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Will Baby Boomers Wreck the Market? (The Sequel)

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
April 10, 2012

IN THIS ISSUE:

1.  Boomers and the Stock Market – Six Years Later

2.  A Few Statistics

3.  Reasons Boomers May Crash the Market

4.  Gloom-and-Doomers Get an Unexpected Ally

5.  Alternative Viewpoints

6.  Conclusion: Headwinds Aplenty

Boomers and the Stock Market – Six Years Later

Almost six years ago, I wrote an E-Letter asking “Will Baby Boomers Wreck the Market?” There has always been a fascination with the Boomer generation due to its enormous size and its potential to bring change to the economy, lifestyles and even politics. Oddly enough, this years-old article continues to be one of the most requested archived issues of my Forecasts & Trends E-Letter.

When I wrote this E-Letter back in 2006, there were many gloom-and-doom predictions that the Baby Boomers were going to wreck the stock markets when they started retiring within the next few years. However the stock markets were on their way to bouncing back from the 2000 – 2002 bear market and the housing bubble was in full swing, so I concluded that it was too early to tell whether the Baby Boomers would be a major threat to the market or not. Here’s part of what I said:

A closer look at demographic trends, as we’ve seen in this article, suggests that Boomer demand for equities is likely to continue to remain high well beyond 2008-2010, the period when many gloom-and-doomers seem to think the stock markets will go over a cliff.”

As we all now know, the stock market did fall off a cliff in 2008 but not because of the investing habits of Baby Boomers. At an investor level, portfolios that were growing healthy in 2006 were dashed again by the 2007 – 2009 bear market, with many investors’ statements showing losses of 40% to 50% or more. Experiencing two major bear markets in less than a decade caused many Baby Boomers to exit the market for good. Even today, others are just waiting to “get even” and then they’re going to bail out.

Will this new aversion to equities on the part of Baby Boomers wreck the market? This week, I’m going to revisit the issue to see if my conclusions are the same as back in 2006. Then we’ll discuss what you should do about it.

Background – A Few Statistics

As most of you already know, the Baby Boom generation is made up of those born in the years 1946 through 1964, and accounts for something over 78 million people according to the US Census Bureau. At present, Boomers represent about 28% of the US population. I’m not going to go through all of the statistics on Baby Boomers as most people are already familiar with them. If you want more information, on Boomer basics, you can refer back to my 2006 E-Letter for more details.

The following statistics relate to information about Boomers since my earlier E-Letter:

  • In 2006, the oldest Baby Boomers were beginning to turn age 60. Today, 10,000 Baby Boomers reach age 65 every day, and will continue to do so for another 18 years or so. The Baby Boom effect on Social Security and retirement is no longer a future event – it’s here!
  • Some studies estimate that Baby Boomers now control over 80% of personal financial assets (of course this includes both stocks and bonds, among other assets).
  • Boomers also account for over 50% of total US consumer spending, and consumer spending accounts for nearly 70% of our GDP.
  • A MetLife study found that Boomers are expected to inherit over $11.6 trillion from parents/grandparents in their lifetimes. (Side note: With this much money being transferred from one generation to another, forget any serious consideration of an estate tax repeal.)
  • For the first time, people over 45 years of age represent a majority of the voting age population… and they vote! In the 2008 election, the US Census Bureau reports that 59% of all Baby Boomers voted, with older Boomers being more likely to vote than younger ones. Boomers over age 55 had a voter turnout of over 70%.

The Baby Boom generation is “back-loaded” in regard to the number of births. In other words, the bulk of births occurred during the last half of the Baby Boom period – 1955 to 1964 – and fewer were born in the earlier years. This is important when considering the effect of Baby Boomer retirement on the markets, as I will discuss in greater detail below. Here’s a chart that tells the story:

US Births: 1940-1980

Reasons Baby Boomers Might Crash the Stock Market

The basic premise behind the idea that Baby Boomers might lay waste to the stock market makes sense intuitively. The idea is that as Boomers retire, they will shift assets away from stocks to less risky alternatives such as bonds, annuities, CDs, etc. and begin living on the interest. All of this selling activity, the story goes, will put downward pressure on stock prices and lead to a major selloff.

