Demographics and Capital Market Returns

Demographic patterns presage unprecedented pressure on U.S. asset values, Social Security policies, and intergenerational amity. By 2010, longevity in the United States will have increased by nearly 15 years since 1940 but the retirement age for full Social Security and Medicare benefits will have increased by only a single year. As those in the Baby Boom approach “normal” retirement age (65), the population will contain nearly twice as many people over 65 relative to “normal” working-age people (age 20–65) as society has ever seen. The simple fact is that moving from the current level of just under 3 workers per retiree to just over 1.5 workers per retiree is a likely formula for interclass and intergenerational rebellion; therefore, something will have to give.We start by analyzing the demographic patterns of the past 60 years. The first element of the problem is the increasing population over 65. The second element is the falling number of workers who provide the goods and services for the retirees (and for their own families). Because of both the Baby Boom of 1946–1958 and the Baby Bust of 1965–1990, the proportion of the population over 65 will soar from 12 percent today to 20 percent in 2030. The result will be deterioration in the dependency ratio—the ratio of those who produce no goods or services (and are thus dependent on others) to those who provide the goods and services for all.This problem has implications for the financial markets: Demographics played a key role in creating the stock market boom of 1975–1999 and will put a lid on asset returns for the coming quarter century. More retirees selling assets to a proportionately smaller roster of potential buyers (workers and their pension plans) equals pressure on asset values. Buyers will want total return, including income and growth; sellers will favor fixed income and fixed purchasing power. One consequence will be an increase in risk premiums required by the next generation and delivered to them by the outsized boomer generation. Goods and services that retirees want—notably, in the health care, leisure, and service industries—probably will experience material inflation. And the higher costs should be reflected in higher wages. Thus, the outcome could be a surge in real wages in the service sector and a continuing surge in medical costs.We discuss the various “solutions” to this problem that have been proposed. Financial and macroeconomic solutions will not work, because the problem is at heart a demographic one. Three demographic solutions could, however, help restore the dependency ratio: vastly increased immigration by young people, increased emigration by retirees, and a substantial rise in the retirement age. A common denominator in all of these solutions is (1) more workers and (2) fewer retirees. Although immigration of workers and emigration of retirees might slightly improve the dependency ratio, however, only a rising retirement age will make a large difference in the problem.How high the retirement age would have to go can be calculated in various ways. For example, if the recent and current retiree burden is comfortable for society, as would appear to be the case, the dependency ratio would need to match its 1980–2000 average. Then, to keep support ratios from rising from current levels, the retirement age would have to rise from 65 to 72–73 between 2005 and 2035.Whatever policy decisions are made, indications are that the laws of supply and demand are already bringing about just such a “solution.” The capital markets (i.e., investors at large) are already beginning to price the impact of future retirees' plans into asset valuations. And the media are full of accounts that retirees and near retirees are even now reassessing their ability to retire in light of stock market losses and reduced return expectations.