Why A Demographic 'Great Sell Off' Will Anchor Down Markets

Includes: AUD, DVY, TLT
by: Nicholas Pardini

Historically, stock market returns are tied to expected earnings growth of companies. As the prospects for the economy improve, rising profits should float the boats of the equities markets. However, demographic factors may outweigh company fundamentals in dictating future equity performance. Due to the eventual retirements of the Western and Japanese baby boomer generation and the economic struggles of young people across the globe, I expect a global "Great Sell Off" on risky assets such as stocks, venture capital, speculative real estate, options, and commodities in favor of lower risk and income focused investments.

What will cause this "Great Sell Off"? First, population and income concentration is heavily skewed towards those over fifty. The wealth gap between those under 35 and people over 65 is at an all time high of 46 to 1. The reason for this include baby boomers having the opportunity to invest in stocks and real estate at pre-bubble prices along with the fact American youth are burdened with a weak job market and large amounts of student loan debt not seen by previous generations. Social security transfer payments and medicare also contribute to this income disparity to a lesser degree. The net result is a heavy concentration of assets disproportionately controlled by those over fifty and retirees. Once these people start to retire and or die off, they will need to sell of their financial assets and real estate to cover retirement expenses or the needs of estates. The problems lies in the fact that during the time when the elderly liquidate their assets, the smaller and poorer youth will not be able to afford to buy these products at their previous highs. Factoring out inflation expectations, these investments will need to be sold at fire sale prices as desperate sellers will need the money to support retirement living or for paying estate taxes.

The consequences of a demographically driven sell off are widespread and drastically change the rules of investing for the near future. Early signs of the "Great Sell Off" can explain a lot of economic oddities since the 2008 financial crisis. First, it can explain why yields have remained low in the Treasury market (NYSEARCA:TLT) (and other stable governments' bonds) despite record amounts of money printing by central banks. Investors closer to retirement have grown scared of volatility in the equity markets and have shifted to buying bonds to maintain a fixed income and capital preservation. High dividend blue chip stocks have been some of the strongest performing equities during the past few years as well due to the baby boomer generation's shift from capital gains growth to income that can finance retirement.

In addition to these changes in investment preferences, the "Great Sell Off" also has macroeconomic implications. The first major one is the European debt crisis. Younger Europeans on lower incomes will be unable to subsidize the pensions and benefits of retirees which will continue to put a strain on European sovereign budgets and the continuity of the Euro. The demographic income disparity is the most stark in Japan, where 33-60% (depending on the survey) of Japanese youth between the ages of 25-34 either does not work or marginally survives on low wage jobs. The growth of this NEET generation has severely reduced Japanese birth rates and also creates a generation which cannot afford to invest in Japanese government bonds once retirees cash out. This will create a sovereign debt crisis worse that Europe's as their debt to GDP level is 220%. In the US, the issues of unfunded liabilities in the form of social security and medicare commitments pose issues for America's long run solvency. A "Great Sell Off" will also add negative pressure on housing prices that may further weaken the global banking system. Angry economically disenfranchised youth can also create political tension as what has been seen through the Arab Spring and the Occupy movement.

What does the "Great Sell Off" mean for investors' portfolio strategy. Keep money in liquid securities such as stocks, cash (watch out for inflation risk), or liquid ETFs of commodities and bonds. Committing money into a long term bond, CD's, or real estate would be a bad idea as pressured selling throughout the next decade will open up bargain opportunities in the future. Also, quality companies with high dividend yields (NYSEARCA:DVY) will trade at a premium to historical averages due increased retiree demand. Capital inflows from retirees will also have similar effects in the high yield corporate bond market and government debt stable nations such as Australia (AUD, New Zealand, Switzerland, Chile, and the Scandinavian countries. Growth stocks in US and emerging markets equities on the other hand can underperform due to changes in older investors risk capacities and the lack of capital coming from young investors who can afford to take the risk.

Due to a combination of disparity between the current wealth and future income levels of baby boomers and those currently under 35 years old, I expect there to be a "Great Sell Off" in risky assets and a transition of capital to fixed income and high income paying stocks. The delaying of retirement among many baby boomers may slowdown this trend and lower the volatility of asset declines, but the same pressures will still be intact. Investors need to pay attention to this trend because it may cause severe macroeconomic tensions (such as a Japanese debt crisis) in the near future. Valuations of specific asset classes such as dividend stocks or speculative growth companies must also be analyzed differently in this new demographic paradigm.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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