One of the “prophets of doom” that I featured back in 2006 was Harry Dent, who is most famous for his prediction that the Dow would reach the 40,000 level by 2010. However, Dent also predicted that the bottom would then fall out of the stock market as Baby Boomers hit retirement and started cashing in stocks in favor of more stable investments. As I noted back in 2006, Dent predicted a 12 to 14 year bear market and depression after 2010.

We did have a major bear market and severe recession, but not for the reasons Dent predicted. However, I thought it would be interesting to see what Mr. Dent is saying now regarding his prediction that Boomers would crash the market. Suffice it to say that he hasn’t changed his mind about what might eventually happen in the future.

Dent argues that the European sovereign debt crisis will pull the US into a new recession, which will be made worse by lower spending by retired Baby Boomers. Even those not yet retired will likely continue to pay down debt and reduce consumer spending. He looks to Japan as the model of what might happen, where their stock market is still down 80% from its high 20 years after its financial crisis.

Dent may have a point in regard to retiree spending habits. As I noted in my blog last Thursday, the era of low interest rates has not only failed to stimulate business, but has also reduced the income of those who depend upon interest earnings, primarily retirees. What wasn’t recognized back in 2006 was that lower consumer spending by retirees would be mandatory, due in large part to the plunge in interest income, not discretionary.

Much more importantly, a MetLife survey in recent years found that 69% of retirees overestimate how much they can withdraw from their retirement savings annually, with 43% saying they can withdraw 10% per year while still preserving principal. This puts them on a collision course for running out of money, at which time their spending will definitely be cut. Until then, however, consumer spending by retirees may remain high.

Prophets of Doom Get an Unexpected Ally

Retiree spending aside, there’s still the issue of cashing in stocks to either spend or place in less risky investments. In 2011, the gloom-and-doom crowd got an unexpected ally – the San Francisco Federal Reserve Bank. Last year, Fed researchers Zheng Liu and Mark M. Spiegel released a paper predicting that retiring Baby Boomers will be likely to shift from buying stocks to selling stocks to finance retirement. The bottom line, according to the report, is, “Statistical models suggest that this shift could be a factor holding down equity valuations over the next two decades.”

Needless to say, this non-product-oriented report from a “neutral” Federal Reserve Bank got a lot of attention – and is still making the news. To be fair, the SF Fed paper doesn’t predict a market crash, but does see a major uphill battle for stock prices in the years ahead. However, that hasn’t kept the financial press from using terms like “sinking” or “crashing” the stock market when reporting on this Fed paper.

Target-Date Funds:  Another factor related to Baby Boomers wrecking the market involves “automatic” adjustments that will be made by specialized retirement products and distributions from employer pension plans. Almost everyone is now familiar with “target-date” mutual funds, also known as “lifestyle funds.” These funds invest based on a person’s age or assumed date of retirement. As the shareholder gets closer to retirement, the asset mix in the fund automatically adjusts to increase bonds and decrease stocks.

Some have said that the popularity of the target-date funds (they are found in over 80% of larger 401(k) plans) could affect stock values in the future as they automatically shift from stocks to bonds. But given the predictability of these shifts, I don’t think there will be much of a problem. The market will likely price in these shifts since it will know when to expect them. Also, current target-date assets are only about 11% of total 401(k) assets, so I don’t see a major problem caused by target-date funds in the near future.

Lump-Sum Distributions:  Another potential stock market disruption could come in the form of lump-sum distributions from employer pension plans. Even though most pension plans are set up to pay a monthly benefit, many permit retiring participants to take a lump-sum payment instead of a monthly check. In that case, the money goes from being managed by a group of trustees or other money managers to being managed by the retiree inside a Rollover IRA. Aside from the concern that a retiree may spend too much too soon, there’s also the possibility that allocations to stocks will be lower in self-directed IRAs than under professional management. Of course, the converse could also be true.

