The boomer bust
Will aging boomers pull their money out of the market and cause an asset meltdown on their way to retirement?
(FORTUNE Magazine) - Bob Dylan, bard of the baby-boomers, turned 65 a few weeks ago. The milestone passed without much fanfare, but it was an unmistakable reminder that the generation that had hoped to stay forever young is nearing retirement age.
Dylan is slightly ahead of the crowd, but the first of the boomers hit 60 this year, with nearly 8,000 Americans reaching the mark every day. Talk about times a-changin'.
That aging is bound to be unsettling - and not just for boomers. The graying of such a massive cohort will strain programs such as Social Security and Medicare. But it will also have a broader economic impact, potentially affecting private investments as much as public entitlements. A number of market experts warn that the population shifts ahead may spark an asset meltdown that could weaken equity returns - if not devastate them - for a decade or more.
Among those sounding the alarm is the unlikeliest of Chicken Littles: Jeremy Siegel, the Wharton finance professor and author of the bullish investing bible "Stocks for the Long Run."
"The demographic trends of the past have just not been strong enough to offset all the other influences on the stock market," Siegel says. "But this is the granddaddy of all demographic shifts. We have never witnessed anything like this, and I am convinced it is going to be a determinant of asset prices going forward." Stocks and other assets, he warns, could plunge by as much as 50 percent.
Frightened yet? Now comes the flip side: For every doomsday prediction about the boomer impact, there is a persuasive argument that aging trends will play out calmly. In fact, the general consensus among those who have studied the subject is that while some difficult adjustments are on the way economically, a boomer-induced blowup is hardly likely. (And, as we'll see, even Siegel is more optimistic than he seems.)
What's more, many of the smartest investing pros are betting the opposite way--that boomer demographics offer great opportunities to build wealth (see "Four Ways to Play the Baby-Boom Effect").
Anyone managing a long-term portfolio - which means anyone hoping to retire - must understand the subtleties of the often overheated demographic debate. Forecasting market moves ten or 20 years down the road is an invitation to embarrassment. Yet the underlying population trends are clear.
Baby-boomers - defined by the Census Bureau as the 78.2 million Americans born between 1946 and 1964 - are living longer and staying healthier than past generations. The average life span today is about 77 years, up from 69.7 in 1960. As boomers age, the number of Americans 65 and older is expected to more than double, from 35 million in 2000 to 72 million in 2030.
By that point the Census Bureau projects that one in five Americans will be a senior citizen - which means that the country as a whole will have a greater proportion of seniors than Florida does today. That's not only because of the extraordinary size of the baby boom but also because it was followed by a so-called baby bust, as cultural changes and the birth control pill led to a period of reduced fertility rates starting in the mid-1960s. (U.S. demographics represent only part of the picture: Europe and Japan are aging even more dramatically.)
Given those trends, Siegel and others suggest that a stock market slump could come about largely as the result of supply and demand. Boomers have amassed trillions of dollars in stocks and other assets. As they leave the workforce, the argument goes, new retirees will pull more and more of their money out of the market to spend on everyday needs and wants.
Pension funds will also become net sellers as they cash out to pay their obligations. But those looking to dump stocks, bonds, and real estate will find fewer buyers in the market. In the end, just as boomers loading up on assets during their peak earning and investing years may have helped propel the boom of the 1980s and '90s, their selling would force asset prices to fall.
Compounding the pain, the coming age wave also means fewer workers will be left supporting a greater number of dependents. Though life expectancy continues to rise, retirement age has not been moving up in tandem, Siegel notes. As a result, the ratio of workers to retirees will drop from about five to one today to an estimated 2.6 to one by 2050. Barring large improvements in productivity, that would slow economic growth, as a new study by Federal Reserve economists suggests. Of course, any slowdown would hurt corporate profits and potentially exacerbate a bear-market slump.
