Baby Boomers and Stock Valuations
Will the retirement of baby boomers impact the valuations of stocks? Research published by the Federal Reserve Bank of San Francisco argues it may.
The study’s authors, Fed researchers Zheng Liu and Mark Spiegel, say age differences explain about 61% of the valuation changes that occurred between 1954 and 2010. They determined this by first calculating the ratio of adults aged 40–49 to those aged 60–69, which they called the M/O ratio (ratio of middle-age cohort to older-age cohort). They then compared the M/O ratio to the year-end price-earnings ratio for the S&P 500. As the M/O ratio rose from 0.18 to 0.74 between 1981 and 2000, the S&P 500’s price-earnings ratio tripled from 8 to 24. During the past decade, both the M/O ratio and the price-earnings ratio declined.
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A reason for the shift is that as investors age, so do their allocation requirements. Older investors are likely to be more conservative, with a greater preference for asset preservation than asset growth. (Though Fidelity’s survey suggests this may not currently be the case.) As a result, bonds would be favored over stocks.
Liu and Spiegel then applied their methodology to predict future trends. Using the Census Bureau’s projected population data and assuming earnings grow at the average long-term inflation-adjusted annualized rate of 3.42%, they came up with a bearish forecast. Specifically, they predict the S&P 500’s price-earnings multiple will fall from 15 in 2010 to about 8.3 in 2025, before rebounding to about 9 in 2030.
This is not the first study to predict that the retirement of baby boomers will have a negative impact on stock valuations, but like others before them, Liu and Spiegel listed several caveats. Among them were volatility in bond prices and more foreign investment in U.S. stocks. Other economists have theorized that immigration of younger workers into the U.S. could also increase demand for stocks. Plus, to the extent that older investors allocate more to stocks than expected, stocks prices will also benefit. Thus, future stock valuations may be considerably different than what current demographic trends suggest.
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