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. 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 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”.