The impact of a changing demographic structure on the price of financial assets, especially stock prices has been the subject of extensive research and discussion for some time (Quayes & Jamal, 2014). Data gathered from the U.S Census estimated there were 65 million US born baby boomers accounting for more than 20% of the US population in 2014 (Colby & Ortman, 2014). Thus, when we consider the vast stake the baby boomer generation have on the stock market, it is of no surprise it is questioned the impact this generation will have on stock prices while they begin to transition into the retirement phase of their lives (Shambora, 2006). Research suggests that the strength and the dramatic rise in the United States (US) stock prices, especially through the 1980s and 1990s (when baby boomers were in their peak savings) is predominantly attributed to the accumulation of assets from those of the baby boomer generation (Shambora, 2006). Therefore, as it is presumed when the baby boomers retire, they will divest themselves of the assets they have accumulated and liquidate their holdings, this will put a downward pressure on stock prices (Parker, 2001). It is important to understand the baby boomers’ presence in the stock market and examine the potential expected movement in stock prices which may arise from this generation entering retirement, as this can give individuals who are planning their anticipated retirement valuable insights on their projected capital longevity, as well as the policy makers behind social security reforms (Shambora, 2006).
When we define the baby boomer generation, they are described as the demographic cohort those born between 1946 and 1964 (Owram & Doug, 1997). Being that the baby boomers were born post war, they gained increased wealth and affluence, in comparison to any preceding generation due to the widespread post-war government subsidies in housing and education (Landon, 1980). Furthermore, given they were more active and physically fit than previous generations, amongst other variables this enabled them to peak in levels of income and benefit from superior retirement schemes, which thus generated a significant boom in the economy (Landon, 1980). Shambora (2006) suggest, as there is an increase in population “the number of consumers in their prime earning years require more imports, thus demand for domestic equity, more investment, thus supply of assets and demand for securities, thus higher securities prices”. In addition, frictions that challenge efficient market hypothesis suggest investor asset allocation. Investment advisors perpetually recommend an investment portfolio with 50% invested in fixed income and 50% investment in stocks given long standing rules that enforce this asset allocation (Benartzi & Thaler, 1995). This inflexible asset allocation strategy means that as new money becomes available for investment, a portion must be put into the stock market regardless of perceived aggregate value of the market. Despite this concept can create distortions between price and value of stocks, this further contributes to the natural accumulation of stocks for the baby boomers. This fits well with the idea that workers entering their prime earning years increase their savings and continue this pattern until retirement. Some of these savings are likely to be channelled into the stock market and thus creating an economy boom.
Whilst these factors and other variables this indeed may have motivated stock price increases; it is speculated this could also result in a drag in future stock price growth (Shambora, 2006). However, as it is suggested that the baby boomers in their prime age may accumulate their wealth especially through the stock market, when they come to retire, they will liquidate their savings and assets to supplement their retirement and as such convert their assets to fund consumption (Shambora, 2006). When we consider that equities are generally considered more risker than bonds, retirees may seek to sell their equities first, to preserve their capital for longevity which can in turn drive stock prices down (Shambora, 2006). Thus, this can present a downward pressure on asset prices (Parker, 2001). Because demand forces can determine securities prices, when a population demographic shift, such as when the baby boomers retire and liquidate their equities, this can create excess demand or supply for securities and in turn asset prices adjust to these market force, known as the meltdown hypothesis.
Shambora (2006) provides valuable research on such expected stock movement prices and his interest steams from the meltdown hypothesis. His research estimates that “although the baby boom glut may have indeed motivated stock price increases, they also will create a drag on future stock price growth and there will be a fall in asset prices when the baby boomers retire” as suggested by the meltdown hypothesis. Shambora (2006) argues that because Efficient markets hypothesis would have us believe that asset prices reflect only the current perception of firm valuation and that other factors will not affect the demand for or supply of securities and supply and demand therefore adjust simultaneously and immediately so that prices always reflect fundamentals, often in reality this can be somewhat untrue. He argues that because events continually test the rigidity of this theoretical price–value relationships, frictions can prevent the simultaneous adjustment of supply and demand and stock markets are viewed as only partially efficient because stock prices respond to a number of factors in addition to valuations based on fundamentals. Thus, he highlights the importance of the impact of the demographic shit the baby boomers transitioning into retirement will have on stock price because if efficient market hypothesis would have us believe that stock prices reflected only underlying value, the addition or subtraction of participants would have no effect (baby boomers liquidating their vast stake in the share market). Furthermore, we need to consider the change in various behavioral characterizes, such as risk tolerance (by liquidating equities into cash for readily available funds for consumption this reduces investors risk tolerance to elongate the longevity of capital through retirement). This part of Shambora (2006) research is important because if we considered that demand for equities were perfectly elastic, then underlying value would be the only factor affecting equity prices. Evidence suggests this is not the case and that investors change in asset allocation strategy is slow to change and that shocks to behavioral factors have a direct effect on stock prices and can often have a delayed reaction to the price of stocks.
Shambora (2006) extensive research uses a semi-structural vector autoregression model based on a simple conceptual framework of equity price determination is estimated. He does this in order to capture linear independences through multiple time serious and allow an evolving variable. Shambora (2006) identifies that through the baby boomers prime earning years their capacity to save increases and these savings are directed to the stock market. He notes that while baby boomers continue with this pattern it increases stock prices due to increased workers in the labor force. Furthermore, once they start to leave the labor force and stop accumulating this wealth this will send a downward trend on stock prices. Although, his research suggested there is no major impact initially to stock prices because of its slow and consistent digression this has far more serious effects and will create a slow evaporation of stock prices, rather than a meltdown. His motivating variable through his research is the impact of the baby boomers retiring at the same time. He funds that if 50% of baby boomers at age 65 retire this impact has a slow crawl of growth under that of historical benchmarks. However, he also funds that if 75% of the baby boomers retire when they turn 65 the index dramatically slows and will unravel stock prices for many years. Thus, retiring baby boomers will produce a drag on the market. If retires postpone the reduces the immediate effect however due to the greater numbers the unravelling of stock prices would go on for many years. The effect is more pronounced as more works switch to a leisure life.
Some of the stellar movements of the stock markets over the last 20 years has been due to the participation of the baby boomers and an opposite pressure will prevail when these baby boomers decide to retire. While it is suggested that when baby boomers retire there may be no immediate shock in prices, eventually the impact will create a very slow digression on stock prices. This is due for behaviors effect that have a slow onset to stock prices and that market efficient hypothesis cannot be solely relied on. Therefore, it is critical that when people are planning their retirement, they consider these effects as well as policy makers to consider if they need to review social security policies.
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