Either way, the risk from lump-sum distributions may also be too small to affect the overall market. One reason is that, as noted above, not all employer plans offer this option. Plus, recent legislation has made it harder to get a windfall lump-sum distribution from a pension plan. I also expect pension rules to be tightened to discourage lump-sum distributions in the future, especially if early Boomer retirees start running out of money.

Rob Arnott Weighs In:  One final warning about Boomers and the stock market comes from Robert D. Arnott, a highly respected researcher and portfolio manager. Arnott agrees with the premise that Boomers will sell stocks to fund retirement income. He says that this selling activity coupled with fewer younger investors to buy these securities, will “keep a lid” on prices.

Arnott notes that less than 10 years ago, there were 10 new additions to the workforce for each new senior citizen. This year marks the first time that the population of senior citizens will rise faster than the working-age population. Read this carefully: In 10 years, the working vs. retired ratio will reverse so that there are 10 new senior citizens for each new working-age individual. This demography can’t be good for the markets, according to Arnott. I agree.

In addition to muted returns from stocks, Arnott continues to see strong spending demand from Boomers, which will have the potential to fuel inflation. This inflation along with slower economic growth brought about by demographics, debt and deficits could mean real returns close to zero. Arnott is quick to point out that he’s not painting a gloom-and-doom scenario, but for anyone to continue to expect 8% or 10% a year from their stock portfolio is “naïve.”

Alternative Viewpoints

Since my previous article, we’ve had a global financial crisis in which home and financial asset prices plummeted. Government intervention in the banking system and the markets has occurred that would have been thought impossible in 2006. As a result, we have also become quite familiar with the “T word” (trillion) when talking about both ongoing federal government deficits and the amount of wealth that has simply vanished into thin air. Has this changed my opinion and that of other experts?

As a general rule, no. Experts still disagree about the potential negative effect of the Baby Boom Generation on stocks. I have listed below a number of arguments against the gloom-and-doom scenario, as well as my own comments. I think you will find them useful.

  1. Boomers, as a whole, are more familiar with investments than any previous generation. That means they may be more likely to consult a professional or seek out independent advice in publications or on the Internet to help them allocate their portfolio. If that is the case, I don’t know of many asset allocation programs that completely exclude equities in retirement portfolios. That’s likely because most professional money managers know that bond prices can be just as volatile as those of equities, and sometimes even more so.

  2. Evidence from earlier retirees does not support the idea that Boomers will immediately cash in stocks upon retirement. A 2009 CBO study found, in part, “…empirical evidence about the behavior of earlier groups of retirees suggests that baby boomers will not sell their accumulated assets quickly after they retire.” The important thing to note here is that the CBO did not use assumptions to reach its conclusion, but rather habits of actual pre-Boomer retirees.

  3. Will inheritance save the day? Some have suggested that the transfer of an estimated $11 trillion of wealth over Boomers’ lifetimes will help with retirement income. However, I think this is a false hope. While inheritance may make a difference to some Boomers, studies show that 80% of this $11 trillion of wealth is concentrated in only 10% of the pre-Boomer generation. This uneven distribution of wealth means that the bulk of future wealth transfers will go to those who need it least. An AARP study put it this way: “…inheritances are unlikely to make a significant contribution to the retirement savings of most Boomers.” 

  4. As shown in the birth chart above, the number of Baby Boomers in each year is back-loaded. As a result, it is a false assumption that all Boomers will suddenly cash in their stocks at one time. In fact, early Boomer retirees are more than offset by Boomers still in the accumulation phase of their retirement savings. This might mean more demand for stocks instead of less, at least until we start seeing these larger groups of Boomers retire.

  5. When I wrote my previous Boomer article in 2006, the market was in full bull mode. Now, however, Boomers have been hit with two major bear markets in less than a decade, as well as a generous helping of uncertainty about the future. Reviewing mutual fund inflow and outflow data, it is my opinion that at least some of the migration out of the stock market has already occurred. To the extent that this is true, there will be less of an effect on the stock market as these Boomers retire.

