The aging of the baby boom appears to have great influence on the economy and markets. It appears to explain why the economy is much weaker than indicators like initial unemployment claims suggest. It helps explain the depth of the great recession and why the economy remains weak. It may explain why the stock market is about to crash.
We're going to focus on the impact of the first leg of the baby boom that occurred in 1947 as it hits three significant points in the life cycle. First, we will look at when people are most likely to leave a job without being fired. Then, at when people are most likely to start contributing less to the production of goods and services. And finally, at when they are most likely to sell stocks.
Initial Claims falsely indicate Strength
Historically, when initial unemployment claims are in the low 300 thousands the economy grows faster than it has been. Below is a chart of annual GDP growth (in black) and the 4-week moving average of initial claims (in red). Claims suggest the economy should have grown at about 3.3% in the last year rather than 2%. The discrepancy was even larger going into the great recession. On the other hand, in the late 1990s growth was stronger than initial claims suggested.
In wondering why the economy was so much weaker than indicated I wondered if the aging baby boom generation played a role. After all, if people are leaving jobs voluntarily a business can reduce its work force with attrition rather than firings. At about age 59 and a half people appear most likely to leave a job without being fired. They may leave to start a business, find a less demanding job, to retire early or for health reasons. The chart below shows the residual GDP growth, or the rate of growth less the growth estimated by initial claims in the chart above. It also shows the percent of the population aged 50 in red with a 9.5-year lead time. Age 50 with a 9.5-year lead time shows the influence of people at age 59 and a half. This was the lead time with the highest correlation. Note: the percent of population scale is inverted. So a rise in the percent of the population age 50 is shown as a dropping red line.
In 2006 growth started becoming weaker than initial claims indicated it should be; this corresponds on the chart with the percent of the population age 50 rising (falling on chart) to 1.5%. By contrast, when the percent of the population age 50 was less than 1% GDP was stronger than initial claims suggested. It's very reasonable that when the birth dearth of the Great Depression was 59.5 there were fewer people than normal leaving by attrition. Looking forward, the correlation suggests initial claims will over estimate growth at least through 2020.
Declining Economic Contributions
Even though people are more likely to leave a job at age 59 they still usually contribute to growth a bit longer. Significant declines do appear to occur around age 62.5. Below is the five-year rate of GDP growth (in black) with the population age 50 (in red) leading almost 12.5 years.
So the Great Recession corresponds with the first leg of the baby boom born in 1947 turning 62 and a half. After 1947, births declined for a few years resulting in fewer people turning 62.5 the last three years. In the chart above this corresponds with growth strengthening a bit the last 3 years or so. Going forward the number of people reaching this age begins to rise (fall on chart). This larger share of the population reaching the age where they are less able and or willing to contribute to growth will be an economic headwind for a number of years.
Waiting For Wave of Selling
During retirement people tend to lighten up on equities. Some get out of equities all together. What may be the trillion dollar question is when the first leg of the baby boom generation will sell the most stock. The chart below takes a stab at answering.
Currently the best correlation suggests that at age 67 they will sell. That's 67 or age 50 with a 17 year lead time. It further suggests the selling should have already started. The black line in the chart above is the S&P 500 adjusted for inflation. Looking at the market this way we appear to be in a secular bear market that started in 2000 with a series of lower tops and lower bottoms. The 2007 top was lower than 2000, and currently the real price is 2.3% below the 2007 top. The 2009 bottom was lower than the 2003 bottom.
Are we about to experience the largest share of the population to ever enter the peak age of selling stock? I can't get too excited about the chart indicating the selling should have started a couple of months ago. Two years ago the strongest correlation suggested the peak age of selling was 65 and a half. This bull market (or up leg in the secular bear as the case may be) has shifted the lead time for maximizing the correlation 18 months. If two years of rising markets can shift the lead time that much it casts some doubt on the meaning of the correlation. While I still expect a huge wave of selling from the baby boom generation, it may not come until something else breaks the upward momentum of stocks. Baby boomers may be willing to let it ride as long as they can.
On the other hand, the selling may have begun and we just don't see it because our measuring stick is shrinking. Priced in euros our market peaked back in May. Priced in pounds it peaked on August 1. On the Wednesday, the Fed announced no taper and stocks went up about 1%, the trade weighted dollar index fell 1%. So, there was no gain for non dollar observers.
After years of being told we were the "cleanest dirty shirt in the laundry hamper" foreign stock markets have outperformed the U.S. market the last few months and from a non dollar perspective it looks like our market could have topped and be headed down. Even so, the big wave of selling I have been expecting the last year and a half has not started, yet. We are still dancing on the edge of a value cliff.
In the last 20 years stock valuations according to the PEses that I use are about twice as high as they averaged in the 120 years prior to that. This article has more info on the PEses. Currently, the PEses is just above the average of the last 20 years. So if the last 20 years are the new normal we are near normal and there is little to worry about.
What if the last 20 years were an aberration that is about to end? As I see it the last 20 years were largely a demographic phenomenon. The birth dearth of the Great Depression went through the peak years of selling stocks while the baby boom generation went through the peak years of buying and holding stock. So an unusually small group of sellers combined with the biggest ever group of buyers pushed prices and valuations to unheard of levels.
The Depression babies are long past the age of selling stock. The tail end of the baby boom is still buying stock, but they are being displaced by the birth dearth of the 1970s. So the number of people reaching the peak age of buying stock has been in decline for several years and will continue declining for several more. The baby boom while buying less stock remains in the age of holding it. Perhaps the only thing holding valuations at twice the normal level is that baby boomers have not reached the period of selling.
One Catalyst Away
Anything that spooks 67-year olds could tip off the biggest selling spree in history. We are perhaps one catalyst away from starting the third and most destructive down leg of the secular bear market. The catalyst might be a government shutdown, a weak jobs number, a stock price rally that falls short of a new high or dozens of other events. I expect the next leg of the bear market to take the PEses down to the 11 it hit in 1982, or perhaps even the 7 it hit in 1932. Once we hit a low valuation like an 11 or especially a 7 the market will be in position to start a real secular bull market like ones that started in 1920, 1949 and 1982.
For now, the economy faces a demographic headwind that means it is weaker than many indicators like initial claims suggest. The stock market (SPY) faces a demographic cliff.
Additional disclosure: There is no guarantee analysis of historical data their trends and correlations enable accurate forecasts. The data presented is from sources believed to be reliable, but its accuracy cannot be guaranteed. Past performance does not indicate future results. This is not a recommendation to buy or sell specific securities. This is not an offer to manage money.