Market commentators propose plenty of reasons for why the S&P 500 continues to make new all-time highs. There are three basics concepts that get repeated in various forms. Each has a perspective on the market that is based on the facts and information they value:
- Bear: This bull market is ending now and should have ended years ago, except for those pesky central bankers providing free money (all that free money is going to hurt us in the long run via uncontrollable inflation).
- Neutral: The bull market has been going on for a long time and doesn't look to be ending, but with the Fed raising rates and the current geopolitical situation, a recession could be on the horizon (growth is good, but it can't last forever).
- Bull: This bull market will just keep going because innovation will keep driving markets higher, and current valuations are fully justified by low inflation and low interest rates (new technology will always make things better, so there's nothing to worry about).
It is surprising how many of these experts don't think about the underlying drivers of the markets. Money flows are what drive the market higher or lower. This is fairly clear in the short term, where stocks are driven by discretionary buyers and sellers. When lots of market participants want to buy a stock, the price goes up because the forced sellers (market makers) move their offer prices up due to the increased demand. The same thing happens in reverse when lots of sellers appear. The concept can be applied to markets as a whole, with the "stock" in question being index funds like the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) or the iShares Core S&P 500 ETF (NYSEARCA:IVV).
In the long run, it's assumed that valuations become more important, and this is true to some extent. The famous quote from legendary value investor Benjamin Graham is as follows: "In the short run, the market is a voting machine. In the long run, it's a weighing machine." But how long before the weighing machine takes over? It might be that the voting machine can dominate on longer time scales as well.
Getting back to the bear versus bull perspective above, I can appreciate the theories that give importance to central bankers, because they can truly make money flow where they want it to flow. Of course, they have mandates to abide by, so they aren't always providing liquidity like they have been since 2008. Even when central banks are accommodating, their influence (at least in equity markets) is small when compared to something else that people don't talk about very much: demographics.
Considering the whole population and how their behavior changes at different stages of life is really what determines trends in society. No matter what Warren Buffett decides, he only manages something like $500 billion at Berkshire Hathaway (BRK.A, BRK.B). Yes, I said only $500 billion. Stick with me on this. Janet Yellen and the Fed have a balance sheet of $4 trillion in bonds, and that has impacted the stock market indirectly as well, but the real power lies in the hands of the average American worker in aggregate. Retirement plans alone in the US total about $26.6 trillion. Contributions to those plans are at least $200 billion each year. On top of that, plenty of people also have taxable accounts that add to the power of demographics. What people are doing on average really matters. When a group controls over $26 trillion, should we think about how they invest and what they are likely to do next? I certainly think so, and happily, we can make some pretty good estimates.
Now let's dig into some demographics. To do this, we need to estimate some things (i.e., build a model). Here are the two most important inputs in our model:
- Estimate what the average worker is saving for retirement based on age.
- Estimate how many people there are in the U.S. by year of birth.
Combining these two pieces of data can give us a sense of what to expect from the $26 trillion elephant in the room. Here's what I have assumed is the average savings rate by age.
This is my own estimate based on data that I can find and some basic understanding of how people save through the different stages of life. The shape of this curve is what is important. While kids are still at home or in college, much of our income goes to them, but around the age of 50, people start to save more for retirement and do so until they retire. Then, the withdrawals start in the approximate age range of 62-70. As the number of people alive decreases at higher ages, I start to decrease the size of the withdrawal above age 75, as well to account for life expectancy. Once you average across the entire population, you should get a fairly smooth curve like what I have shown above. The exact percentages for the savings rate are not as important as getting the shape of the curve correct.
Also, the savings rate across the curve is a percentage of the overall average income, so I've built in some adjustments for changing income throughout life. The key data point is actually the age when the savings rate is at its maximum. In the calendar year when the number of people at this age starts declining (the peak of the baby boomer generation passes this age), the net savings rate will start to go down and our trend will start to change as we will see later.
Next, we need to estimate the number of people there are in the U.S. by age. The best data I found with 1-year age buckets (year of birth) was compiled by infoplease from the Department of Health and Human Services birth rate statistics. I could not find 2010 census data by age that wasn't aggregated across multiple years, and what I did find in graphs and aggregrated tables matched fairly closely with the birth rate data, so I am using this birth data for my population estimates. I did need to interpolate the birth rate data before 1950, but expect these trends are fairly smooth, and therefore, these estimates are plenty accurate for this analysis.
The birth data peaks in the late 1950s and really starts to decline in 1962, and then bottoms in the late 1970s. When I apply the savings rate estimates to these population estimates over time, we get an interesting pattern of aggregate savings. This is done by multiplying the savings rate for each age by the number of people who are that age in one particular year and then summing across all ages. The total is plotted for each calendar year in the following chart.
I would not trust the exact magnitude of the estimated annual savings in the chart above very much. It could be off significantly for many reasons, but I believe the upward trend of increasing savings (contributions to retirement accounts, etc.) for the last decade is a very significant factor driving this bull market, and high valuations aren't really going to stop the 401(k) contributions. What will stop these net positive contributions is baby boomers retiring. As the middle of the baby boomer generation is now in its peak savings years between the ages of 55 and 65, this trend is going to slow and will end by the early 2020s. That is when investing will become a true challenge, as the exit doors are small and it's possible that too many people will try to get out at the same time.
It's also possible that this change will be gradual and will give us a sideways market for a decade or more. Of course, such a market has to have some bear market corrections mixed in, and whether the first one comes in sooner than the above aggregate savings chart implies is very dependent on other shorter-term factors. Also, there is nothing to say that the chart above has the zero line correctly placed. It could move up or down and therefore shift the crossover to net distributions sooner or later than 2024. Finally, we had a pretty bad bear market in 2008 with a positive savings rate, so don't be surprised if a bear market comes while the net savings rate is still positive.
I would actually argue that the sideways market from 2000 to 2009 was shorter than typical (13-17 years is more common) because of the demographic trends I've covered here propped the markets up earlier than might have been the case otherwise. For now, enjoy the ride as the US stock market keeps making new highs. It's unlikely to stop suddenly with 401(k) and IRA contributions driving the gains. Other factors will cause volatility, and a recession could be the thing that makes the almost-retired baby boomers head for the exits early and end the party sooner than expected. Whatever happens, the savings rate should stay positive for several more years before the elephant in the room makes its exit.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.