The oldest members of the baby boom generation, born between 1946 and 1964, began to turn 65 this year. Those who don’t have traditional pension plans will need to sell their assets to finance retirement. “A looming concern is that this massive sell-off might depress equity values,” according to a Federal Reserve Bank of San Francisco report released this week.
Researchers Mark Spiegel and Zheng Liu forecast that real stock prices will follow a downward trend until 2021, cumulatively declining by about 13 percent relative to 2010, largely due to population aging. They then expect a slow recovery in which real stock prices don’t return to their 2010 level until 2027. However, they also assert that long-term investors shouldn’t shy away from stocks. Their calculations suggest that the real value of equities will be about 20 percent higher in 2030 than they were in 2010.
The researchers made these predictions by calculating the ratio of middle-aged people between ages 40 and 49 to older people age 60 to 69 from 1954 to 2010. They then compared this population aging ratio to the year-end price-earnings ratio of the Standard & Poor’s 500 Index, adjusted for inflation and average inflation-adjusted earnings, for the same years. They found this measure of population aging to be correlated with the performance of the stock market. For example, when the baby boomers reached their peak working and saving ages between 1981 and 2000, the aging ratio quadrupled and the price-earnings ratio tripled. As the baby boomer generation started to age in the 2000s, both ratios declined substantially.
“This evidence suggests that U.S. equity values are closely related to the age distribution of the population,” according to the report. Spiegel and Liu estimate that the aging ratio explains about 61 percent of the movements in the price-earnings ratio during the period studied. They then used Census Bureau data to predict the population aging ratio from 2011 to 2030 and then forecast the path that the price-earnings ratio is likely to follow in the next few decades. “The model-generated path for real stock prices implied by demographic trends is quite bearish,” they write.
The researchers acknowledge there are several factors that could mitigate the impact the demographic shift will have on the stock market. Retired individuals may continue to hold equities throughout their retirement to leave to heirs or in case they live longer than expected. Foreign demand for U.S. equities might also reduce the downward pressure on asset prices. And, of course, many other factors drive demand for stocks.
However, the San Francisco Fed remains concerned that population aging will depress the stock market. Spiegel and Liu write: “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.”