"Stocks depend on earnings, and earnings depend on a growing economy," says forecaster Harry S. Dent, who predicts a 12- to 14-year bear market starting around 2010. (For the record: This is the same Harry Dent who predicted in 1999 that the Dow would rise to 44,000 by 2008.)
A weak market might spur boomers to stay in the workforce longer in order to maintain their standard of living. The average retirement age would have to rise from 62 today to 74, by some calculations. "Society can't afford to have baby-boomers retire on schedule at 65," says Robert Arnott, editor of the Financial Analysts Journal and chairman of asset-management firm Research Affiliates.
Other economists contend that market pressures won't force boomers to work longer; they'll choose to do it on their own. Whether because of lack of savings or a desire to stay active, boomers will put off retirement and thereby help stave off any market selloff. (Already, workforce participation among older workers, which had fallen for almost 50 years, seems to have bottomed out and begun ticking higher.)
But even if boomers do start selling their assets, skeptics of the meltdown hypothesis note they won't all be calling their brokers at once - the generation spans 18 years, after all - meaning the selling pressure at any one point would be mitigated.
Moreover, some economists who have studied the issue say it's hard to pinpoint a cause-and-effect connection between population changes and market swings. And predicting how aging trends play out isn't as straightforward as it might seem. Consider a 1989 paper co-written by N. Gregory Mankiw, a Harvard economist and former chairman of the President's Council of Economic Advisors.
Titled "The Baby Boom, the Baby Bust, and the Housing Market," the article predicted a tumble in real estate prices beginning in the 1990s, due to population trends. That crash, as we well know, never came. The point, many economists say, is that even if the demographic picture does influence stocks, other issues matter more.
"Although it's important and it is inexorable, it doesn't in itself sway the market year to year, day to day, or even decade to decade," says Milton Ezrati, senior economic and market strategist for Lord Abbett & Co. "There are other factors to consider."
Skeptics also question some basic assumptions of the doomsayers. Robin Brooks, an economist with the International Monetary Fund who has studied the relationship between demographics and asset prices, suggests that the typical life-cycle model Siegel and others use, in which consumers amass assets during their working years and sell them off in retirement, doesn't apply to everyone.
That's because wealth, including stockholdings, is concentrated among the rich, with the wealthiest 10 percent of Americans holding some 90 percent of stocks. Average Americans, even if they emptied their retirement plans, would have relatively little stock to sell. The median amount in a boomer's 401(k) is just over $44,000, according to Hewitt Associates, an employee-benefits consulting group. And the superrich wouldn't need to dump their assets to pay for their retirements.
In fact, if there were a stock selloff of any significance, they might well be buyers, helping balance the market, Brooks says. (On these matters, Brooks notes, he speaks only for himself, not the IMF.) In addition, economists including John B. Shoven of the Stanford Institute for Economic Policy Research suggest that rather than face the prospect of a sharp selloff in stocks, companies would most likely opt to boost their dividends, allowing retirees who need income to continue holding their shares.
Many economists who have studied the question conclude that even if asset prices do see some downward pressure, a nosedive brought about by investors rushing for the exits is unlikely. "The realistic concern is that demographic drag may lead to somewhat lower returns," says MIT professor James Poterba, "but I think the concern about an actual decline in the level of prices is overstated."
Even Siegel admits that a 50 percent plunge in asset prices is unlikely. "Mine is a worst-case scenario," he says. What could go right? As emerging economies such as India and China flourish and their citizens become more affluent, he says, they could step in to buy American assets--and even take controlling stakes in American companies.
Those changing realities also mean that global diversification will be more important than ever for investors. "It's just imperative," says Siegel, who recommends that portfolios include a hefty 40 percent weighting in international markets.
In the end, Siegel believes that if we embrace globalization - and if boomers accept a few more years on the job - "there may be no deleterious effect on stock prices." For that to happen, a generation of people who have rewritten the rules at every stage of life will have do so again when it comes to retirement.