The Demographics of Stock Investment
July 6, 1999
"Demographics support an ongoing Big Shift of
household financial assets into equities
- and does so for another dozen or more years."
Edward Kerschner, Paine Webber Investment strategist, WSJ 07/06/99 p C1
Hmm!
Wonder if he is right! Has he done his homework, or is he just eyeballing
it?
I begin this statistical exercise with a bias that many of the things
discussed in the financial media concerning stock valuations - things such as
earnings, interest rates, etc - are not predictive of long term trends.
Rather, the critical element in determining stock prices is financial flows
- money flowing into stocks versus money flowing out. The bull market of the 1980s
and 1990s has been propelled by demographics. A huge cohort of "baby
boomers" born between 1945 and 1964 began reaching age 35 - an age at
which serious saving and investing typically begins - in 1980. Two years later,
the great bull market began.
The demographics of the baby boom have driven the dividend yield on the
S&P 500 down to 1.2%. A retiring boomer with a $1,000,000 account will
receive only $12,000 per annum in dividends. For Boomer stockholders to live at
anything like their current lifestyles, they are going to be net sellers
throughout their retirement years.
The question is, when does this process begin?
In the past, I have speculated that selling pressure from retiring boomers
will not be felt until about 2007. But is that accurate?
First, a few facts.
The typical corporate retirement plan allows early retirement at age 55 with
full vesting. Defined benefit plans also typically allow early retirement at
age 55 with significant subsidies for early retirement. Because of favorable
reduction factors, the early pension has a greater present value than the
normal retirement benefit typically provided at age 65.
For purposes of funding, the typical corporate defined benefit plan assumes
an average retirement age of about 58 years. This means that the average dollar
of pension liability walks out the door at age 58.
The earliest age at which Social Security benefits are payable is age 62.
The average age at which Social Security benefits actually commence is age
63.5.
So the question is, when does the ratio of Americans aged 60 through 64
begin rising relative to the working age population age 35 through age 60.
As a first stab at this, I gathered the Census Bureau 1999 population
projections by age for 1996 and later years. Although the Census Bureau
provided projections through 2010 for ages 60 to 64, the nearest to a working
age population that they provided was the age 15 to 45 group.
As the table below demonstrates, the age 60 to 64 group grows relative to
the 15 to 45 group in every year, with a marked accelleration beginning in
2001, and an even steeper accelleration starting in 2005, when the oldest baby
boomers hit age 60.
Retiree to Work Force Ratios |
|||
Year |
Age 60-64 |
Age 15-44 |
Ratio |
1996 |
10001 |
119626 |
0.0836 |
1997 |
10062 |
119854 |
0.0839 |
1998 |
10261 |
120022 |
0.0854 |
1999 |
10508 |
119998 |
0.0875 |
2000 |
10654 |
119969 |
0.0888 |
2001 |
10925 |
119915 |
0.0911 |
2002 |
11310 |
119691 |
0.0944 |
2003 |
11938 |
119501 |
0.0998 |
2004 |
12383 |
119417 |
0.1036 |
2005 |
12807 |
119428 |
0.1072 |
2006 |
13085 |
119453 |
0.1095 |
2007 |
14233 |
119463 |
0.1191 |
2008 |
14772 |
119490 |
0.1236 |
2009 |
15453 |
119551 |
0.1292 |
2010 |
16215 |
119728 |
0.1354 |
But I was disturbed by the fact that the Census projections in the above
table showed the ratio growing even in 1996. I was expecting to see a decline
in this ratio throughout the 1990s market rally.
I suspected that the 1999 Census projections might be distorted by
immigration, and in particular, the addition of a million or more minimum wage
persons each year who will not factor into the stock market investment equation
over the next 10 years.
Further, I found the totals for the age 15 to 45 group puzzling given the
low mortality of this group and the huge legal and illegal immigration of
nearly 2 millions per annum. The stagnant number of from 119 to 120 millions
each year implies huge out-migration from the United States or far higher
mortality than any reasonable mortality table would show.
Therefore, I decided to obtain the raw 1990 census data by 5 year age
groups, and then adjust that data forward for the next 20 years, reducing the
number in each group each year by the healthy female mortality from the PBGC
tables published under section 4062 of ERISA for the oldest year in the 5 year
group. This amounts to a unisex mortality assumption of the female table set
forward 2.5 years. It should be an excellent assumption for the portion of our
population that invests in common stocks and mutual funds.