  6. When analyzing population data, one variable that cannot be accurately estimated is the number of immigrants that may come to the US to fill jobs or the effects of foreign investment in US stocks. The SF Fed paper specifically notes that foreign investment could “…potentially alleviate the adverse impact of US demographic trends on stock markets.”

  7. Finally, it is widely expected that many Baby Boomers will have to delay retirement as a result of not saving enough for retirement and losses incurred during the two bear markets since 2000. According to AARP, 69% of Baby Boomers plan to delay retirement and work beyond age 65. While working longer, these Boomers will likely continue to save and invest rather than cash out their stock holdings.

The above list is not exhaustive as there are obviously other good reasons why retiring Baby Boomers will not singlehandedly bring the stock market to its knees. However, I think you can see from the discussion above that for every argument that the market will crash when Baby Boomers retire, there’s another that says it won’t. Unfortunately, it’s impossible to tell which argument will win out in the end, but there are ways to invest with the potential to handle virtually any scenario.

Conclusions – Headwinds Aplenty

I find it interesting that my conclusion today is much the same as it was almost six years ago. Here’s what I said back in 2006: 

“While I’m sure there are other arguments for and against a Boomer-caused market meltdown, I think you can see from those listed above that there is hardly agreement on the subject. In fact, if I had to say there was a consensus among the experts, it would probably be that there is no consensus about what will happen when the Baby Boom generation retires.”

I have yet to be won over to the side of the Baby Boomers wrecking the market. Having lived through the “Y2K” scare back in the late 1990s, I am suspect of any wide generalization about what will have an impact on the stock market. The Boomer retirement demographic is much like Y2K – it makes sense intuitively but is not likely to result in the worst case scenario.

However, that doesn’t mean that I think the market will continue to do well in the years ahead. There is no shortage of other factors that could affect the stock market. High gas prices are siphoning away money that could be spent for other consumption. Record deficits and a growing national debt also have the potential to crater the stock market, with or without the Boomer effect. I believe these factors will have more negative effects on the stock markets than the retirement of Baby Boomers.

Add to that the Eurozone crisis and other global uncertainty, especially with Iranian nukes, and you may have another reason why retail stock mutual funds are still showing outflows while taxable bond funds are still attracting assets. The absence of QE3 from the Fed thus far is another headwind to the market going higher. And of course I’d be remiss if I didn’t mention the potential effect of this year’s election on the stock market.

It is my opinion that the US stock market will continue to struggle, perhaps partially due to Baby Boomer retirements, but more so in reaction to all of the other headwinds noted just above.  As a result, I think it’s going to be hard to make much progress in passive index-based mutual fund investing over the next couple of decades. If stocks generate near-zero growth after inflation as Rob Arnott suggests, these programs may be lucky to just move sideways.

The question then becomes what you need to do to protect your portfolio and actually achieve some growth. Space prohibits me from detailing a course of action with the potential to help you navigate the uncertain markets ahead. However, over the next few weeks I will be sharing with you some investment ideas that definitely deserve your consideration.

I’D LIKE TO HEAR FROM YOU! If you are a Baby Boomer and are either just retired or approaching retirement, I’d like to get your opinion of the stock market and what you intend to do in relation to your investments. Papers and surveys are fine, but nothing beats real-life examples to let us know what’s going on in relation to retirement. Just send me an e-mail to gdh@profutures.com with “Boomer” in the subject line. I look forward to hearing from you.

Best regards,

Gary D. Halbert

SPECIAL ARTICLES:

A view from across the pond
http://www.economist.com/blogs/freeexchange/2012/03/financial-markets

Three doomsaying experts who foresee economic devastation ahead
http://www.usatoday.com/money/perfi/stocks/story/2012-02-26/stock-market-bears-doomsayers/53259742/1

 


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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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