the demographic investor

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They follow demographics. In the hyperactive world of investing - with its rapid trades and lust for instant wealth - some analysts take the long view.

Forget Fed Chairman Alan Greenspan with his worries about short-term interest rates. Turn off CNBC and its breathless updates about the dot-coms du jour. Don't even think about listening to the day-trading gurus who promise you riches from buying and selling Dell in less time than it takes to down a cappuccino. Now, relax and start counting heads.

Despite the wildly-gyrating Dow, that's the sane advice of a small but influential community of investment professionals who use demographics to pick stocks, bonds, and mutual funds. At a time when many money managers zip in and out of stocks almost hourly, a growing number of experts now base their investment strategies on the same long-term population trends used by market researchers and policy wonks. And they're spreading the word that understanding demographics can mean the difference between making a killing and getting trampled by the bulls.

Just in the last year, the AIM family of mutual funds launched the Dent Demographic Trends Fund, for which California money manager Harry S. Dent Jr. identifies generational shifts and the sectors expected to profit from them. Likewise, Robert Farrell, a senior investment adviser with Merrill Lynch & Co., recently began highlighting a half-dozen demographic "themes," such as "the aging population" and a "growing Generation Y," to advise clients on the stocks that will benefit from them. At Victoria Capital, a private investment fund based in Washington, D.C., Todd G. Buchholz, the company's chief investment officer, now focuses on the rising Hispanic population as reason to buy ethnic media companies such as Univision Communications.

"You want to go where the numbers are," says Buchholz, a global economist, and author of Market Shock, a book about the financial impact of social trends. "It's the opposite of that old baseball cliche to `hit 'em where they ain't.' You want to hit 'em where they are."

No one keeps track of how many demographic experts prowl Wall Street, but their numbers seem to be growing. Many investment banks and brokerages now employ demographic-minded analysts along with their "technical" analysts who chart the momentum of a stock's price, and the "bottoms-up" specialists who probe a company's balance sheet to predict earnings. Increasing media coverage of demographic news has made population shifts part of every fund manager's stock picks. You'd be hard pressed to find a broker who hasn't concluded that Baby Boomers are getting older and will soon need more prescription drugs. That translates into an expected increase in sales - and a higher stock price - for pharmaceutical companies such as Pfizer, the maker of Viagra.

But "true" demographic investors are also obsessed with long-range trends, tracking the number and ages of people over time in order to identify the pockets of consumers who spend disproportionately more money than other groups. By following their buying patterns throughout their lives, shrewd investors can predict new spending patterns created by demographic shifts. Aging Boomers? Merrill Lynch's Farrell believes they'll benefit the makers of backyard decks (that's why he's recommending the Trex Company) and online bill-paying software (Checkfree Holdings) as they set up their homes as retirement cocoons. "Demographics show you where the opportunities are emerging," says Farrell, who describes himself as a "theme strategist."

While other analysts pour over company balance sheets, demographic investors sift through reports from the U.S. Census Bureau, the Bureau of Labor Statistics, and the National Center for Health Statistics. Richard Hokenson, chief economist at Donaldson, Lufkin & Jenrette, says he gets some of his best tips at conferences held by the Population Association of America, where he listens to professors describe their research-in-progress. At a recent meeting, he learned of the declining divorce rate - from above 50 percent to the mid-40 percent range - and promptly turned bearish on the toy industry. As he explains, "What counts for toys is not how many children there are, but how many adults are related to a child. When divorce rates are falling, there are fewer gift-givers, so you have a negative impact on firms like Toys `R' Us or Mattel."

But demographics can do more than simply indicate a hot sector or a cold stock. In fact, Hokenson believes that its most important use is forecasting inflation, which influences the asset allocation of an investor's portfolio. For instance, aging Boomers have already made major purchases - their homes, cars, and furnishings - which indicates lower borrowing and inflation rates. That, in turn, will keep interest rates low, stock values high, and encourage investors to keep a large share of their assets invested in the stock market. "An aging population produces a disinflation, so you want to own long-date financial assets such as stocks and bonds," says Hokenson. "That will change when Generation Y begins borrowing heavily to form households, and inflation shoots up. You should then place more of your assets in cash and real estate."

A similar story line is offered by Dent, a bestselling author (his latest hit is The Roaring 2000s Investor) and popular lecturer who commands $50,000 per speech. A dozen years ago, he noticed a link between U.S. birth rates and economic growth: A 47-year lag between births and the time Americans reach their peak earning and spending years. Using that correlation, Dent now predicts that the Dow Jones Industrial Average will nearly quadruple to 41,000 by 2008 - the year the number of 47-year-old Boomers crests. As the less numerous Gen Xers enter their heavy spending years, he sees the stock market then drifting into a deflationary decline - that is, until the 83 million members of Gen Y reach their economic prime in another dozen years. "When I saw this single demographic indicator for the market, I almost fell off my chair," Dent recalls. "I didn't think it could be that simple. But our economy is driven by the predictable habits of people."

