Advisors’ most successful clients learned theirformative investing lessons in the late 20th century—a“perfect storm” of favorable demographics and economic trends.

But the past decade revealed starkly different conditions.

This column describes three inescapable trends thatwill drive investments in the developed world for the next fewdecades; a companion column will suggest specific portfoliochanges.

1. Debt

Governments throughout the world have spent more than the taxrevenues they collect, accumulating debt that has risen to levelsmuch higher than their countries’ GDPs.

Each 50% increase in a nation’s debt-to-GDP ratio lowerseconomic growth by more than 1% per year. When debt levels approachunaffordability, lenders shut their wallets: they stoplending.

Governments then must throw spending and taxation into suddenreverse, which often can stifle a recovery or bring on adepression. Greece is only the most recent example.

Research by Professors Carmen Reinhart and Kenneth Rogoffsuggests that the effective limit on government debt to avoid thesemalignant economic side effects is about 90% of GDP. Every advancednation’s debt is far above this level; Greece isn’t even theworst.

When lenders go on strike, governments will first respond withspending cuts and higher tax rates (or taxing things that neverwere taxed before).

Taxpayers will shelter income by doing less of the activitybeing taxed, moving funds offshore to lower-tax jurisdictions, orsearching for loopholes. The revenue raised will fall short ofprojections, so governments will turn to monetizing the debt byexpanding the money supply--which will bring on higherinflation.

This unholy combination is stagflation: slow growth along withhigh inflation. This last occurred in the U.S. in the late1970s. (Dust off your leisure suit!) Stagflation is typicallybad for stocks, as it was then.

2. Demographics

As societies prosper, birthrates drop. Urbanization bringshouseholds off the farm, where large families are an economicasset, into cities where they are a liability.

Economic opportunities for women cause many to defer motherhood.A long term measure of this trend is the “total fertility ratio”(TFR)—the average number of children born per woman during herlifetime.

Population levels are stable at TFRs near 2.0, perhaps 2.05 tocompensate for infant mortality. The rich world’s TFRs fell below 2a few decades after World War II. When fewer babies are born toreplace deaths, populations age and eventually shrink. There arefewer kids in schools, then fewer workers in jobs.

Younger populations must work and save to prepare for eventualretirement, while older populations spend accumulated assets. Aginghas a profound effect on economies, and on different industries. Ayoung population will have vibrant education and constructionsectors, while the strongest sectors among an older population willbe health care and funeral homes.

Societies with entitlement programs like retirement pensions(such as Social Security in the U.S.), will see their costs rise asthe number of older residents grows. Programs will also become lessaffordable when the number of workers who fund the entitlementsystem shrinks.

And like individuals, societies take fewer risks and innovateless as they age. So an aging population means a less dynamiceconomy: less invention, and more resources used to supportdependent populations.

The advanced economies felt the demographic slowdown first:Japan most severely, followed by Western Europe. America’sdemographic slowdown has been muted by immigration.

But for many developing countries entering the global middleclass, their birthrates are also falling rapidly, and theirsocieties are aging. China’s median age will exceed America’s by2020. The longtime flow of Asian investments into American assets,will reverse when their profits must be repatriated home to pay fora growing elderly population.

An aging global society will mean higher interest rates, and adrag on economic growth and stock prices.

3. Democratization

Democratization in the late 20th century introduced threebillion new capitalists (in Clyde Prestowitz’s phrase) in Asia tothe opportunities available by trading with the West.

They will sell their labor in exchange for our technology. Thetrade made possible by democratization has propelled more peopleout of poverty in a shorter time than any event in history.

This trend of democratization and globalization was been a boonfor the world, lifting billions out of poverty and filling Westernstores with cheap goods. But those new capitalists will not becontent with low skilled manufacturing jobs: they will climb thevalue ladder and increasingly compete directly with a growing spanof Western industries.

Even skilled middle class professions in the West are underintense competitive pressure. This is one of the main reasons whymedian incomes in the U.S. have made no real progress for the pastfew decades.

A unique historical moment

Debt, demographics, and democratization combined to superchargeeconomic growth in the late 20th century. But clients should notsimply extrapolate, or they will grossly overestimate our growthprospects in the early 21st century.

The 1980s through early 2000s—what some economists have calledthe period of “Great Moderation” when both unemployment andinflation were low—was the party.

The first few decades of the 21st century will be thehangover. We may still grow, but more slowly than in thepast: 1 or 2% per year (as the pattern since 2009), not the typical4 to 5%.

Professor Larry Summers calls this “secular stagnation.” We call it the “new normal.”

Be income focused

Clients approaching retirement should turn from a growth focusto an income focus; not only due to their own needs, but also dueto the realities of the new normal.

These mandate scaling back clients’ return expectations andtaking less risk with their investments: emphasizing income, notgrowth.