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Posted by Lance Roberts on Thursday, 25 August 2011 00:00
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Recently the San Francisco Federal Reserve Board released a
study on the aging "Baby Boom" population and the effects of
the demographic pull on stock valuations as these "boomers"
move en mass into retirement. From the report: "The baby
boom generation born between 1946 and 1964 has had a large
impact on the U.S. economy and will continue to do so as baby
boomers gradually phase from work into retirement over the next
two decades. To finance retirement, they are likely to sell off
acquired assets, especially risky equities. A looming concern is
that this massive sell-off might depress equity values." [The report isn't long and a good
read.]
This is something that we have discussed previously, however, the report points out the
obvious concern; "Many baby boomers have already diversified their asset portfolios in
preparation for retirement. Still, it is disconcerting that the retirement of the baby boom
generation, which has long been expected to place downward pressure on U.S. equity
values, is beginning in earnest just as the stock market is recovering from the recent
financial crisis, potentially slowing down the pace of that recovery."
There were several very interesting implications in the report such as:
US equity values (in terms of P/E ratios) have been closely tied to demographic
trends over the last 50 years.
The baby boom generation has had a large impact on the U.S. economy as they
saved and invested; now they will have the reverse effect as they become net
liquidators of assets - particularly risk related assets (ie. stocks).
These demographic shifts may present headwinds for the stock markets recovery
from the financial crisis
Due to these demands on assets "real stock prices" may not recover to their
2010 level until 2027.
The last point was the most startling. Most analysts and economists believe it to be a
theoretical impossibility for the economy, and by default the markets, to remain stagnant. However, the extent to which the aging of the U.S. population creates headwinds for both
the economy and the stock market is something that you can see by taking a retrospective
look at Japan.
The Fed report looked only at the middle-aged (40-49) and old aged (60-69) groups. http://www.streettalklive.com/financial-blog/253-boomers-are-going-to-be-a-real-drag.html[8/26/2011 2:12:24 PM]
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Boomers - Are Going To Be A Real Drag
However, I think the issues are more encompassing than just two groups. If we think
about the current employment levels relative to the population as a whole we can began to
understand this is a larger problem. Assuming that the "baby boomer" generation will
begin to liquidate assets as they move into retirement in order to fund living expenses; this
is turn potentially leads to lower economic growth. Therefore, if the economy is growing at
lower rates then we have to further assume that we will maintain higher levels of
unemployment. These assumptions imply that not only will the two age groups identified
by the Fed begin withdrawing assets; but that a much larger percentage of the entire
population will be saving and investing less. The problem that these assumptions impose is that savings are required for productive
future economic investment. When Japan entered into their post crisis decline they had
very high personal savings rates which initially sustained their economic system. Unfortunately, the U.S. does not have the luxury of high savings rates as detailed by the
following statistics in our recent post "Beware Of Long Term Investing": "Let's consider the following facts in regards to the average American worker:
56% of the average workers in America today have less than one years salary
saved with less than $25,000.
76% have less than $100,000; and
90% have less than $250,000 saved.
If we assume that the average retired couple will need $40,000 (the average annual
salary) in income to live through their "golden years," they will need roughly $1 million
dollars generating 4% a year. Therefore, 90% of American workers today have a problem.
However, what about those already retired? Given the boom years of the 80's and 90's
that group of baby boomers should be better off, right? Not really.
54% have less than $25,000
71% have less than $100,000; and
83% have less than $250,000."
Low personal savings rates do not leave individuals much wiggle room in an economy
where incomes are under pressure due to a large unemployed labor pool. The chart
above shows the strong statistical evidence concerning the historical relationship between
U.S. employment and equity markets. The dotted lines represent the likely path of both
employment to total population and the stock market into 2020 assuming the migration of
"boomers" into retirement. The implications of declining employment to population due to the demographic shift
potentially shake the foundations of conventional investing wisdom which assumes that
markets always rise over time. The potential impact of these demographic shifts in the
U.S. parallel closely with the Japanese economy since their financial crisis took hold
almost 30 years ago. The Japanese Experience
In response to their own real estate/financial crisis, Japan
implemented many of the same economic policies that
are implemented in the U.S. currently. The result of those
policies, combined with an aging population, has plagued Japan
with a slow growth economy and struggling financial markets. The Fed report points to this correlation between the financial
markets and these demographic shifts. "Since an individual's financial needs and attitudes toward risk change over the life cycle,
the aging of the baby boomers and the broader shift of age distribution in the population
should have implications for capital markets (Abel 2001, 2003; Brooks 2002). Indeed,
some studies attribute the sustained asset market booms in the 1980s and 1990s to the
fact that baby boomers were entering their middle ages, the prime period for accumulating
financial assets (Bakshi and Chen 1994)."
However, one of the key arguments against the U.S. being like Japan has been the
strength of employment. While the U.S. may not have as severe of an aging gap between
generations; a quick comparison between employment to population ratios leaves little
question. Since both countries face similar hurdles of overburdened social welfare programs, a weak
economy and struggling financial markets; sustained levels of high unemployment drag on
economic growth. This in turn reduces assets that would potentially be invested back into
the system.
We can look at Japanese stock market set against the S&P 500, advanced 10 years to
align time frames, in order to see the impact of demographic trends on stock prices. The
long term trend of the Nikkei continues to be negative as Japan has followed its path of
http://www.streettalklive.com/financial-blog/253-boomers-are-going-to-be-a-real-drag.html[8/26/2011 2:12:24 PM]
Boomers - Are Going To Be A Real Drag
long term economic decline which has impacted employment levels relative to their total
population.
Beginning In 1980, the U.S. has similarly been in a slow
degradation of economic growth. As debt levels have increased
to sustain a higher standard of living; savings rates have fallen
which has detracted from productive investment. Furthermore, the shift from a production and manufacturing base
to a service based economy has further impeded growth by
shifting invested dollars into areas with a lower economic
"multiplier" effect.
We outlined this in greater detail in "The Breaking Point".
The impact of these shifts almost 30 years ago in the U.S. have just now started to be
realized with the bursting of the financial/credit bubble in 2008. With consumers now
entrenched in a "balance sheet" recession, the process of deleveraging an entire
economic system is a process that occurs over a decade or more. This creates a vicious
feedback loop as consumers re-task spending to pay down debt. Reduced expenditures
puts businesses in a defensive position which respond by reducing hiring and increasing
cost cutting (ie. layoffs) measures to maintain profitability. With higher unemployment
comes a competitive available labor pool which lowers wages and salaries. Lower wages
decreases the ability for consumers to expend discretionary income which creates lower
final demand on businesses. This cycle, once entrenched, is extremely difficult to break. This is the reason why the various stimulus programs have failed to create any lasting
economic growth.
Many may scoff at the Fed's report that stock prices will not recover to their 2010 highs
until 2027. The migration of "baby boomers" into retirement, combined with sustained high
unemployment, low savings rates and a weak economy, does not bode well for strong
financial markets into the future. While there are many hopes that the economy will
recover in spite of the abundance of factors building against it; the reality is that we may
be dealing with the "Japanese Experience".
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