The table below presents the results of that study for each year from 1990
through 2010, providing the ratio of ages 60-64/35-59, 60+/35-59, and the ratio
of 60+/25-59.
As I had guessed, all three ratios declined throughout the 1990s, indicating
upward pressure on savings and stock prices. The low points for each ratio,
1999, 2000 and 2000, respectively, are marked with asterisks on the chart
below.
Retiree to Work Force Ratios -
1990 Census |
||||
YEAR |
Ratio of ages |
Ratio of ages |
Ratio of ages |
ICI Stock Mutual | <>
1990 |
0.1447 |
0.5707 |
0.3592 |
19 |
1991 |
0.1388 |
0.5610 |
0.3585 |
42.7 |
1992 |
0.1333 |
0.5507 |
0.3571 |
75.2 |
1993 |
0.1282 |
0.5399 |
0.3551 |
92.2 |
1994 |
0.1236 |
0.5288 |
0.3525 |
77.2 |
1995 |
0.1194 |
0.5172 |
0.3493 |
120.1 |
1996 |
0.1177 |
0.5096 |
0.3486 |
206.5 |
1997 |
0.1162 |
0.5017 |
0.3475 |
229 |
1998 |
0.1148 |
0.4934 |
0.3459 |
159.8 |
1999 |
0.1135* |
0.4849 |
0.3439 |
|
2000 |
0.1139 |
0.4761* |
0.3416* |
|
2001 |
0.1158 |
0.4780 |
0.3449 |
|
2002 |
0.1191 |
0.4794 |
0.3478 |
|
2003 |
0.1224 |
0.4802 |
0.3503 |
|
2004 |
0.1196 |
0.4804 |
0.3524 |
|
2005 |
0.1227 |
0.4801 |
0.3541 |
|
2006 |
0.1271 |
0.4928 |
0.3631 |
|
2007 |
0.1339 |
0.5049 |
0.3717 |
|
2008 |
0.1406 |
0.5163 |
0.3797 |
|
2009 |
0.1472 |
0.5270 |
0.3873 |
|
2010 |
0.1450 |
0.5368 |
0.3943 |
|
So does this mean that the market will turn?
Absolutely, and no later than September of 2003.
The exact timing of when retiree selling will begin to effect price depends,
in part, on the dynamic effects of today's high prices.
What happens when people win $20 million in the lottery? Uniformly, they
find a reason to quit their jobs within a few months after winning. Wealth
makes people retire earlier.
Thus, the enormous wealth generated by this historic bull market could be
provoking early retirements in sufficient number to affect cash flows into
stocks right now.
In fact, the narrowing of the market signaled by the topping of the NYSE
advance-decline line in July of 1998 might be the first indicator of declining
liquidity. Despite the new record highs in the popular indices, fewer and fewer
stocks are particpating. The fall in mutual fund inflows in 1998 over 1997
might also be an indicator, but I would reserve judgment on this because of the
August, September 1998 price decline.
The practical answer is that from now through May, 2002, each of you should
be invested in stocks and mutual funds from Nov 1 through April 30, and out of
the market entirely from May through October of each year. But beginning with
May, 2002 onward, every time the market gives a 10-week rsi oversold reading
and signals a momentum loss, you should invest in a short fund such as Prudent
Bear (BEARX), Rydex Ursa (RYURX), Rydex Arktos (RYAIX) or Fleckenstein's fund.
Before 2010, there will be 2 or more spectacular declines that will make you
nearly as much money as you could have made riding the S&P up from 1990.
The question, then, is what could make cash flows into stocks slow down even
before retirement selling begins in earnest?
To answer that question we must first explore what those flows are.
Below is a chart showing the sources of supply and demand for Corporate
equities from the Federal Reserve's Z1 releases from 1990 through 1998.
First the demand:
Sources of Demand for Stocks |
||||||||
Year |
Households |
Purchases by |
Bank |
Life |
Private |
Public |
Mutual |
Other |
1990 |
-26.3 |
-16 |
0.05 |
-5.7 |
-4.1 |
13.2 |
14.4 |
-13.7 |
1991 |
-33 |
1O.4 |
-8.6 |
17 |
6.9 |
31.2 |
48.5 |
5.1 |
1992 |
24.8 |
-5.6 |
-37 |
24.4 |
30.8 |
17.7 |
59.8 |
0.4 |
1993 |
-57.5 |
20.9 |
-55.2 |
36.3 |
16.9 |
44.3 |
115.3 |
16.7 |
1994 |
-159.8 |
0.9 |
-8.8 |
61.8 |
-1.7 |
29.3 |
100.8 |
1.9 |
1995 |
-192 |
16.6 |
1.6 |
18.6 |
5.9 |
41.3 |
87.4 |
17.4 |
1996 |
-291.5 |
11 |
-17.3 |
46.7 |
-9.6 |
52.2 |
193 |
6.7 |
1997 |
-521.8 |
64.2 |
72.3 |
86.3 |
-16.1 |
53.5 |
166.8 |
1.3 |
1998 |
-527.1 |
42.5 |
39.1 |
107.4 |
-52.7 |
70.8 |
143.3 |
-15.5 |
Notice that the biggest source of expected demand, households, is in fact
the biggest source of supply.
