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Do Retiring Baby Boomers Actually Move Markets? And How Much Do Demographics Really Matter
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Welcome to Money for the Rest of Us. This is a personal finance show on Money. How it works, how to invest it and how to live without worrying about it. I'm your host David Stein. Today is episode 546. It's titled Do Retiring Baby Boomers actually Move Markets? And How Much Do Demographics really Matter? Recently I got an email from a member of Money for the Rest of Us plus he'd been listening to a podcast by strategist Peter Zeihan. Peter says his work intersects geography, demography and energy. And in this podcast he was describing what he says is a much bigger problem that's going on with capital supplies. He contends that most private capital capital being monetary assets that are invested in corporate projects such as the AI Data center build out. He says most of it comes from people in their 50s and early 60s after their K have moved out and they start massively saving for their retirement. Now he suggests it's 70% of total private capital. That seems high to me. But what he's worried about now is that now that 80% of America's baby boomers are retired, they will become more conservative in their investing and move much of those savings from stocks to bonds and that could potentially move markets. This member had some questions regarding the potential impact of the savings that the baby boomers were doing and then the dis savings they'll do and particularly how it could have impacted a variety of asset classes including corporate bonds, non investment grade bonds, where the incremental yield or spread is very, very narrow and whether that savings action contributed to that. We'll address that. But first I want to talk about the whole idea of using diversity demographic trends to make investment predictions. I first became aware of this approach back in 1999. At the time I was on our executive committee at my institutional advisory firm where I was a partner, FEG Advisors. And we were in the process of selling the firm to allow the founders to exit. And so we had investment bankers that we used and we were meeting with potential suitors and one of them was down in Texas and mutuals.com this was a venture backed company and their chief strategist or advisor was Harry Dent Jr. We went down and met with him. I think Harry called in for a conference call while we were meeting with this entity and we did not enter into a merger with them. But Dent is a demographic forecaster and has written numerous books. He believes that demographic data can identify macro and micro trends and he uses these longer term trends, 46 year cycles that's tied to the Birth index to forecast what's going to happen with the stock market with inflation, deflation, booms and bust. His first breakout book was the Great Boom Ahead came out in 1993, and he predicted accurately the stock market boom of the 1990s. In 1999, his book was the Roaring 2000s. And this was probably what he talked about in our discussion when we were meeting with mutuals.com, i just don't remember. But I remember him and I remember the demographic approach which was intriguing to me. So I have followed his work for decades and my takeaway is it's really difficult to make investment predictions using demographic trends. That book, the Roaring 2000s, he believed that by 2008 the Dow Jones US stocks would soar to 21,500 and perhaps as high as 35,000 by the year 2008. Nine years later. @ the time, the Dow was selling for 11,000. That was the prediction among many others. But a number like that stuck in my head and it didn't quite work out. The Dow reached 14,000 in 2008, so 7,000 points lower, about 2.7% price appreciation. It definitely was not a stock market boom, but there was a housing bubble during that period. But he doubled down on that prediction in 2005 in his book the Next Great Bubble how to Profit from the Greatest Boom in History. And in that case he extended his prediction for the Dow to 35 to 40,000 by late 2009 to early 2010. But there would be a devastating crash between 2010 and 2012 that would usher in 13 year bear market in the 2022. And later he extended that to 2023. Now we know what happened there. There was a crash early 2008, the Dow fell 47% down to 7365. But his predictions are tied to demographic trends. And in his book the Great Crash Strategies for a World Turned Upside down, that came out in 2012.
