ongoing investor caution around the impact of interest rate hikes by the Reserve Bank of Australia. The technology sector was the top performing sector, as investor sentiment continues to recover after materially underperforming in 2022. Consumer discretionary was the worst performer, with multiple ASX listed stocks flagging consumer spending is weakening due to rising interest rates and cost of living pressures. Gold stocks also underperformed in the month. 

Small cap stocks significantly underperformed as investor funds moved to the perceived safety of larger cap stocks. As an example, on the ASX, the Emerging Companies index fell -6.4%, whilst the Small Ordinaries Accumulation index declined -3.3%. 

In bond markets, the US 10 year bond yield rose +20bp to close at 3.66%, whilst the Australian 10 year bond rate increased +26bp to 3.60%. Both movements were due to increased inflation expectations. In currency markets, the A$/US$ declined -2% to close at US$0.65. Commodities were broadly weaker in May. Brent crude oil declined -8.6%, copper -6.5%, iron ore -5.0%, whilst gold -1.2%. Thermal coal fell sharply, down -27.3%. 

The numerous interest rate hikes implemented by the Reserve Bank over the past 12 months are clearly having an impact on consumer spending, as evidenced by multiple ASX listed retailers announcing profit downgrades in recent weeks. Whilst some components of the CPI basket are declining (eg. Commodities), other parts such as power prices and wages are still rising (eg. Recent 5.75% award wage increase which commences on 1 July). Services inflation in particular, continues to be too high, as businesses across the board increase prices. With regards to interest rates, given inflation is proving more difficult to reduce to the Reserve Bank's targeted band of 2%-3%, it now appears likely that the RBA will need to lift rates 2-3 more times in this cycle. 

One theme that continues to impact the fund's relative performance versus benchmark is the underperformance of small/mid cap stocks on the ASX, noting the fund has a strong skew to this part of the market. Whilst this has been negative for the performance of the fund in recent months, we strongly believe this focus will produce some outstanding buying opportunities for longer term focussed investors over the next 6-12 months. The Fund continues to see numerous attractively valued stocks across a wide range of sectors and is well capitalised to take advantage of this current short term investor bearishness. 

Australia has been delivered another rate hike in an attempt to "quash" inflation. This month Darren debates with special guest Tim Toohey, Head of Macro and Strategy, the risks posed by rising wages and weak productivity growth, and why the RBA continue to change its goalposts to drive down inflation.

Low fertility is a problem for countries. Many developed markets (DMs) are starting to struggle with ageing populations and their associated social and economic issues.

Meanwhile, it could be a problem even for emerging markets (EMs), which face a slowdown in the growth of their 'working-age' populations over the next 30 years.

Last year, we published two papers - Emerging market demographics 'in focus' - implications for growth and the rise of the global middle class and Emerging market demographics 'in focus' - implications for equilibrium real interest rates - that examined the issues in developing economies.

Our latest on the topic, Towards the peak: How the rise and fall of populations affects economic growth, seeks to advance the discussion by looking at things from a global perspective and asking what this may mean for investors.

Population divergence

The world's population is expected to grow by a further 1.7 billion people to reach 9.7 billion by 2050, according to the latest United Nations data.

However, these numbers hide big differences between and within EMs and DMs. For example, the US' population is expected to increase by some 37 million by 2050, while Germany's could fall by some 4 million over the same period. Lower fertility in some European countries could be partially alleviated by immigration.

Meanwhile, the number of people in developing economies is expected to continue growing, driven mainly by countries in Africa and developing Asia. That said, the population of the largest emerging market, China, began shrinking in 2022.

Its impact on growth...

EMs will drive global economic growth - accounting for some 75% -- in the coming decades. China and developing Asia alone will be responsible for some 60% of that. Despite their own demographic challenges, EMs will likely grow between two and 2.5 times faster than DMs (see Chart 1).

Chart 1: Global GDP increasingly driven by Asia

Source: Haver, abrdn, as at February 2023

India and Indonesia are set to join China among the world's top seven largest economies by 2050. What's more, Nigeria will be just outside the top ten (No. 11), while the Philippines, Pakistan and Vietnam will occupy places within the top 25.

India and Indonesia are set to join China among the world's top seven largest economies by 2050

On the other hand, big oil producers - Russia, Saudi Arabia and Norway - will slip down the rankings as the world transitions to low-carbon energy sources.

We found in our two previous papers that, while the percentage of 15-64-year-olds in EMs (often used as a proxy for the working-age population) is shrinking, the impact on growth isn't as bad as feared because social changes mean that people start and stop work later.

What's more, there's a lot of scope for human capital - the economic value of a worker's skills and experience - to grow in EMs as more people attain higher education levels.

That said, the next three decades will see labour playing a less important role in potential growth, as demographics hold back capital-stock growth. This means potential growth could fall close to zero in the Eurozone and Japan by 2050. But China's ability to improve the quality of its workforce could help offset the effects of its ageing population.

...and impact on productivity

Productivity has been in gentle decline for many economies since the 2007/08 global financial crisis and we don't see much hope for a return to the boom years of the 2000s. Commodity-exporting countries have experienced productivity decline for years, while institutional weakness and political instability pose risks in EMs.

The potential for demographics to create negative feedback loops, including for productivity, could result in additional risks. Ageing populations can strain the sustainability of social welfare models and public debt, which could reduce public spending in other areas and spur emigration. These risks are greatest in the ageing societies of China, Thailand and developed Asia. Other at-risk regions include Latin America (excluding Argentina, Mexico and Peru), central and eastern Europe, Japan and the Eurozone area.

Only a few markets could see productivity improve if a feedback loop operates between demographics and growth. Pakistan, the Philippines, Israel, Nigeria and South Africa are among these as they benefit from improving dependency ratios - due to relatively youthful populations and falling birth rates.

What this means for investors

Here are five things for investors to consider:

1. As emerging markets develop and the ranks of the middle class expand, the share of economic growth dedicated to consumption will rise, leading to notable changes in the relative size of consumer markets around the world.
2. The outlook for Europe and developed Asia looks less promising, with slowing growth set to limit the scope for consumption to rise.
3. Consumer preferences will change. As salaries rise in low-income countries, people will spend less money as a proportion of income on food and clothing; more on housing, healthcare, transport and personal care.
4. Ageing populations everywhere will increasingly skew consumption towards the 'silver economy', amplifying these trends.

Author: Robert Gilhooly, Senior Emerging Markets Research Economist and Michael Langham, Emerging Markets Analyst