And now the traditional sources of supply:
Sources of Supply for Stocks |
|||
Year |
Non-Financial |
U.S. Purchase |
Financial |
1990 |
-63 |
7.4 |
17.9 |
1991 |
18.3 |
30.7 |
28 |
1992 |
27 |
32.4 |
44 |
1993 |
21.3 |
63.4 |
53 |
1994 |
-44.9 |
48.1 |
21.4 |
1995 |
-58.3 |
50.4 |
4.8 |
1996 |
-69.5 |
60 |
0.8 |
1997 |
-114.4 |
41.3 |
-5.6 |
1998 |
-267 |
75.9 |
6.3 |
Notice once again that Corporations are the normal source of supply.
Corporations are supposed to issue new stock and use the stock market as a source
of capital. Now they are doing the opposite. They are buying back their stock,
net of new issues, in record quantities at record high prices.
The two charts above scream at anyone willing to see and think. What we have
is the household sector (consisting of founders, executives selling stock
acquired on exercise of their stock options, and retirees selling long held
stocks to support themselves in retirement) disposing of stock at unprecedented
rates.
What you see above is a massive inter-generational transfer of cash from the
Baby Boomers and the Corporations that employ them to founders, option eligible
executives and to wealthy retirees.
A cynic would argue that the executives are looting their corporations of
cash to prop up the value of executive options. In the high tech sector,
companies sell puts on their own stock and buy calls, all on inside
information. They use the proceeds to finance stock buy-backs, thereby forcing
the call writers to cover. Dell has raised over $3 billions in the last two
years playing this game. Microsoft does it too. All growth funds need do to
out-perform the market is track option prices and volumes on these tech stocks
and buy when puts are plentiful and cheap. After all, the biggest writer gets
to peek at the company's order book!
It is unprecedented in human history.
I should note parenthetically, that the above tables should also make clear
why new companies (less than 15 years of public trading) will outperform old
ones heavily owned by 80 year old widows.
The $500 billions of cash being pulled from the market each year is an
enormous amount of money. Can it countinue? Which sources of inflow are the
least stable?
The answer is relatively obvious. The $267 billions in corporate buy-backs
are the least stable flow. These corporate buybacks of listed companies
exceeded profits net of taxes and net of dividends for 1998 of all corporations
by $55 billions. Public corporations are borrowing money to buy back their
stock. A recession would crumple the buy-backs. So will rising interest rates
driven by rising inflation.
The increasing popularity of corporate buy-backs from 1994 through 1998, the
truly manic phase of this bull market, tells us that the most manic and
optimistic of all investors are the CEOs of public corporations.
In August and September of 1998, corporate CEOs stepped in massively and
bought in the face of the sell off. In the Q3 they bought at a $308 billion
annual rate and in Q4, at a $491 billion annual rate. They did it because their
own businesses looked reasonably good and interest rates were plunging to
record lows. Borrowing to finance buy-backs was cheap.
It was the CEOs of the fortune 500 who bailed out the stock market in 1998.
Alan Greenspan was only a bit player who encouraged the banks to lend them the
money to do it.
They are the wild optimists, and anything that sours their mood will cause a
quick spill in the market. A rising dollar - rising interest rates - a serious
economic slowdown - banks worried about declining credit quality, any of these
could cause CEOs to become much more cautious about buy-backs.
The CEOs will continue this behaviour only if they think that it will
produce a higher market and higher option values later. If they become
convinced that the market is headed down, they are not about to throw good
money after bad. Given the incentives, they buy high and sell low.
Recognize the enormous leverage in the flows. We have $500 billions in
supply at these prices. If demand from buy-backs disappears, we have a $200
billion or so deficit in demand. Prices would have to fall a long way to bring
the $500 billion supply down to equal that lower demand.
