[Reuters Breakingviews] The great boomer selloff may overwhelm US stocks

By Felix Martin

LONDON, May 23 (Reuters Breakingviews) - There’s no shortage of theories around to explain the stalling of the U.S. stock market this year. Possible culprits include nosebleed valuation multiples, sky-high real interest rates, extreme policy uncertainty and the sustainability of the national debt. Yet the biggest threat to the four-decade-long run in American equities lies in the United States’s superannuating population. Three decades ago, the infamous "market meltdown hypothesis" predicted disaster once the baby-boom generation hit retirement age. That fear didn’t play out straight away, but the idea may be about to have its day.

The alarmingly named theory postulated that the age structure of the U.S. population might constitute a time bomb for the stock market. Rising to prominence in the 1990s, it rested on a simple observation. The so-called baby-boom cohort, born between 1946 and 1964, is much larger than those before and after it – a pig passing through the body of a python, as one memorable metaphor put it.

Economists warned that this demographic lump set the stage for a drama in two acts. In the first, the stock market would boom, as the postwar generation entered its prime earning years and ploughed its growing retirement savings into equities. In the second, however, the process would swing into reverse. The boomers would attempt to fund their sunset years by offloading their nest eggs onto a much smaller Generation X, those born between 1965 and 1980.

Since the latter cohort is much smaller than the former, the story goes, the supply of stocks for sale would swamp demand. Cue the inevitable equity market crash that gave the market meltdown hypothesis its blood-curdling name. "The words 'Sell? Sell to whom?' might haunt the baby boomers in the next century", wrote investment guru Jeremy Siegel in the 1998 edition of his classic “Stocks for the Long Run”. "Who are the buyers of the trillions of dollars of boomer assets?"

The 1980s and 90s seemed to corroborate the first part of the story. Net purchases of financial assets by U.S. private pension funds grew from an average of less than $30 billion a year in the 1970s to more than $80 billion in the following decade and over $100 billion annually in the final 10 years of the millennium. The predicted uptick in valuation multiples duly followed. By 2000, the cyclically adjusted price-earnings ratio of U.S. stocks, a widely followed measure calculated by Yale University’s Robert Shiller, had climbed from a low of under 7 in 1982 to over 44.

In the 2000s, however, the disastrous denouement failed to materialise, and the market meltdown panic thus receded. The dotcom crash and subsequent recovery suggested that the late-90s run-up in equity valuations had more to do with irrational exuberance than demographics. The growth of defined contribution pension schemes, alongside the traditional defined benefit ones, provided a new source of demand for U.S. assets. The boomers themselves confounded expectations by staying healthier and working longer than previous generations, relaxing the need to liquidate their savings.

Successive waves of supportive economic policies also helped. The globalisation of financial markets meant that instead of struggling to offload shares onto the piddling Generation X, U.S. boomers were greeted by a global savings glut desperate to invest in American companies. U.S. monetary and fiscal policy also became notably market-friendly, with low inflation and light taxes allowing increased leverage and higher margins. Even when crises did occur – above all in 2008 – policymakers had the market’s back. The meltdown hypothesis was thus forgotten. In the era of bank bailouts and Federal Reserve money printing, the market melt-up hypothesis was a much more compelling bet.

Yet the dynamics that worried the demographic doomsters of the 1990s remain alarmingly intact. Perhaps the retirement-age selloff was just deferred. Last year, even the youngest baby boomers turned 60, while the oldest are fast approaching their ninth decade. U.S. private pension funds have indeed turned from net buyers of financial assets to net sellers as a result. Older defined benefit plans, which guarantee a fixed income, made the switch more than a decade ago. Including defined contribution schemes, where only the amount paid in is fixed, net flows have been negative for most quarters since 2021, according to data from the Federal Reserve. The day of reckoning has finally arrived. The boomers’ mass drawdown of their savings has begun.

Meanwhile, the generation of U.S. savers available to absorb the boomers’ selling is as puny as predicted. According to World Bank data, there were 5.5 working-age Americans for every over-65 in 1990. By 2023 that number had fallen below 4. It was based on just such a collapse in the ratio of demand and supply that the market meltdown hypothesis Cassandras warned that stocks could easily drop by a third when the boomers sold.

That might turn out to be an underestimate. Since the 1990s, two new demographic factors have emerged which threaten to make a U.S. market meltdown even more painful than its original prophets predicted.

The first relates to the inflows of international capital that helped bail out the early retiring boomers after the turn of the millennium. Much of the purchases came from countries that were teetering on the brink of a demographic cliff edge themselves. Europe, Japan and China were the biggest buyers by far. In all of them, the fall in the ratio of the working-age to the retired has been as steep as, or even steeper than, the equivalent shift in the United States. In other words, just as U.S. boomers are accelerating their selling, the foreign buyers who have been picking up the slack are now facing drawdowns into a dearth of demand themselves.

The second new demographic factor may be more important still. The anomalous size of the American postwar generation conferred not just economic but domestic political clout too. For more than three decades, the boomers were the largest voting cohort. As late as 2010, they still made up more than a third of the U.S. electorate. Shortly after 2015, however, that dominance came to an end. Voters born after 1981, namely millennials and Generation Z, usurped the boomers.

It would be facile to ascribe the successive political earthquakes that have rocked the U.S. since 2016 to that demographic shift alone – not least because over-65s have tended to favour President Donald Trump. Yet it is surely no coincidence that it was just as the boomers’ electoral ascendancy was finally eclipsed that the political settlement in favour of globalisation went into precipitous decline. The generation of millennial Vice President JD Vance just doesn’t have the same vested interest in the policies that staved off the boomers’ initial date with destiny.

“Bull markets don’t die of old age”, the market adage goes. On this occasion, however, the market adage may be wrong.

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