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This baby boom generation as a primary driver, where he said there's been a 25 year trend of rising baby boom spending, but it peaked in 2007 and now the economy would slow, especially after 2012 through 2023. Dent writes, this wave of declining spending is not something you can fight with a few trillion dollars of stimulus. Dent was correct. The economy from year end 2012 through 2023, it had slower economic growth 2.5%. And that includes the economic contraction and recovery from the pandemic. We're just going to 2023 so that it was true. But and this is where it's really challenging. We can look at the demographics, see the trends, but we're not sure how that will translate into the investment markets. If we look at the return of the US stock market from 2012 to 2023, it does not reflect a crash scenario. US stocks returned 13.1% annualized. US growth, led by mega cap stocks, returned 16% annualized and global stocks overall returned 9.2%. Indeed, the US economy grew 2.5% per year. On a real basis, we factor in inflation, it grew roughly 5 to 6% and earnings per share growth for the US stock market over that time was 6.3% per year. Earnings per share were boosted by share buybacks, something that I'm not not sure if Dent commented on. But it allowed earnings per share growth to grow. Plus you had 2% or so contribution from dividends and that's over an 8% return. But the actual return was 13% because the price to earnings ratio, what investors were willing to pay for a dollar's worth of earnings went from 14.6 at the end of 2012 to close to 25 by the end of 2023. And that added 5 percentage points to return. So that's hard to predict ending valuations, the appetite for investors, or willingness to pay more for earnings growth. Dent, in his book the Demographic how to Survive and Prosper during the Great Deflation of 2014-2019 wrote, Governments are going to keep drugging themselves with QE until they fail and the economy corrects itself between 2015 and 2020 when all four cycles point down together. I have never cycle alignment. He's talking about the various long term cycles that influence these economic and investment outcomes. But we didn't see a crash. We did see a period of much lower interest rates, but now we've had higher interest rates as we had inflation coming out of the pandemic due to massive, even more massive QE with capacity constraints that led to high inflation, which we're still having inflation above the Federal Reserve's target with inflation running at 3% per year. Before we continue, let me pause and share some words from a new sponsor to the show, Gilt. I don't know how you feel about taxes, but I always dread tax season individually for our business. I hate when I get an envelope from a state or from the federal government because usually it means bad news. We're dealing with tax issues in California and Montana right now and it can be really frustrating. What I want from an accountant is not just tax planning, but strategies and solutions. For me and my business. And that's what you get with Gilt. You get a dedicated CPA and a full tax team who work with you to build a proactive strategy that actually evolves as your business grows. They focus on the real levers that matter for business owners entity structure, retirement contribution planning, hidden credits and deductions. And they also handle compliance for both business and personal taxes. So everything is in one place. Make taxes part of the business plan. With Gelt, your CPA and their AI enabled platform align your tax strategy to how your business grows. Instead of scrambling once a year, you get proactive quarterly reviews and clear next steps so you always know what's happening and why. Visit joing.com and schedule your discovery call today. That's J-O-I N G-E-L-T.com joingelt.com.
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We've discussed demographic trends in the past, such as episode 487 where we looked at the UN's population estimates long term going out to the mid-2880s and it's a pretty wide range. Their base case is 10.3 billion inhabitants, up from 8.2 billion. But the longer term trends, which are very difficult to forecast because what is life expectancy going to be? What about the fertility rate that impacts longer term outcomes? And then to try to forecast 10 years stock market returns based on demographics when you get surprises such as a pandemic, even if you get the economic growth forecast right, you could miss share buybacks by companies that juice earnings per share. Dent writes, demographics are the key to the future. If you don't understand such trends, from the trivial to the tremendous, you will miss many things that you should have seen coming. And I agree that demographics are important. They're one element that influences stock market returns and the level of interest rates. And we've discussed them in the past. The primary driver, for example of economic growth is the number of workers. Demographers are able to see is the size of the working age population increasing. And if you have more workers, they can produce more things which leads to higher economic growth, more output, which leads to higher corporate profits, which can help the stock market. That those are base understanding. But that's just only one aspect of it. The other thing that drives economic growth is innovation, it's productivity. Are the workers able to produce more with the same amount of resources? And that aspect of the economy is driven by ideas. Which ideas are going to be life changing is unknowable. We're seeing that right now when it comes to AI, how big will that impact be. And so it can't just be the number of people, it's what are they doing, how productive are they? And then of course they need capital, which is what Peter Zeihan is referring to. But baby boomers are just one source of capital. And there's a statement that Zeihan made that I just don't agree with, I think is wrong. He mentioned that 80% of American baby boomers have now retired. So about 80% of