Admittedly, not all money managers buy into the notion of demographics-as-investment-destiny. Long-range trends can always be altered by short-term events: Too many nasty interest rate increases, a meltdown in the Far East, the firing of a CEO in Silicon Valley. And consumers can be fickle. You'd think that Baby Boomers having had their hearing marred by too many Led Zeppelin concerts would start wearing hearing aids en masse. Yet hearing aid market penetration actually dropped between 1984 and 1997, from 23.8 percent to 20.4 percent, because Boomers are still too vain to wear ear pieces. Hearing aid companies such as Hearx have been in the dumps for years.

"Demographics are very precise, but consumption isn't," observes Margaret Mager, a retail analyst at Goldman Sachs. "A lot of 40-year-olds buy as if they're twentysomethings."

Still, the pros know that the wisdom behind monitoring demographic trends is supported by one of the golden rules of investing: Buy and hold. Although profit fever has no doubt infected the more than half of Americans invested in the stock market, demographics allow money managers to defend long-term strategies. Here, then, based on interviews with leading demographic investors, are a handful of hot population trends they've identified along with the sectors, stocks, and funds forecast to capitalize on them.

#1 Boomers In Retirement "It's hard to find a sector that's not going to be affected by the Boomers," says Jim Thompson, director of shareholder education at Scudder Investments. And he has a point. Boomers are still the pig in the python of the nation's population and, for keen-eyed investors, the cohort to watch. The 78 million Baby Boomers born between 1946 and 1964 - nearly one-third of the U.S. population - have sparked heavy consumer demands at every stage of their lives, from jeans and fast food as teenagers, to minivans and SUVs in middle age. Now that the oldest Boomers are 55 years old, investors are starting to anticipate their consumption patterns in retirement.

Dent supports buying equities in three sectors during this Boomer-fueled growth period between now and 2008. Health care, because older consumers spend more on doctors, drugs, and medical devices; financial services, because Boomers won't get serious about investing and saving until they're close to retirement; and technology, because they helped launch the computer revolution and are fueling the current love affair with the Internet. Although Dent doesn't recommend individual stocks, other pros following his pronouncements make the picks while gauging market psychology and political events. And they've been on a tear. Since the Dent Demographic Trends Fund debuted in June 1999, it has soared 66 percent in value as of August 23, 2000, compared with 24 percent for the S&P 500 (not counting its 5.5 percent sales charge).

Van Kampen Funds has also tapped Dent's ideas to sell more than $1 billion of so-called Roaring 2000s unit investment trusts. The firm has launched such trusts for five quarters in a row, and its stocks in the current portfolio include Genetech and Medtronic (health care), Chase Manhattan and E superscript *Trade (financial services), and Cisco and JDS Uniphase (technology). Dent recently veered from his practice of leaving the picking to others when he encouraged Van Kampen to drop Disney from one portfolio because its business was "slowing demographically" as Gen Ys aged beyond the Mickey Mouse years. He's also down on toy companies and cereal makers for the same reason.

At Merrill Lynch, Farrell also claims that the health care, technology, and financial services sectors will thrive, thanks to aging Boomers. But he adds the travel and leisure industry to his picks, and he isn't above naming names of individual stock "beneficiaries" of the demographic trends. Noting that the World Tourism Organization predicts a rise in international travelers, from 612 million in 1997 to 1.6 billion in 2020, he recently forecast earnings growth in industries ranging from airlines and hotels, to restaurants, casinos, and theme parks. In a June report, he listed the following sector beneficiaries: Continental Airlines, Four Seasons Hotels, Harrah's Entertainment, and Park Place Entertainment. Unlike Dent, Farrell also likes Disney.

Because investors may agree on a long-term outlook but disagree about the stocks with staying power, some pros suggest buying indexes or mutual funds that specialize in a particular industry. For instance, analysts note that one way to play the Boomer-fueled health care rise is through sector funds such as Fidelity Select Biotechnology, Monument Medical Sciences, and Eaton Vance Worldwide Health Sciences. Farrell, for his part, advocates investing in "leadership stocks" within a sector. "If you're dealing with a true, long-term demographic trend, the market will show which companies are the leaders," he says. While many biotech stocks tanked in the last decade - 44 of 100 IPOs listed in the early 1990s no longer exist - Amgen dropped 60 percent before clawing its way back to new highs. "The companies that aren't leaders," Farrell adds, "will drop 90 percent and never come back."

