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Demographics and Stocks: Right Conclusion, Wrong Reasons

In yesterday’s Financial Times, John Authers wrote an interesting piece in which he summarizes comments made by Barclays analyst Tim Bond on the role that demographics play in the stock market: “Long view: How baby boomers lead bear market by the nose”

Bond rightly points out that equities became a savings vehicle for the masses in the 1950s and that this trend increased sharply in the early 1980s as the Baby Boomers entered early middle age.  And then the string of bubbles started.  Authers writes,

Mr Bond suggests, extremely plausibly, that this can chiefly be attributed to demographics. As the baby boomers aged, and the long bull market made them more confident, so they “over-invested” in assets around the world… [T]he size of the pool of capital available to pour into Asian stock markets, or into internet stocks, was disproportionate to the availability of investment opportunities. It was in nobody’s interests to tell the boomers this, as the investment industry is paid according to the amount of assets it manages.

Looked at in the longer term, Barclays compared cyclical price/earnings ratios on stocks since 1950 with the ratio of 35-54 year-olds in the population. As the chart shows [in the print edition], the fit is excellent. Stock valuations became most extended just as the cohort of baby boomers were saving and producing most.

Authers provides a chart in the print edition (not available online) that strongly resembles the HS Dent Spending Wave.  And like the Spending Wave,

The implications for the future are discomfiting. The proportion of 35-54 year-olds in the population will keep declining for another decade, while the imminent growth in the retired population should be very sharp.  That means equity valuations should keep coming down. The demographic shift that drove an equity bull market for two decades can be expected to drive a bear market for another two decades. That implies that this bear market has another decade to run.

Authers and Bond manage to reach the same basic conclusions as HS Dent, though we do differ with their way of getting there.   HS Dent has NEVER suggested that Baby Boomer investors were what drove the stock market boom of the past 20 years.  The reason for this is simple: while many Boomers do have 401k plans and other investment vehicles, most have very low balances.  Most financial assets are concentrated in the hands of a relatively small slice of America’s wealthy.  Bill Gates, for example, will not be liquidating his 401k plan to fund his retirement.  And neither will the moderate rich, those Americans with portfolios in the $2-$10 million range.

It is the Dent view that the Baby Boomers influence the market with their spending.  Boomer spending drives corporate profits, which in turn drives the market over a prolonged period.  When the Boomers cut back, companies lose their pricing power — and their profitability!

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy