The Spirit of Entrepreneurship
I’m a big fan of the United States, the future of its economy, and, as a result, to possessing a home bias with respect to U.S. stocks (versus foreign stocks). Why? Because in the U.S. we have an attitude that makes things happen. In other words, we are a country of entrepreneurs.
Entrepreneurs are those who establish a business, either as a sole-proprietor or with others, with the view of making profits. Often these individuals are bold innovators, introducing novel products to the marketplace or changing the way services are delivered. These entrepreneurs are often disruptors, as they often provide products or services that are more efficient that those already in existence. They enable “creative destruction” to occur – a threat to existing business ventures that compels the owners of those businesses to also innovate or to acquire other businesses that do.
In a recent analysis sponsored by Shopify, and undertaken by Deloitte, countries’ economies were ranked by those that are most conducive to entrepreneurial success. It should be no surprise that the United States ranked first.[i] It is this drive that has led the U.S. to possess the world’s largest economy, recently measured at 26.85 trillion U.S. dollars (of gross domestic product, or GDP) per year.[ii]
Working-Age Population Growth (or Declines): U.S. (Historic)
Aside from the spirit of entrepreneurship, in the past U.S. economic growth has been spurred forward by the growth of its working-age (i.e., ages 15-64) population, as seen in this graph from the St. Louis Federal Reserve Bank:
Working-Age Population Growth (or Declines): European Union (Historic)
In contrast, working age population in the European Union, a region that collectively represents either the 2nd or 3rd largest economic area, has already experienced a decline:
Working-Age Population Growth (or Declines): Japan (Historic)
On a percentage basis, Japan – the world’s fourth largest economic area, has seen an even greater decline in recent years for their working-age population:
Working-Age Population in China Starts to Fall, But Increased Productivity May Offset Much of Its Decline:
What about China? Depending upon the accuracy of the data, China as a geographic region represents either the 2nd or 3rd largest economy in the world (either just larger than, or smaller than, the economy of the European Union). Earlier this year, by some estimates, India surpassed China’s overall population. Yet, the United Nations still estimated China’s overall population as 1.43 billion people in 2022 – larger than the entire populations of North and South America (1.04 billion), and larger than the entire population of Europe (744 million).[iii]
China’s working-age population appears to be set to fall – from nearly 800 million in 2022, to less than half that by the end of the 21st Century.[iv] While this will no doubt impact China’s economic growth, the continued migration of labor from rural areas to urban areas, the increase of China’s educated population (which leads to labor productivity increases), and the shift from labor-intensive factories to higher-value production based on technology will, to a significant degree (or even totally), offset China’s projected decline.
India: The “Young” Country
India’s population is now the largest in the world, and with a relatively young population (average age of around 28.4 years[v]) India possesses a demographic advantage in comparison to China, Japan, the European Union, and even the United States. India has a larger working-age population (1.1 billion people) than any other major economy.[vi]
The increased workforce participation by women in India results in further expansion of the number of workers, including skilled workers. India is the global leader in women graduates in the sciences, technology, and engineering, with 47% of its university graduates in this area being women.[vii]
Will Technology Overcome Labor Shortages?
While India and sub-Saharan Africa are likely to see working-age population expansion over the next two decades, most of the rest of the world will face a shrinking labor force due to the decline in the number of those of working age. A decreasing supply of labor generally translates into lower economic output.
Yet, several factors may intercede. The increased use of technology, from industrial robots to artificial intelligence, will likely offset the loss of production in many industries due to shrinking labor forces. Some governments are already providing incentives to work longer. Other countries have incentivized couples to have more babies. New medical therapies may enhance not only lifespan but also the years of life in which one’s health is good enough to tackle many tasks. And, while a growing percentage population of the elderly in many countries is likely to place strains upon those economies driven by the need to support their aging citizens, technology in the form of robots, self-driving cars, and more may lead to more ways to facilitate care for the aged – as well as their mobility.
In contrast to China, the United States will likely continue to see increases in its working-age population, albeit at a much smaller pace than was seen in the 20th Century. In absolute numbers, however, by 2060 China will still possess about three times the number of workers as the United States, and by such time many more workers in China will be educated and skilled.
Summary: Projections of Economic Growth by Region
In summary, in terms of pure data on working-age population, India, followed by the United States, appear to be best positioned to continue their economic expansion.
Yet, many factors are at play, including the increased educational levels and skills of people in China, India, and other emerging markets countries.
