Many baby boomers have already diversified
their asset portfolios in preparation for retirement. Still, it is disconcerting
that the retirement of the baby boom generation, which has long been expected
to place downward pressure on U.S. equity values, is beginning in earnest just
as the stock market is recovering from the recent financial crisis, potentially
slowing down the pace of that recovery.
This Economic Letter examines the
extent to which the aging of the U.S. population creates headwinds for the stock
market. We review statistical evidence concerning the historical relationship
between U.S. demographics and equity values, and examine the implications of
these demographic trends for the future path of equity values.
Demographic trends and stock prices:
Theory
Since an individual’s financial
needs and attitudes toward risk change over the life cycle, the aging of the
baby boomers and the broader shift of age distribution in the population should
have implications for capital markets (Abel 2001, 2003; Brooks 2002). Indeed,
some studies attribute the sustained asset market booms in the 1980s and 1990s
to the fact that baby boomers were entering their middle ages, the prime period
for accumulating financial assets (Bakshi and Chen 1994).
However, several factors may mitigate
the effects of this demographic shift. First, demographic trends are predictable
and rational agents should anticipate the impact of these changes on asset demand.
Consequently, current asset prices should reflect the anticipated effects of
demographic changes. In addition, retired individuals may continue to hold equities
to leave to their heirs and as a source of wealth to finance consumption in
case they live longer than expected (e.g., Poterba 2001).
Foreign demand for U.S. equities
might also reduce the downward pressure on asset prices. However, the effect
is probably limited for two reasons. First, other developed nations have populations
that are aging even more rapidly than the U.S. population (Krueger and Ludwig,
2007). Second, there is substantial evidence of home bias in equity holdings.
Individual investors typically hold disproportionate shares of domestic assets
in their portfolios. For example, in 2009, the foreign equity holdings of U.S.
investors were only 27.2% of the share of foreign equities in global market
capitalization. While the low level of international equity diversification
is still not well understood (Obstfeld and Rogoff 2001), it suggests that foreign
demand for U.S. equities is unlikely to offset price declines resulting from
a sell-off by U.S. nationals.
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