From a risk-off perspective, change always looks like imminent catastrophe. For example, take the Roaring Twenties. Here was a decade still coming to grips with the twin horrors of WWI and the Spanish Flu, and yet what the status quo decided to focus its attention on was the specter of cigarette smoking debutantes with skirts hiked above the ankle.
While the thought of a church deacon deliriously proclaiming the End of America as a result of naked ankles at a jazz club is amusing in retrospect, it was considered a reasonable assumption at the time. Just as an influenza virus will trigger a coughing reflex in order to perpetuate itself, half-baked ideas have a habit of exploiting and reshaping their environments to suit their both their immediate existence and efficient transmission in the future.
Just think of all the discredited concepts that Wall Street analysts and seasoned investors alike just "knew to be true" over the years: The Soviet economic juggernaut in the 1950s, the corporate Japanese takeover of America in the 1980s, the unstoppable rise of China, the "imminent collapse" of the dollar, the confidence-pumping benefits of austerity in southern Europe.
Such widespread misconceptions can lead to a prolonged and systematic mispricing of risk if they're taken seriously by enough people. One such argument currently making the rounds is the so-called Demographic Cliff: The "inevitable" sell-off in the markets as the baby boomers retire and liquidate their assets.
On paper, the argument appears compelling. There's no question, the retirement of tens of millions of boomers in the coming decades will have a major impact on everything from health care (count on surging demand) to real estate (good-bye, suburbs; hello, beach house).
The thinking is that the generation that loaded up on stocks as they saved for retirement will crash the market once they sell those shares to pay for retirement. Today, 10,000 Baby Boomers reach age 65 every day, and will continue to do so for another 18 years or so. Baby Boomers control over 80% of all personal financial assets, account for over 50% of total U.S. spending. How can the market do anything but fall with such fundamentals to look forward to?
Here are five reasons why we're not going over the Demographic Cliff:
1. Global cash flows. Money knows no geographical boundaries. If U.S. stocks were to decline, dividend yields would rise, resulting in a influx of foreign capital into the U.S. (Most U.S. companies are already globalized in any case, with 40% of corporate profits coming from consumers overseas.)
Fig. 1: Foreign direct investment, net inflows (BoP, current US$)
(Source: World Bank)
2. Inheritance. While asset values has reduced projected inheritances for baby boomers by 13%, two-thirds will eventually receive an inheritance, probably in late middle-age.
Fig. 2: Percent of Boomers Receiving an Inheritance, by Age at Receipt
It's estimated that for every dollar that baby boomers inherit, 50 cents will be saved and 50 cents will be spent.
3. Rising inequality. Without getting on my soapbox, you can't sell what you don't own. Collectively, boomers are the wealthiest generation in history, but only 9 percent are affluent (defined as having pre-tax incomes of $150,000 or more if working, or $100,000 or more if retired). Stock ownership is extremely concentrated among the very highest income brackets. In 2006, those in the top 10% held 68% of financial assets, according to the Government Accountability Office. Today, the top 10% own closer to 80%. In fact, one quarter of Boomers have no savings or investments at all.
Fig. 3: Wealth groups' shares of total household stock wealth, 1983-2010
4. Generational backlog. The bulk of births occurred during the latter half of the "boom" period. (Think: Eisenhower to Kennedy, rather than Roosevelt to Truman.) Retirement will likewise be staggered in. The majority of baby boomers will retire between 2020 and 2030.
Fig. 4: U.S. Births, 1900-1998
(Source: Consumer Insight) [PDF]
5. Retirement isn't a bill that comes due all at once. Simply stated, there's no compelling reason for the majority of boomers to insist on lump sum liquidation -- and thereby lose a huge chunk of their savings to taxes -- rather than converting their 401k into an immediate single Llfe or joint-and-survivor annuity. It's difficult to imagine how they would survive a higher rate of inflation by taking the lump sum (see Fig. 5 below.)
Fig. 5: Erosion Of The Value Of The Dollar At Various Rates Of Inflation
(Source: Merrill Lynch Wealth Management)
Historians would be hard pressed to name a generation more prone to apocalyptic hyperbole than ours. The apocalyptic agitation of 1,000 A.D was necessarily limited by the Julian Calendar. Outbreaks of mass hysteria during the Renaissance -- such as the Dancing Plague of 1518 -- were either limited to small townships or reserved for religion. Even the infamous Salem Witch Trials were comfortably confined to Massachusetts.
Today, anyone with a ball point pen and a napkin can whip up an impeding apocalypse and market it to investors using viral marketing tactics. What was once the province of chain-letters has now become uncommon wisdom -- the "inside scoop."
Why uncommon wisdom should trump common wisdom is beyond me. In my experience, what tends to be lacking is the latter of the two. You didn't have to be a genius or even particularly clever to make a boatload of money in 2009. All you had to do was ignore the sirens, and remember that longevity implies a certain viability and resiliency all by itself.
Yes, the baby boomers are retiring, and yes, that will cause us to rethink and re-organize our much maligned medical system. To assume that the U.S. healthcare system must fail simply because it contains contradictory elements is absurd. All enterprises contain such contradictions. They're a feature, not a flaw. I expect that the sky will continue not to fall on our heads, and that the companies best positioned to take advantage of 21st century demographics -- namely, United Health Group (UNH), Monsanto (MON), Toll Brothers (TOL) and British-American Tobacco (BTI) -- will continue winning. For those of you who are curious as to why I picked those four companies as potential demographic plays, see my previous article, "10 Demographic Trends Investors Should Be Thankful For".