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Michael Brandl > Macro Updates > Archives > May 5, 2005 May 5, 2005 Baby-boomers and a stock market crash? I had lunch the other day with an esteemed colleague of mine. After a discussion of Longhorn football the conversation, naturally, turned to economics. My colleague stated “I have pulled all of my money out of the stock market.” I was surprised. Naturally, I asked the simple question of “why?” The response I got went something like this “with all of the Baby boomers retiring, they are sure to sell off their stocks to pay for their retirement. There clearly are not as many young people to buy all those shares, thus stock prices will fall and continue to fall. The market is sure to crash or die a slow death.” You may have had similar conversations or read popular books putting forth a similar story. Even the Wall Street Journal ran a story with the same “popular” conclusion in this morning’s addition. While these dooms-day stories tend to sell books at Barnes & Noble as well as newspapers and business magazines, the truth is a little duller and far less interesting. James Poterba, a very well respected at MIT, presented a paper at the Fed’s annual meeting at Jackson Hole, Wyoming last year on the subject. (For a brief summary see the 2004Q4 edition Economic Review from the Kansas City Fed who sponsors the conference: http://www.kc.frb.org/PUBLICAT/ECONREV/revarchives.htm#2004 ) Poterba showed that despite what many people think as savers age, and enter into retirement, they tend not to liquidate huge amounts of their financial assets. Poterba used data from the Survey of Consumer Finances, which is The best dataset going and shows that this is a rather robust outcome (which means it hold under a variety of situations).Poterba correctly points out that it is important to remember that the wealthiest 1% of equity holders hold over half of the U.S. corporate equity. When one looks at this group the overall results are the same: those in retirement tend NOT to sell off their equity holdings. Thus, a stock market crash, or even rapid decline, is…well…unlikely based solely on the baby-boomers retiring. All of this, of course, does not necessarily mean that public equities are guaranteed to continue to have outstanding performance. (For an excellent read on the subject see “Asset Pricing” by John H. Cochrane from the Princeton University Press. It requires a little calculus knowledge, but is very well written) Equities have certainly outperformed bonds recently and the returns to equity more than compensate investors for the risks inherent in equities. Yet we are not certain this will continue into the future. On the other hand, if the U.S. economy continues to grow and expand equities might perform better than they have over the last 50 years. In addition, many argue we have only seen the tip of the iceberg when it comes to the “IT Revolution.” If IT continues to increase productivity and profitability as it done over the past 10 years or so, equity returns may be extremely high. The general consensus is that the equity markets will continue to perform reasonably well and perhaps even very well over the next decade or so. With the caveat that predicting anything that far into the future in this field should be taken with a huge grain of salt. One thing is for sure…the gloom and doomers, while they sell lots of books and newspapers (remember “The Coming Depression of the 1980’s” stupidity?), the research is usually not of the highest quality. The truth it seems is much less exciting... All
the best,
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