Ultimately, the stagnant work force projected by the Census department, and
the swelling number of retirees with stock to sell will put an end to the
corporate buy back game. Once the corporate CEOs recognize the demographic
reality, they will not even try to prop up their stocks. Instead, they will
begin to respond to retirees calls for higher cash dividends, persuade their
consultants to begin pushing cash bonus plans tied to dividend increases, and
lobby to have cash salaries in excess of $1,000,000 made deductible to the
corporation once again.
Until then, investing is a game of guessing at how optimistic the corporate
CEOs are.
Upon seeing the above two tables, I began to realize how anomalous the fund
flows must be from a historical perspective. Markets simply could not function
at all over the long term with the normal sources of supply and demand reversed
in this way.
And the thought of asking corporate employees to put their retirement
savings into stocks priced by such unsustainable flows seems criminal.
We have lots of excellent studies on the net analyzing the market in terms
of PE ratios, price to book ratios, price to sales ratios and similar measures.
For one of the best see <>Alan
M. Newman. We have excellent valuation models like the federal Reserve's
own model which you can see at <>Dr. Ed
Yardeni's Economics Network. An excellent historical PE range chart can be
seen at <>Decision
Point.
But excessive valuations have had no predictive value in this market.
This is a new era all right. But the newness has nothing to do with
technology, the internet, valuations or inflation. It is a new era because
money flows have been warped beyond recognition.
And to see how truly unique the 1990s have been, I prepared a similar chart
of demand and supply from the nine years of 1954 to 1962, a period of
dramatically rising stock prices.
First, a picture of typical bull market demand flows:
Sources of Demand for Stocks |
|||||||||
Date |
Households |
Purchases by |
S&Ls |
Insurance |
Private |
Public |
Mutual |
Closed End |
Other |
1954 |
0.3 |
0.5 |
0.1 |
0.5 |
0.7 |
0 |
0.3 |
-0.6 |
-0.1 |
1955 |
0.4 |
0.1 |
0.1 |
0.3 |
0.7 |
0 |
0.4 |
-0.3 |
0 |
1956 |
1 |
0.3 |
0.1 |
0.1 |
0.9 |
0 |
0.5 |
0.2 |
-0.2 |
1957 |
0.5 |
0.1 |
0.1 |
0.1 |
1.1 |
0.1 |
0.7 |
0.9 |
0.2 |
1958 |
0.3 |
-0.1 |
0.1 |
0.2 |
1.4 |
0.1 |
1.1 |
0.8 |
-0.5 |
1959 |
-1 |
0.4 |
0 |
0.5 |
1.7 |
0.1 |
1 |
0.1 |
0.1 |
1960 |
-1.2 |
0.2 |
0 |
0.7 |
1.9 |
0.1 |
0.8 |
0.6 |
0 |
1961 |
-1.1 |
0.3 |
0.1 |
0.8 |
2.3 |
0.2 |
1.3 |
-1.4 |
-0.4 |
1962 |
-2.7 |
0.1 |
0.1 |
0.6 |
2.2 |
0.2 |
0.9 |
0.1 |
0 |
And now a more typical picture of bull market supply.
Sources of Supply of Stocks |
|||
Year |
Non-Financial |
U.S. Purchase |
Financial |
1954 |
1.6 |
0.3 |
-0.3 |
1955 |
1.7 |
0.2 |
-0.2 |
1956 |
2.3 |
0.1 |
0.6 |
1957 |
2.4 |
0 |
1.3 |
1958 |
2 |
0.3 |
-0.4 |
1959 |
2.1 |
0.2 |
0.5 |
1960 |
1.4 |
0.7 |
1.1 |
1961 |
2.1 |
0.8 |
-0.9 |
1962 |
0.4 |
1 |
0.3 |
In the above charts, capital markets operate as we expect. Households buy stock
and corporations issue it.
The truth is that the stock market can only operate as an inter-generational
cash transfer mechanism during periods when we have a falling ratio of retirees
to workers.
As soon as a static or declining pool of workers detects selling pressure
from retirees in the form of flat or falling prices, they will stop investing
until dividend yields compensate them for the risk of rising retiree sales.
Once Joe SixPack goes on strike, the buy-back bravado of the CEOs in the face
of market sell-offs will quickly disappear.
Don't expect foreign investment dollars to bail out our stock market.
Indeed, the demographics for the G7 nations are worse than ours. See the graphs
at the end of <>Urban
Institute Research Paper.
Protect yourselves!