#2 Life Expectancy Rises At the turn of the 20th century, when life expectancy was 46 years, Germany's Bismarck government promised to pay pensions for those over the age of 65 - mostly because it didn't think many people would live that long. Since then, doctors and diet have doubled the average life expectancy for Americans to nearly 80 years, and the 85-plus age group is the nation's fastest-growing population segment. Scudder's Thompson actually divides retirement into two phases: The early stage when people in their mid-70s work a second job and do a lot of their traveling; and the later stage when the oldest retirees lose their ability to work and travel. That's when they're likely to boost the earnings of firms offering health care, home repair, and assisted-living communities.

As seniors look to improve their quality of life, Buchholz thinks the biotechnology sector will thrive from demand for gene therapy to cope with cancer and other diseases. Following the motto "change multiplied by people equals opportunity," Buchholz is especially bullish on companies doing research in treatments for breast cancer and Alzheimer's disease - ailments that affect the most Americans. Other experts see happy days for the long-term care industry and companies that provide assisted-living services, nursing homes, and retirement communities. Although stocks in the sector are currently weak, Merrill Lynch's sector analysts endorse Manor Care and Brookdale Living Communities.

"Seeking the fountain of youth" is another of Farrell's demographic themes, as older Americans become preoccupied with maintaining their youthful appearance. Industry experts expect fitness-related products and services to grow more than 10 percent annually over the next several years, and Farrell's colleagues pick Bally Total Fitness Holding Corporation and Direct Focus to capitalize on this trend. They also expect Rexall Sundown, a supplier of natural supplements, to benefit from the vitamin-popping ways of about 60 percent of U.S. consumers, and Candela, a laser technology company, to profit from the sharp rise in cosmetic surgery procedures. Skin rejuvenation procedures are up 800 percent since 1990.

Many futurists believe that the desire of retirees to protect their wealth will increase their consumption of financial services. But there's debate on what will happen in 2011 when the first Boomers reach 65 and begin their line dance into retirement. Doomsayers predict that a massive withdrawal from the stock market will lead to a crash. Optimists - including most demographic investors - predict a more gradual cashing-in as seniors learn to cope with ever-lengthening retirements. Buchholz falls into the latter camp, and says that banks and brokerages will benefit. "The fear of living too long has replaced the fear of dying too soon," he writes in Market Shock. "Therefore, retirees cannot sell off their assets and quickly spend them down. Who knows how much money they will need from 65 to 85, or 95, or 100?"

#3 Minority Majority The Census Bureau has predicted that the most dramatic population increase in America this century will be seen among Hispanics. In five years, the Hispanic-American population - currently numbering 31 million - will become the nation's largest minority group, overtaking African Americans to compose 13 percent of the populace. Already, Hispanics spend roughly $460 billion in the marketplace, and their economic impact is expected to grow along with their numbers.

In Market Shock, Buchholz observes that the increasing Hispanic population should boost the earnings of firms such as Univision, which owns TV stations and targets Hispanics with news and entertainment programs. Its Los Angeles station, KMEX, routinely pulls in higher nightly news ratings than network affiliates because of its appeal to both new immigrants and second-generation Latinos. In addition, as Latin America opens up to broadband technology, Hispanic broadcasters based in the United States may have an edge developing media businesses there.

The relative youth of the Hispanic population - the median age of Hispanics will only be 28.8 in 2020, almost nine years younger than that of the total population - will further transform industries that cater to minority groups and immigrants. Merrill Lynch analysts advocate investing in companies that sell food, children's clothing, and cleaning products - goods all bought by Hispanics in great numbers. Farrell also claims that the increasing affluence of Hispanic households - the percentage earning over $50,000 a year will jump by 50 percent between now and 2005 - will boost bank stocks such as Texas Regional Bancshares, which serves the Hispanic residents of the Rio Grande Valley.

Studies show that the longer immigrants stay in America, the more likely they are to buy homes, which means a future bounce in the housing industry. Over the next few years, housing experts predict a boom in rental apartments and starter homes to satisfy both young immigrants arriving in this country and Gen Ys forming their own households. "They'll rent first and buy later," says Orawin Velz, a senior economist with the Fannie Mae Foundation in Washington, D.C.

Later in the decade, the increasing numbers of Hispanic immigrants who have been in the country for over a decade will catch up with the single-family home market - although their selections may lean toward modest manufactured houses. While upscale consumers tend to regard mobile homes as fodder for Weather Channel twisters, they've proven attractive for less-affluent, younger families - which include plenty of minorities. Between 1995 and 2010, the number of immigrant households should increase by 3.6 million, representing 21 percent of U.S. household growth, according to Fannie Mae analysts. Notes Buchholz: "Investors should be searching for home-building and real estate development firms that aggressively court the Hispanic and Asian populace."