We are only beginning to comprehend the impact of artificial intelligence on our lives, and its impact on productivity and labor demand. Technological developments over the next 50 years will likely accelerate. Think back to 50 years ago, when both Microsoft and Apple were still 2-3 years away from being launched as companies, and the Xerox Alto was launched as the first personal computer to use a mouse. The internet was launched only 40 years ago (although data was first transmitted over ARPANET over 50 years ago). The impacts of those innovations have been tremendous on the labor force – causing many jobs to disappear, but creating a host of new jobs in new industries.
Is the U.S. in Danger of Losing Its Lead in Entrepreneurship?
Which brings me back to my first theme – entrepreneurship. America is a land of opportunity. As Stefan Caliman wrote earlier this year in ResearchFDI:
The United States has long been recognized as a global leader in entrepreneurship, innovation, and business creation. With its diverse population, strong economy, and a culture that encourages risk-taking and innovation, the US has fostered a thriving entrepreneurial ecosystem that continues to attract entrepreneurs from around the world. From Silicon Valley’s tech giants to Wall Street’s financial powerhouses, the USA offers a fertile ground for entrepreneurs and startups to thrive.[viii]
However, we should not take this for granted. In recent years corporate interests have yielded far too much influence in our politics, and they have spent large amounts of funds to prevent creative destruction or other adverse changes to their businesses. For example, large oil, gas, and coal interests have advanced a largely anti-science agenda, despite the overwhelming evidence that climate change not only exists, but that it is human-induced and poses significant economic risks (and political risks) to most regions of the world. I wish that, here in the U.S., we could focus on the cost-benefit analysis of policy decisions affecting industry, and our economy, rather than in debating whether climate change exists.
Education drives productivity in a country. As an educator for the past 12 years, I am all for changing how we educate our youth. I favor a focus on skills acquisition (not just foundational knowledge), innovative teaching methods that foster deeper learning and critical thinking, and a newer focus on competency-based and mastery-based educational structures. However, many who bemoan higher education today don’t realize that higher education – and educators – face unique challenges today, which did not exist four decades ago. Nor do many recognize that greater education fuels economic growth.
In summary, America should not stand idly by. We should not permit entrepreneurship and innovation fade. Rather, the development of new technologies in our university and corporate science laboratories and their deployment by engineers, entrepreneurs, and astute managers, is needed in order to foster America’s future as an economic powerhouse. Federal, state, and local government tax and other policies should remove barriers to innovation and to business start-ups. Volunteers should continue to aid our youth, whether in core educational pursuits or in preparing young people more directly to succeed in our global economy (as is done by Junior Achievement and many other fine organizations).
What Does All This Mean for Investors for the Balance of the 21st Century?
United States and Canada. As you might surmise, over the very long term I remain bullish on the U.S. economy. Despite the lack of rationale discourse in Washington, D.C., American business continues to soldier on. While the future pace of U.S. economic growth is expected to slow (as U.S. working age population growth is slowing, relative to past decades), new technologies and the spirit of entrepreneurship may well propel the U.S. economy to new heights, with (hopefully) a higher standard of living for everyone.
Emerging Markets. China faces challenges which it may well overcome through enhancements in worker’s educational attainments and productivity, assuming its government acts rationally. India possesses the greatest opportunity for economic growth, provided the country can attract capital to provide the better jobs for its citizenry. Many other emerging markets countries will likely see substantial economic growth and development over the long term, although the pace of same will be uneven, and some countries will fail (due mainly to poor leadership). In essence, investing in “emerging markets” stock funds looks positive, over the very long term (many decades).
Goldman Sachs issued a study in June 2023 that predicts that the market capitalizations of stocks in emerging markets are likely to exceed the market capitalization of U.S. stocks over the next three decades, with U.S. stocks’ global market share falling from 47% in 2022 to 27% in 2050, while emerging markets stocks share of the global market increases from 27% currently to 47% by 2050.[ix] They attribute this growth in large part to the expansion of economies in emerging markets countries, but also to multiple expansion (i.e., going from undervaluation to fair valuation). By 2075, Goldman Sachs predicts China, India, Indonesia, Nigeria, Pakistan, Egypt, and Brazil will be 7 of the 8 largest economies, with the United States coming in third in that list.[x]
Foreign Developed Markets. The largest demographic challenges are seen in Europe and Japan, roughly equivalent to the countries that make up the MSCI EAFE Index (ex-U.S.), which captures large and mid-cap stocks in 21 developed markets countries around the world (Japan: 23%; UK: 15%; France: 12%; Switzerland: 10%; Germany: 8%; Other Countries: 32%). Absent substantial immigration, and/or absent the emergence and deployment of productivity-enhancing technologies at a large scale, the economies of many foreign developed markets appear poised to shrink. And, with such shrinkage will come increased pressures on the stocks of many corporations headquartered in such countries – particularly those corporations not engaged fully in the global markets.
