How Changing Demographics Are Affecting The Bond MarketAuthor: Thomas ByrneLast Updated: December 12, 2013 There are two good editorials in yesterday’s Wall Street Journal. The first, authored William Galston, discusses how changing demographics could have profound effects on U.S. productivity and GDP. He makes reference to the boost the economy received by baby-boomers coming of age from the 1960s through the 1980s and how that helped to drive economic growth for several decades years, Mr. Galston states:“Between 1970 and 2000, America enjoyed a “demographic dividend.” Because the labor force was rising faster than the adult population, raising hours of work per capita and allowing per capita GDP to rise faster than productivity. But now the dividend is turning into a tax. Because the share of workers in the population is declining, output per capita will grow more slowly than productivity. All other things being equal, this trend augurs much slower growth in Americans’ income and wealth.”This is something Bond Squad has discussed many times (most recently, yesterday). We believe that changing demographics could create economic headwinds for as many decades as they provided tailwinds. This is not a pessimistic view, it is just reality. However, this does not mean that the U.S. economy will not grow, nor does it mean that equity markets will not perform well. We believe that the economy is probably capable of trend growth (in the 3.00% area), but interest rates will probably have to be kept lower than during the years that the baby boomers were reaching adulthood to facilitate trend growth.It is this structural change to the U.S. economy which makes us leery of fixed income strategies based on economic recoveries of the recent past. The truth is: we have never been in a recovery such as this one. We have never been in a situation in which the first Fed actions to unwind monetary policy stimulus could result in yield curve steepening. Traditionally, less accommodative Fed policy started with raising the Fed Funds Rate, which would cause the yield curve to flatten. This makes reading the yield curve (as one might read tea leaves) to predict future economic conditions more difficult.In the past, a flattening yield curve (usually caused by Fed tightening) presaged slower economic growth, or even a recession. This was because the Fed was deliberately trying to slowdown the economy. It is because of this that we consider the shape of the yield curve indicative rather than predictive. This time, a steeping yield curve (caused by the Fed reducing and then halting asset purchases) could be indicative of growth moderation. In other words: Long-term rates could rise because the Fed believes that the economy is strong enough to grow without extraordinary stimulus, but the result could be growth running in the 2.00% to 3.00% range with tailwinds from very low policy rates helping to offset demographic headwinds. Low short-term rates should help limit the rise of long-term rates. We believe that the Fed has these demographic headwinds in mind when it states that policy rates could remain low for a significant time after economic data reaches Fed thresholds.By Thomas Byrne – Director of Fixed Income – Investment ConsultantThomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.EmploymentNovember 2012 – Present, Wealth Strategies & Management LLC, Stroudsburg PADecember 2011 – November 2012 – Bond Squad, Kunkletown, PAApril 1988 – December 2011, Citigroup and predecessor firms, New York, NYJune 1986 – March 1988 – E.F. Hutton, New York, NYThomas ByrneDirector of Fixed IncomeWealth Strategies & Management LLC570-424-1555 Office570-234-6350 CellE-mail: [email protected]Twitter: @Bond_SquadHigh yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.