those finances have been turned into more conservative investments. In other words, he's suggesting they've already gotten more conservative, yet the stock market's still booming. Spreads are very, very narrow still for bonds. And he says we're moving into an environment where things like goosing interest rates, lowering them down in order to increase lending doesn't work because the money isn't available. He's overlooking the fact that banks can create money out of thin air as part of lending. The world is not capital starved. It can be capital constrained. But it, it isn't just what baby boomers decide how to allocate their retirement balances because the size of that just isn't that large. And we'll see that in a few minutes. There are many sources of capital. One is bank lending, which is magical in terms of their ability to lend money. They just do it by changing the digits. They, they put a deposit in a checking account and they offset it with an account receivable. And the money supply grows. Federal Reserve can increase the money supply through QE when it's paired with governments running budget deficits. We can have capital flowing from overseas investing in the US and much of the stock market boom from 2012 through 2024 was non US investors investing in US stocks helping to push up valuations. And so that can be a source of capital for public equities as well as private opportunities. One way to measure well, where are we in terms of the equilibrium level of capital, whether we're there or not? Sort of. The clearing rate is known as the natural rate of interest. Sometimes R Star, it's his real net of inflation and central bankers estimate what that is and there's times when it's much higher. So again, this was a real rate of interest. And I polled and I'll link to it analysis by the New York Fed. And back in the 90s during that Internet bubble, the estimate of the real interest rate R Star, the natural rate of interest was over 3%. And then during the 2010s, 2012s, during that demographic bust, I guess as Dent was referring to that natural rate of interest was much lower, as low as under 1% from 2012 to 2015. And so overall interest rates were low. But we did not get a crash, we didn't get deflation. We just had very low interest rates. And then that real rate of interest, that natural rate of interest increased over 2% by 2021. And so it flows in there and it's unobservable. And that's one of the discussions the Federal Reserve has, is they're trying to set a policy rate. And Chair Powell suggested that that natural rate of interest, the policy rate including inflation, could be between 3 and 4% right now, that it is higher than it was back in 2015. And part of it is this AI buildout and the demand for capital there. So real rates are higher despite slowing birth rates around the world. So it isn't just the birth rate. It's are there ideas that need to be funded and how willing are investors to fund that? And that's the thing that's driving markets right now, not demographics. I wrote about this in our monthly investment strategy report for Money for the rest of us plus, and I was looking at AI and there was a study by JP Morgan Fundamental Research where they estimate global AI infrastructure spending will reach 5 trillion in 2030. And it's so huge that capital that 5 trillion needs to earn a rate of return. And if it's a 10% rate of return, these companies would need to generate an additional 650 billion a year in revenue indefinitely. That's equivalent according to JP Morgan of every iPhone phone user paying an extra $35 per month for AI services. Think about that now. Are you paying for AI services? I know we are at our company three accounts at OpenAI, that's 60 bucks. We're doing our part, if you want to look at it that way. But most people aren't and most people don't need to because it's free. And then when we think about this, this level of spending, we don't even know if it will need to be $5 trillion because a lot of these models, particularly out of China, are open source and they're becoming cheaper to train in some aspects to, to the level of the current large language models. Much of the investment that is taking place is hoping for even better models. But that is uncertain. We don't know. Which gets back to trying to make predictions of interest rates in the future based on demographics, the level of inflation deflation just nearly impossible. We can see it in dense work. There is a record there. Some things were correct. The underlying demographics were correct. The impact of that on financial markets, by and large was not correct. 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So let's turn to this member's question regarding Peter Zeihan's worries about baby boomers shifting from stocks to bonds and how that could impact things. The Federal Reserve does some analysis and they estimate baby boomers control about half of the private sector household net worth $85 trillion, $27 trillion is in stocks and mutual funds. So that could include some stocks. And if it's mutual funds, it could be bonds. Another almost $18 trillion in real estate equity, $8 trillion in private businesses. But when you think about it, and we talked about this a few weeks ago in my David Bach, and he was talking about the trillions of dollars locked up in retirement savings accounts of baby boomers that are unwilling to spend them because they don't want to pay taxes on it, I think that's one element. I don't think that's all of it. And I definitely don't agree with giving an eight year tax break, flat tax for that money coming out. But the money's there, but it's not all going to be spent at once. And it's not all moved from stock to bonds at once. If baby boomers move, let's say $27 trillion in stocks, on the high end, they move 1% to 2% a year. That's 270 billion to $540 billion of movements from stock to bonds. The average daily U.S. trading volume is 400 to $600 billion per day, hundreds of trillion dollars a year. This potential movement from baby boomers is from stocks to bonds. It's very small in the scheme