But…in the Shorter-Term, Watch Valuations:
A strong U.S. dollar at present and the overvaluation seen in growth stocks in the United States has made both emerging markets stocks, as well as foreign developed markets stocks, appealing in the near term.
I turn again to Research Affiliates, a firm that does, in my view, an exceptionally good quantitative analysis of the valuations of various asset classes. Below is a chart setting forth data from Research Affiliates, as of September 30, 2023:
| Expected 10-Year Nominal Average Annualized Returns | |||
| ASSET CLASS | 5% probability of returns less than: | Mean Projection of Expected Returns: | 5% probability of returns greater than: |
| U.S. large company stocks | -1.1% | 4.6% | 10.4% |
| U.S. large company value stocks | 1.2% | 7.0% | 12.8% |
| U.S. small company stocks | -0.2% | 7.3% | 14.9% |
| U.S. small company value stocks | 1.1% | 8.6% | 16.1% |
| Developed markets (ex-U.S.) stocks | 3.7% | 9.8% | 16.0% |
| Developed markets (ex-U.S.) value stocks | 5.1% | 11.6% | 18.1% |
| Developed markets (ex-U.S.) small company stocks | 3.5% | 10.3% | 17.1% |
| Developed markets (ex-U.S.) small company value stocks | 5.3% | 11.9% | 18.4% |
| Emerging markets stocks | 3.0% | 10.6% | 18.2% |
These are estimates, or projections, only, and are NOT a guarantee of any future returns. There is a distinct possibility that the returns of one or more of the asset classes may be significantly lower, or significantly higher, than the range of estimates provided for that asset class, as set forth above. Stock returns can be affected by many factors, including but not limited to changes in valuation levels with ending results significantly above or below the historical average levels, changes in tax policies, changes in interest rates, changes in the rate of inflation, changing investor perceptions and appetites for risk, and many different macroeconomic factors. All the returns shown are gross nominal expected returns, prior to any deduction for mutual fund / ETF or other fees, expenses, transaction costs within a fund, and the fees of any separate (from the fund) investment adviser. Nominal returns also do not reflect the impact of taxes which may occur, depending upon the type of account in which the investments are held, along with other factors. You cannot invest directly into an asset class; investments must be made by purchasing securities (individual securities, mutual funds, ETFs, etc.). SOURCE OF DATA: Research Affiliates, Asset Allocation Interactive (as of Sept. 30, 2023). Please note that the outcomes stated are hypothetical in nature, and that neither Research Affiliates nor its Asset Allocation Interactive tool, in presenting this data, is recommending any specific securities (stocks, bonds, funds, etc.).
As seen in the chart above, foreign developed markets and foreign emerging markets stocks are anticipated to outperform U.S. stocks by a significant margin over the next ten years. This is due to Research Affiliates’ view (as of Sept. 30, 2023) that, in terms of U.S. currency, foreign developed markets stocks (overall) are undervalued relative to their historic norms, while U.S. stocks (overall, and in particular growth stocks) are overvalued relative to their historic norms. This view is confirmed in a recent paper by Brian Chingono of Verdad that looked at valuation ratios based upon price-to-book ratios (where lower ratios means “less expensive” stocks, or undervalued stocks), stating: “the North American market trades at 3.9x Price/Book versus market averages of 1.9x in Europe and 1.4x in Japan, according to data from MSCI.”[xi] For emerging markets, stocks in India appear overvalued, but most other emerging markets countries possess stocks that are, overall, undervalued in Research Affiliates’ view.
There is nothing certain in the data presented above. Indeed, there is a broad range of possible outcomes, wholly dependent upon economic growth in various countries, changes in tax and other policies, and the end-point (10 years from now) in valuations. Rarely does the end point attain reversion to the exact mean, as predicted in the “mean projection of expected returns” column in the foregoing chart. In other words, estimates of future stock returns are just that – estimates. There is a broad range of potential returns, and the “mean” return that is shown, while indicative of the best guess, is still a guess made through the lens of a very cloudy crystal ball. All this means that diversification among asset classes – and among the world’s various capital markets – remains a key tenet for investors.
