Demographics vs. Stocks

The final week of the year ended on a flat note; the S&P500 was virtually unchanged from the prior week.  Volume, unsurprisingly in a week bracketed by two holidays, was very light.  But interestingly, as with the prior week, the VIX (or fear) index rose again, this time almost 8% as traders braced themselves for some possible turmoil ahead.

There were only a few economic data releases.  The Case-Shiller home price index fell, but much more than expected.  Consumer sentiment also fell; it was expected to rise.  Initial jobless claims fell under 400,000, but the seasonal adjust–mysteriously–was massive; it added 133,000 jobs, meaning that the actual unadjusted claims figure was 522,000.  This represents an increase of 25,000 over the prior week’s unadjusted claims.  More importantly, it depicts a jobs picture that’s far more downbeat than the “adjusted” figure does.  Finally, the Chicago PMI was better than expected.

Technically, the S&P has turned slightly bearish on the daily charts.  We’ll need to see more confirmation to over the next week to make this a more definitive call.  But at least the end-of-the-year mystery ramp seems to be running out or steam.  On the weekly charts, the uptrend is still intact; but the long-term bearish divergences are building.

The blog Contrary Investor recently published an insightful piece on the impact of demographic forces on the US stock market over the next several years. 

Drawing on the work of demographer Harry Dent, the blog outlined the ways in which the retirement of the baby boomer population will impact stocks.

Warning:  Prepare Yourselves for an Extended Period of Pain.

Dent focuses on the 45-55 year old subset of the baby boomers.  This group is declining in relative size.  And whenever this happen in the past, the S&P 500 also–not coincidentally–declined.  For example, the last time the 45-55 year old group peaked was 1974, and the stock market dropped and/or stagnated for the next eight years.  BUT one of the main reasons the damage was not even worse was because of the explosion of employer retirement programs that kicked in back then; together with savings vehicles like the IRA, these programs pumped a huge flow of capital into the stock market for the ensuing years.   

So as the next wave of boomers began to blossom in the 1980’s, the seeds for the great 20 year secular bull market were in place.  And when the effects of the huge secular credit expansion is factored in, the great burst of economic and stock market growth made even more sense. 

But now, these positive forces are about to go into reverse.  Retiring boomers will not only eliminate their savings contributions, they will now start selling off their investments to provide a source of income.  Insurance companies, mutual funds, private pensions and even public pensions will need to sell–on a net basis–more stocks than they buy.  Also, many of these retirement funds will shift away from stocks and into bonds to better ensure that they’ll be able to make their scheduled payouts, without the higher risk of loss that’s embedded in higher allocations to stocks. 

While foreign holdings and purchases of US stocks should remain strong, these investors represent less than 15% of the total stock ownership distribution.

The bottom line is this:  the US stock allocation of insurance companies, private pension funds and public pension funds is near all-time highs, when one looks back over the last 65 years.  This allocation percentage is about to plummet. 

Perhaps we’ve already begun to see the effects of this shift.  Over the last 34 weeks, equity mutual funds and ETF’s have seen a net outflow of almost $100 billion.  Yes the stock market has risen over this period anyway.  But as Contrary Investor concludes, in the US stock market, demographics and institutional investor asset allocations have been “tailwinds” that “are set to become headwinds”. 

Making money will still be possible, but for the next 10 years or so, this will become much more challenging, especially for those who’ve been conditioned to simply “buy the dips” and let the favorable winds do the work for you.

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