#4 Generation Y Grows Up Another population bulge has occurred as a result of Boomers having babies. Generation Y - the roughly 70-million Americans born since 1983 - is said to already possess $167 billion in spending power. Typically these teenagers devote a high proportion of their spending to food and entertainment, clothes, and shoes. But apparel and footwear stocks have languished in recent years due to rising interest rates, and at Goldman Sachs, analysts recommend only two companies in this sector: Liz Claiborne, because of recently acquired companies targeting younger consumers; and Intimate Brands, which owns Victoria's Secret and Bath & Bodyworks. "Kids like malls, and these chains have a lot of mall stores with items that have low price points," says Margaret Mager, a footwear and apparel analyst at Goldman.

With lower interest rates predicted over the next few years, Mager thinks two other companies will emerge because of their focus on Gen Y consumers: Genesco, which owns a chain of teen shoe stores called Journeys; and Vans, which builds skate parks - the better to lure Gen Ys to mall stores. Says Mager, "Mall developers want to make young consumers feel comfortable shopping there so they'll make it a lifelong habit."

Some Wall Street analysts believe that Gen Ys are also likely to drive up demand for electronics and specialty toys. Merrill Lynch's Farrell recommends large companies such as Sony, Philips Electronics, and Texas Instruments. He also pinpoints another company to watch, Hot Topic, a mall-based retailer of music-influenced apparel for teens. Toy companies have had a topsy-turvy record recently due to the Internet revolution, but Farrell likes Hasbro because of its emphasis on handheld wireless devices for accessing online games.

This preoccupation with toys should shift over the next decade as the oldest Gen Ys marry, start their own families, and begin spending money on cars, apartments, furnishings, and appliances. In addition, this bulge of twentysomething consumers should mean higher earnings for companies involved in mortgages, fulfillment services, and commercial real estate. "Shopping centers should do well because these consumers will need more retail space," says Dent. "They'll be in the market for their first car, an apartment, and plenty of cheap furniture. Already, Ikea on a Monday morning is packed, and it should get even more crowded."

#5 Telecommuters Telecommuting, which started in the 1980s and exploded in the 1990s, has been pegged as the largest workplace trend of the new century. Nearly 20 million Americans are telecommuters, reports the International Telework Association & Council in Washington, D.C. And that figure is only expected to rise as people and jobs continue to move to the fringes of metro areas, where available land can accommodate new homes and businesses. With voicemail, e-mail, cell phones, and the Internet connected to every spot on earth, these exurbanites can carry their offices wherever they go.

All of which means that companies selling home office supplies and equipment should thrive, according to Merrill Lynch. Analysts there are high on companies such as Staples, which gets about half its sales from home office workers, as well as tech leaders Microsoft and Hewlett-Packard. They also like a handful of other technology companies, even after the spring sell-off: IBM, America Online, Leggett & Platt, and Pitney Bowes. Over the long term, analysts believe that demographics will spark continued growth in those tech leaders.

The exurban boom should also boost the fortunes of resort towns, which will find a way to lure affluent Boomers for year-round residences, maintains Dent. "Technology allows Boomers to live anywhere," he says, "so the new paradigm shift is to work where you vacation and vacation where you work." By Dent's reckoning, that means investing in property in communities like Telluride, Colorado, and Bisbee, Arizona, or betting on hotel chains such as the Four Seasons that are moving into these areas. "Look for upscale resort and development companies," he says. "Nobody's ever heard of Carbondale, Colorado, but it's booming on the outskirts of Aspen. It's like buying the exurbs of Aspen."

Of course, timing also plays a role in demographic investing. Many financial planners advise clients to develop portfolios timed to when they'll need proceeds from the sale of investments: to buy a new home, pay for college tuition, or fund an early retirement. They also report that different kinds of funds perform best in what Dent calls the "four seasons of investing": inflation, growth, deflation, and a maturing period. With the economy still in a growth mode, 'tis the season to own large-cap growth stocks. Bonds do best in a deflationary period, small-cap stocks during a period of inflation, and global stocks star in a maturing period. "If you understand demographics and choose the right sectors in the right seasons, you will outperform the market over the long term," declares Dent. "Demographics are not just a factor for investing in the market, they're the factor."

Even then, harnessing population trends to your advantage takes lots of patience and a modicum of luck. The use of demographic data doesn't produce a perfect crystal ball but it can help investors identify coming changes and, quite possibly, make smarter investment decisions. And, for once, you don't have to be the first person to capitalize on an insider's tip. There's plenty of time to track a demographic trend and make money the old-fashioned way: slowly and steadily.

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