Ten Years From Now, Will Retiring Baby Boomers Cause a Stock Market Meltdown?

Baby boomers are often seen as a herd, rushing together from trend to trend. In the ‘80s and ‘90s they got a taste for stocks, helping to drive the greatest bull market in the country’s history. But what will happen when the boomers retire? Will they stampede out the gates and leave the market in ruins?

“I’m a baby boomer and I worry about it,” says Wharton finance and economics professor Andrew B. Abel.

Stock market observers have long debated the issue. There’s little argument that as boomers became more affluent in their 30s and 40s, they poured money into stocks and other investments. Indeed, mutual fund assets in the U.S. soared from less than $48 billion in 1970 to $6.9 trillion at the end of 2000, according to the Investment Company Institute, the funds’ trade group. Heightened demand, as any first-semester economics student knows, tends to push prices up. From 1980 through 2000, total return for the Standard & Poor’s 500 exceeded 2,000%, or more than 16% per year, well above the long-term average of 9 or 10% a year.

About 35% of mutual fund assets are held in retirement accounts such as 401(k)s and IRAs, the ICI says, and investors are sure to view much of their other holdings as retirement savings as well. In addition, trillions of dollars worth of stocks are owned by pension funds, annuities and investment-type life insurance policies.

But 10 to 15 years from now, millions of boomers will retire. Instead of putting money aside for their old age, they will begin cashing in. It stands to reason that this will reduce the demand for stocks. As any beginning economics student knows, lower demand means lower prices.

Except that it might not be that simple. That’s the conclusion to be drawn from a friendly debate between Abel and MIT economics professor James Poterba. “A few people, including myself, have developed models in which a baby boom generated an increase in stock prices,” Abel said in a recent interview. If you take these models and look at the increasing stock prices when the baby boomers are middle aged, then carry them forward and look to see what happens to stock prices when those baby boomers are retired, stock prices fall.”

But in March of 2000, Poterba presented a paper questioning this “asset market meltdown hypothesis.” Essentially, Poterba argued that historical evidence shows retirees don’t simply reverse the process and spend everything they’ve accumulated. Instead, they reserve some of their savings in case they live longer than expected, and they hold additional assets for their heirs. He termed these issues “lifetime uncertainty” and the “bequest motive.”

Baby boomers’ demand for stocks will therefore not slacken in retirement at the same pace it grew prior to retirement, Poterba argued. With demand thus shored up, prices should not fall as others have predicted, he said.

Abel challenges this view in a new paper, “Will Bequests Attenuate the Predicted Meltdown in Stock Prices when Baby Boomers Retire?” He focuses on the bequest motive – boomers’ presumed desire to preserve portions of their estates for their children and grandchildren.

Conceding that Poterba is essentially correct in his analysis of this factor’s effect on demand for stocks, Abel argues it is equally important to examine the other half of the Economics 101 equation – supply. While Poterba assumes the supply of stocks is constant, Abel argues that when demand goes up, supply follows.

According to this view, as stock prices rise, companies realize they can raise more capital by issuing new shares, just as oil companies step up drilling when gasoline prices rise. Indeed, the market for new stock offerings did boom in the ‘90s as share prices soared.

Any analysis that overlooks this factor is likely to miss the mark, said Abel. In the 1980s, for example, two Harvard economists predicted that real estate prices would fall once the baby boomers had formed households and purchased homes, since demand would slacken, Abel recalled. But that research failed to anticipate boomers’ demand for ever-larger houses and second homes. So builders have continued to add to the supply of homes even though the bulk of the boomer generation has long since acquired first homes.

Once the increasing supply of stocks catches up with the heightened demand, stock prices could well stabilize.

Retired boomers probably will not sell all their stocks, and, taken by itself, this could help keep stock prices up, Abel said. But the previous increase in supply may offset this extra boost in demand. By selling stocks to fund retirement, boomers will therefore cause a net slackening in demand that will not be matched by a reduction in supply. Stock prices could thus fall substantially after the boomers retire.

In an interview, he said there are too many uncertainties to make a precise prediction of how supply and demand will affect stock prices decades from now. But his analysis shows that any attempt to forecast must account for changes in supply as well as changes in demand, he said.

Abel added that other factors could reduce the baby boom generation’s influence on stock prices. Immigration and increases in birth rates among younger people could reduce the boomer’s demographic significance. Many boomers may continue working full or part time after they reach the traditional retirement age, reducing their need to sell stocks to raise cash. Moreover, a decade or more from now, foreign investors may be a bigger factor in U.S. financial markets. “By then, three billion Chinese may be holding stock and holding up our stock market, he said.

As a practical matter, should investors worry about a boomer-driven stock market meltdown?

Certainly, the possibility is ignored at one’s peril, Abel said. “Economics gets a lot of things wrong,” he said, “but there are some really powerful forces at work. Whenever you’re trying to sell something at the same time everyone else is trying to sell something, you lose.”

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Ten Years From Now, Will Retiring Baby Boomers Cause a Stock Market Meltdown?. Knowledge@Wharton (2001, June 06). Retrieved from http://knowledge.wharton.upenn.edu/article/ten-years-from-now-will-retiring-baby-boomers-cause-a-stock-market-meltdown/

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