Baby Boomer Fears Cast Another Pall Over Markets

Wednesday, 07 Sep 2011 09:48 AM

 

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Even as anxiety over policy inertia, banking and sovereign debt crises dominate the headlines, a long-festering concern over the impact of aging Western populations on stock markets is returning to add even greater gloom.

Hopes are dimming for a resolution of the worst ravages of the 2007-2009 credit shock before the mass retirement later this decade of the "baby boom" generation - the outsized population cohort born shortly after World War Two.

For many convinced of the long-term power of demographic trends on financial markets, the fuel for ever-rising stock markets is already evaporating fast and a 10-year equity bear market at least is in the offing.

These long-held concerns are now critical in a decade where the 79 million U.S. people born between 1946 and 1964 start retiring as soon as this year and larger boomer retirement waves build to peak around 2020-2022.

The concern is that the ebb and flow of U.S. stock markets over the past 50 years is highly correlated with the available pool of household savings channeled into equity investment.

Assuming peoples' prime savings years are those between ages 40 and 65, the proportion of the population in that bracket is therefore key to driving the market. As early as the 1980s, economists feared the impact this may have on U.S. housing markets -- and the recent real estate bust may owe it something -- but stock market connections are more convincing.

The data is alarming. Movements in the ratio of these high savers to both retirees and younger adults has presaged long cycles in real equity prices from the downward funk of 1970s to the subsequent 18-year equity boom through the late 1980s and 1990s as boomers swelled the ranks of prime savers.

The worrying bit for the United States is that ratio peaked in 2010.

EERIE CASSANDRA

Fashionable fear of "Japanisation" of Western economies - where the United States and Europe start to mirror the past 20 years of Japan's economic stagnation, deflation and soaring public debt - also resonate here as Tokyo stocks proved to be an eerie Cassandra.

When the prime savings ratio peaked in the early 1990s in Japan -- where aging is more advanced than in Europe or the States -- a two-decade bear market in the Nikkei ensued.

Returning to the theme in late August, economists at the San Francisco Federal Reserve outlined similar fears and concluded these demographics may act as a depressant to equity values over the next two decades -- with markets' tendency to frontload these concerns providing headwinds from now.

Focusing on the assumption that boomers will tend to "de-risk" their savings by selling equities for bonds as they approach retirement, the paper looks at the ratio of middle-aged Americans aged 40-49 building equity to the older grouping aged 60-69 shifting toward safer fixed-income bonds.

It then compares that trend to the price/earnings ratio in stock markets to illustrate the historical link and gloomy projections involving a 13 percent decline in real stock prices between 2010 and 2021. Their model reckons stock prices will not stage a strong recovery until 2025 and real prices won't regain 2010 levels until 2027.

"The demographic changes related to the retirement of the baby boom generation are well known," the paper concluded. "This suggests that market participants may anticipate that equities will perform poorly in the future, an expectation that can potentially depress current stock prices."

The asset-switching behavior has already been evident in core bond markets over the past decade where pension funds have shifted en masse to better match liabilities. The recent surge in Treasuries -- in the face of mounting debts, a credit downgrade and temporary default threat -- shows this may still be packing a punch.

The pension fund industry is already caught in this bind. By collectively driving bond yields down further while pulling the rug from equities, they threaten a vicious circle of falling asset returns that is increasing pension deficits in the increasingly rare defined benefit schemes.

"In pension funds you have a policy of shifting out of equities and into bonds closer to the retirement age," said Gary Smith, head of official institutions at BNP Paribas Investment Partners. And "the entire pension industry is aging."

Caveats to the gloomy prognosis are plenty and may partly explain why increasingly myopic markets have resisted the idea, which circulated as far back as the 1980s when the looming boomer retirement was seen to spell doom for the housing market.

Offsetting factors include people retiring much later than 65 and also the impact of overseas investors from younger developing nations, via sovereign wealth funds for example.

Many have also argued for years these predictable trends should already be factored into prices by "efficient" markets.

Yet in the light of what we know now about markets' failure to properly price future risks surrounding the credit crisis, this seems far less plausible or optimistic at best.


© 2014 Thomson/Reuters. All rights reserved.

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