Monday, March 6, 2006

With baby boomers turning 60, an old and disturbing idea has resurfaced: Will the retirement of that generation cause a lengthy bear market in stocks — or worse?

It’s a simple enough idea. Just as the 78 million Americans born between 1946 and 1964 helped fuel a spectacular bull market in the 1980s and 1990s by buying stocks, they will have just as big an impact on the downside when they retire and begin selling stocks to live on.

The demographics-as-destiny concept has spawned a number of books over the past decade, based on the idea that the human life cycle from childhood to old age provides predictable patterns in spending and, in this case, saving and investing. That’s why some experts contend the stock market is destined to struggle with below-average, single-digit investment returns for another 10 or 20 years before post-boomer investors bid up stock prices again.

Not so, said other market watchers.

Mutual fund executive Milton Ezrati, senior partner and strategist for Lord, Abbett & Co., calls it the “baby boom market myth.”

For one thing, Mr. Ezrati said, “demographic forces are not the only influences on financial markets, even in the long run.” Nor will all boomers retire and sell at the same time. Given the generation’s 18-year span, plenty of late boomers will still be in their peak investment years as early boomers enter retirement, critics of the thesis said.

Still, the “baby bust” thesis has gained credibility from the prestige of some of its advocates, including Yale professor Robert J. Shiller, whose book “Irrational Exuberance” anticipated the 2000 stock market collapse.

One of the most persuasive arguments about the boomer bear market comes from a trio of less-famous professors in a 2004 research paper: John Geanakoplos at Yale, Michael J.P. Magill at the University of Southern California and Martine Quinzii at the University of California at Davis. Their study, “Demography and the Long-Run Predictability of the Stock Market,” points out that before the market’s dot-com collapse in 2000, stocks went through three major stages after World War II: a postwar boom in the 1950s and early 1960s, the deeply bearish 1970s and the historic boom from circa 1982 through 1999.

Their second major point is that human behavior changes with age, including investing and money management habits. Young adults, age 20 to 39, are big spenders, consuming goods and services. In middle age, 40 to 59, they are more likely to invest in stocks to build wealth and plan for retirement. And older people tend to sell their shares to meet retirement expenses.

If you connect those two elements, the professors said, you find that the aging of the baby boom generation matches the stock market performance so far, contributing especially to the 1980s-1990s bull market as their population cohort entered middle age.

Why, then, shouldn’t the same generation have just as much downside impact going forward as they retire and change their investing habits? American seniors certainly have enough financial clout to roil the market, according to the Investment Company Institute and the Securities Industry Association.

The ICI/SIA stock ownership study shows that 50.3 percent of U.S. households owned stocks outright or in mutual funds in 2005, compared with just 19 percent in 1983 — about when baby boomers were just entering the prime saving and investing time of middle age. The report shows that 52 percent of all stock market investors were 50 or older last year, of which 19 percent were 65 or older.

“The impact of the aging population on markets, employers and culture cannot be overstated,” William D. Novelli, executive director and chief executive of AARP, wrote in a position paper. “Just as the baby boom flooded maternity wards, ignited school construction and made ‘youth’ the cultural icon of the 1950s, ‘60s and ‘70s, the ‘senior boom’ of this century will shape the 2010s, ‘20s and ‘30s.”

Quite apart from the baby boom thesis, some Wall Street strategists anticipate prolonged below-average stock market returns for other reasons.

They expect returns of no more than 6 percent to 7 percent in 2006 and beyond. The long-term average return for stocks of Standard & Poor’s 500 size is about 10.4 percent per year, according to Ibbotson Associates, a Chicago market research firm.

These are disturbing thoughts for investors who have already learned what subpar stock returns are like following the collapse of technology stocks in 2000. Even after recovering from the 2000-2002 bear market, the S&P 500 has posted only one strong year — 26.4 percent in 2003. It gained 8.9 percent in 2004 and only 3 percent in 2005, not counting reinvested dividends.

But critics of the baby bust thesis find a lot to quibble with — enough to offer some hope for a better long-term outlook.

“Undoubtedly, the retirement of the baby boom generation will strain the economy and its financial markets,” Mr. Ezrati wrote in Pensions & Investments, a publication for institutional investors. “The strain, though clearly present, will fall far short of the urgency and degree voiced by some of today’s more pessimistic forecasts.”

Critics of the demographic thesis point out that as the baby boomers move into retirement, another large population cohort — people born since 1964 — will enter its peak savings and investment years, putting upward pressure on stock prices.

Baby boomers also expect to live longer and retire later than previous generations. Possibly half the generation expects to do some work during retirement and won’t need to cash in shares.

The most convincing argument against the baby bust is the impact of foreign investment in U.S. securities, which has mushroomed in recent years and shows no signs of ending. Even the three professors who proposed the baby bust thesis concede that the emergence of a global economy has changed the investment game.

“The future evolution of U.S. equity prices may well depend more on countries that invest in the stock market than on the U.S. alone,” they conclude.

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