of things. Same for interest rates. If 250 to $500 billion was moved into bonds, the total US bond market's over $50 trillion, with the US treasury issuing one and a half to over $2 trillion a year to fund the deficit. And again, you got the Federal Reserve involved. They're often buying bonds now. They're not foreign flows. And so it's not just baby boomers that have determined what the spread or incremental yield is for investment grade bonds or the all overall interest rate. There are many factors. The demand for capital in terms of what ideas need to be funded and how much capital does does that need to be funded. And so many elements that I'm uncomfortable making a prediction based on demographics. But there is something intuitive or narratively appealing about using demographics to make investment predictions. Pretty tidy. You can actually see some numbers and visualize it. Makes for great graphs, great copy. But I've been investing for decades now and I've not seen it work. I have exposure to India because I can see that they are one country where the workforce is growing, especially if more women join the workforce. But I don't know how that's going to work out. There are so many other forces. Saw one article the other day that said these large language models might have the biggest impact in India as billions of people have access to information that didn't have before generating ideas, helping them become more productive, more efficient. And that could help India's economy and its stock market. Would I make a prediction of that in terms of some level of the India stock market? No. But it's a demographic position I've taken and I've made whatever 3% of my net worth invested there. But that's why we we have asset gardens. We're diversified among many different type of assets. Sure, we have exposure to US stocks which are expensive right now, but we don't know how this AI boom will work out. In that strategy report we suggested being underweight US stocks because of valuations and to allocate to less expensive areas because those Areas would also benefit from AI spillover because there is technology spillover as ideas spread more quickly than they ever have. So in conclusion, I'm not worried about baby boomers becoming more conservative in their investment. 1 I'm not necessarily convinced that they will tremendously because that's a generation that many of them have access to defined benefit pension plans and so their defined contributions just ends up being in some regards more of a surplus. And, and this is a generation that was comfortable investing in stocks and made a lot of wealth investing in stocks, could be on average less inclined to sell stocks because they've done well. So don't get hung up on demographic predictions. We can be aware of them, but to me it's way more important to look at what is the data showing now. I can rank 46 stock markets around the world by various metrics to see what's attractively priced, can see what forecasted earnings growth is for those markets. I can look at the level of interest rates and the incremental yield or spread. We can look at the term premium, the excess compensation investors demand to hold government debt. And is that changing? Those are the metrics that we can look at and make our allocation decisions without having to forecast something catastrophic or something amazing. We can make reasonable predictions and that's something we'll be doing next month of Money for the rest of us. Plus as we update our 10 year expected returns and ranges with the data underneath that says how we came up with those assumptions. And that's what we're trying to do. Reasonable assumptions to help guide us, knowing we could be surprised. In fact, one of the plus episodes that I did for members a few weeks ago is it's we've been doing these expected return assumptions for Money for the Restless plus for over a decade. And I went through every assumption and said, well, here's what we got right, here's what we got wrong and here's why that's a useful exercise. So there's a happy medium there. Not to be overly predictive, focused, heavily tied to demographics, nor to completely ignore it. We can find a balance, be aware of the demographics, recognize a degree of humbleness, that there are surprises that occur. But we can see where we are now in terms of valuations, interest rates and what's going on now. And that's why I call it investing on the leading edge of the present. That's guided my approach to investing for several decades now. And it's what we teach on money for the rest of us and on money for the rest of us plus our membership community. That's episode 546. Thanks for listening. You may be missing some of the best money for the Rest of Us Content Our weekly Insider's Guide email newsletter goes beyond what we cover in our podcast episodes and helps elevate your investment journey with information that works best in written and visual formats. With the Insider's Guide, you can discover investing in economic insight provided only to our newsletter subscribers. Unlock greater investing confidence with high value snippets from our premium products plus membership and asset cap. Further connect with the money for the Rest of Us team and community. And when you sign up, we'll also send you our exclusive investing checklist to help you invest with more confidence right away. You'll also get our introductory email series on eight essential investment principles that, if followed, can make you a better investor. We'll also share our recommendations for podcast episodes, articles and books. The Insider's Guide is the best next step to get the most out of your investment journey. If you're not on the list, go to moneyfortherestofus.com and subscribe right there on the homepage. Everything I've shared with you in this episode has been for general education. I'm not considered your specific risk situation. I've not provided investment advice. This is simply general education on money investing in the economy. Have a great week.
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