Uncategorized, Weekly Update

All Hail the Central Banks!

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Published February 7, 2020


We were reminded again this week of the psychological power of central banks over today’s market participants. An announcement early in the week of new money(!) pushed into Chinese markets by the Chinese central bank (PBOC) made stock investors forget all about the potential global economic hurdle that is the coronavirus (with investor enthusiasm aided by a reduction in the spread of the virus).

Central banks continue to provide critical backstop to global markets. A key assumption change allowing this central bank aggression has been the lack of inflation. The textbooks would have us believe that aggressive monetary policy (e.g. “easy money”) should create heightened demand for scarce resources, thus driving inflation upward. That rising inflation pushes interest rates higher, eventually forcing central banks to close the monetary floodgates. But that inflation remains elusive this time around. Perhaps that’s because the world’s aging population has a preference for the steady income of bonds. It also might be influenced as a good chunk of the central bank’s largess flows to higher net worth individuals who have a tendency to spend a lesser percentage of their cash flows (e.g. they are net savers). The other end of this argument being that wages generally have remained stagnant for quite a long time (thus limiting the impact from the net spenders). With substantially more of the central bank cash flowing to net savers than net spenders, inflation remains muted.

Returning to the focus on the impact of aging demographics brings us to this article originally in Fortune magazine, brought to us via Ben Carlson’s A Wealth of Common Sense blog. This article provides a good counterpoint to the above notion that aging demographics will increasingly starve stock markets of capital. Enjoy!

“As the baby boomer generation hits retirement age in large numbers this decade, there are a number of potential ramifications. One of the loudest warnings I’ve been hearing for a number of years now is how boomers will destroy the markets as they sell out to fund their retirement (and focus their investments on bonds).

Here are my thoughts on this risk.

There are 73 million baby boomers in the United States. By 2030, this entire generation will be age 65 or older as roughly 10,000 boomers are reaching this standard retirement age on a daily basis. In the year 2000, just 12% of the U.S. population was over the age of 65. By 2030, that number will nearly double to more than 20%.

This wave of retirees offers both challenges and opportunities for the financial services industry. Many of these retirees will require advice when it comes to spending down their portfolios; deciding when to take social security; dealing with estate planning, healthcare needs, and tax strategies; and designing a fulfilling post-work life.

The surge of baby boomer retirees will also present challenges for the financial markets. The baby boomers own the bulk of stocks in this country, which makes sense since they have had longer to accumulate financial assets than younger generations. But this fact troubles many people, who worry that once baby boomers go to sell their stocks en masse, the market will crash.

Here are some reasons these fears are overblown.

Many boomers are unprepared for retirement

According to a report from the Stanford Center on Longevity, one-third of baby boomers have no money saved in retirement plans. And for those who do hold a positive retirement balance, the median account value is just $200,000.

When combined with social security and potentially some pension income, many retirees will be able to make things work in terms of keeping up their lifestyle. But many are woefully prepared financially for a retirement that could last two, three or four decades in some cases.

Therefore, many boomers will be forced to work longer. The fact that people are living longer means this shouldn’t come as a surprise, and this fact will likely push back stock selling for a large percentage of boomers.

Stock ownership is concentrated

One of the reasons inequality has continued to worsen in this country is because not enough people hold financial assets. The stock market has been a wonderful money-making machine over the past 10 years but that doesn’t help if you don’t participate.

It’s estimated that the top 10% of households by wealth hold close to 85% of the stocks in the U.S. (which is up from 77% in 2001). This concentration of wealth means most of the stocks retirees hold won’t need to be sold. They are more likely to be passed on to the next generation.

Investors have other assets

Considering the low levels of interest rates and high recent returns in the stock market, you would expect the bulk of money in investor portfolios would be allocated to equities. But that’s not the case.

Average U.S. Investor Equity Allocation

While the level has been steadily rising since 2009, the average household allocation to stocks is still only 44%. Investors also hold cash, bonds, real estate, commodities, their own businesses, and other assets.

So retirees won’t be relying exclusively on the stock market to fund their retirement. And the idea that retirees will immediately shift the majority of their stock holdings into bonds for their relative lack of volatility doesn’t hold water for the simple fact that interest rates are so low and people will have many years ahead of them to continue to grow their capital. If anything, you could make the argument that a lack of retirement savings and a longer lifespan will force people approaching retirement age to invest more in equities, not less.

Someone has to buy those assets

While those 70+ million baby boomers will all be age 65 or older by 2030, they won’t be the largest age group at that point. In fact, they aren’t the largest age group right now. That distinction belongs to the millennials, who number around 87 million. There are also more than 70 million people in Gen Z.

Although young people are financially behind where their parents were at the same age, due to a combination of the timing of the financial crisis and slower wage gains in recent decades, millennials are prime candidates to step up to the plate to buy any assets boomers are willing to part ways with.

Educational Attainment of 25 to 37 Year Olds

Another reason millennials are behind where their parents were at the same age, when it comes to finances, is that they are by far the most educated generation in history. This means this group has put off some of their earning years upfront to hopefully earn more down the line.

Eventually, younger generations are going to play catch-up when it comes to their financial situations. The oldest millennials will be 39 this year, so a big part of this group is now well into their 30s—a prime age for household formation and moving up the career ladder. This progression is happening later in life for millennials but that means they will be buyers of financial assets for decades to come.

The stock market can and will crash in the years ahead. That’s simply part of the deal one accepts when investing in risk assets. But there are plenty of reasons to believe retiring baby boomers won’t destroy the financial system just because some of them will be net sellers in the years ahead.”

Market Update

Investors looked this week to how stocks would respond to the first real test of the uptrend begun last October. For this week, at least, the answer was positive. The prior week saw a selloff on fears of a global economic slip, with the impact of the coronavirus unknown and the potential for a serious impact to the global economy possible. However, Monday’s report on U.S. manufacturing activity shifted investor focus back toward a positive tone. The report noted a return in U.S. manufacturing to an expansionary reading for the first time in six months, thus lending credence to the market’s rally on a coming improvement in economic indicators. Stocks rose +0.7% on the news. By contrast, the global economic concerns continued playing havoc with oil prices, which fell again Monday, and are now down over -20% in four months. Stocks accelerated Tuesday in a +1.5% surge fueled by the Chinese central bank’s overnight moves to inject funds into markets to bolster investor confidence. Stocks pushed higher again on Wednesday. This time, a +1.1% lift as a report on U.S. employment trends came in much better than projected; and as investors pointed to a deceleration in the number of coronavirus cases. Thursday brought a quieter day but another +0.3% add to the indexes. Analysts pointed to an announcement of a reduction in Chinese tariffs on U.S. goods. Markets in Asia have also rebounded this week, to further support a change in investor attitudes. Friday’s monthly jobs report proved solid. But investors turned more cautious, unwinding the two-day rally in commodity-related shares and leaving stocks down -0.3%.

Stocks bounced back solidly this week after a two week slide, more than recouping the losses, to push indexes to new highs. The S&P 500 gained +3.25% while the Nasdaq 100 (QQQ) powered higher by +4.62%. The small-cap Russell 2000 (IWM) logged a +2.71% recovery, though this index remains below prior high levels.

Warm wishes and until next week.