But, despite the uncertainty, it is good to have a likely statistical advantage. In other words, over the next 10 years, evidence-based investing, and particularly the value stock strategy, looks highly appealing. In contrast, the S&P 500 Index®, which is followed (and invested in) by many investors, looks likely to underperform its historic average annualized return (since 1926) of between 9% and 10% (on average, over very long periods of time).
In the chart above, we also see the perception that value stocks are poised to outperform growth stocks in developed markets. In the U.S. we may well be in another growth stock “bubble,” in my view. In some foreign countries growth stocks appear slightly overvalued, but not in bubble territory.
Avantis Investors, another firm with excellent research on valuations, examined the historical data from 1980 through 2019 and found that when growth stock valuations were above the median, relative to value stock valuations, the value premium was stronger in the subsequent five-year period on average. As of late September 2023, the median valuation spread remains quite high – i.e., well above the median.[xii]
In Conclusion.
For several decades foreign markets stocks have, on average, over the longer periods, underperformed U.S. stocks. The next decade may well see this change. Over the next several decades, emerging markets may well take over the market capitalization lead from the United States, but betting against America’s passion for entrepreneurship and innovation has seldom been profitable over the very long term.
It should also be noted that large publicly traded companies headquartered in the United States, and in Europe and Japan, often derive significant revenues from sales and operations in emerging markets countries.
Additionally, the prospects appear bright for value stocks, in nearly all markets, relative to the prospects for growth stocks. A portfolio that tilts toward value stocks, on a highly diversified basis, possesses excellent prospects for outperformance over the very long term (i.e., 10 to 20 years).
A multi-factor approach, employing the size factor (small-cap risk premium), price factor (value risk premium), profitability factor (or its cousin, the quality factor, which is defined in different ways), and aided possibly by other factors, likewise has a very strong probability of outperforming broad market funds over the next 10-20 years. As discussed in prior editions of this newsletter, the employment of multiple factors (selected for their academic support) when designing overall investment strategies will tend to smooth out performance when any one factor disappoints.
Dr. Ron A. Rhoades serves as Associate Professor of Finance and Director of the Personal Financial Planning Program within the Gordon Ford College of Business at Western Kentucky University. He teaches and has taught courses in Retirement Planning, Applied Investments, Advanced Investments, Estate Planning, Financial Plan Development, Personal Finance, Money & Banking, Risk Management and Insurance, and Principles of Finance. He is regarded as a national expert in the application of fiduciary duties to the delivery of investment and financial planning advice. Ron’s upcoming book, Mastering the Science and Art of Investing: Strategies for Maximizing Returns with Multi-Factor Portfolios, is anticipated to be published later in 2023 or early 2024.
END NOTES
[i] https://cei.org/blog/america-takes-entrepreneurship-index-top-spot-former-soviet-bloc-countries-close-behind/
[ii] https://ceoworld.biz/2023/08/24/the-worlds-largest-economies-in-2023/
[iii] https://www.pewresearch.org/short-reads/2022/07/21/global-population-projected-to-exceed-8-billion-in-2022-half-live-in-just-seven-countries/
[iv] https://www.eastasiaforum.org/2023/03/19/demography-poses-no-imminent-threat-to-chinas-economic-modernisation/
[v] https://www.ey.com/en_in/india-at-100/reaping-the-demographic-dividend
[vi] https://www.aljazeera.com/features/2023/4/18/overtaking-chinas-population-will-india-gain-or-lose
[vii] https://www.ey.com/en_in/india-at-100/reaping-the-demographic-dividend
[viii] Stefan Calimanu, Why The US Leads The World In Entrepreneurship And Innovation, ResearchFDI (May 17, 2023)
[ix] Kevin Daly, Tada Gedminas, The Path to 2075 – Capital Markets Size and Opportunity, Global Economics Analyst / Goldman Sachs (June 8, 2023)
[x] Id.
[xi] Brian Chingono, More Bang for Your Buck, Verdad (Sept. 5, 2023)
[xii] Focus on the Horizon: Tuning Out the Noise with Valuations and Returns, Avantis Investors® (August 2023)