The Milken Institute debate that was highlighted in an earlier article, [1] Common Stock Legend Disavowed: Professor Siegel’s Epiphany, brought into focus two opposing views regarding the possible negative impact on stock prices to be caused by the retirement of the Baby Boomer generation.

Michael Milken, the Chairman of the Institute, took an optimistic stance, suggesting that the problem would probably resolve itself through improvements in technology and productivity enhancements.

Linking economic stability and growth to enhanced productivity and new technology is a popular theme among economists, including ex-Federal Reserve Chairman Alan Greenspan.

Productivity and Technology Can’t Save the Baby Boomers

As described in the essay, “[2] Profits and Population“, American economic growth over the last fifty years has had more to do with the expansion of the number of people working in the money economy than with advances in technology and productivity.

The initial impact of productivity improvements and new technology is to put people out of work.

Unless government policy and societal customs encourage education, savings and investment, and entrepreneurial activity, higher paying new jobs will not be created fast enough to employ workers displaced by productivity enhancement and new invention.

In the United States, over the last generation, certain societal trends have had an increasing, long-term negative impact on the economic well-being average Americans:

• The unionization of public education with a consequential decline in teaching standards and outcomes (See: “[3] Workers’ Capitalism“);

• The shift of political power to non-elected, permanent government officials (See: “[4] Democracy’s Snare“);

• The shift of long-term capital allocation decisions from individuals to fund managers seeking extreme short term goals guided by ‘modern portfolio theory’ (See: “[5] Fallacies of the Nobel Gods” and “[6] The Asset-Lite Movement“);

• The union of the interests of fund managers and hired-professional corporate executives, giving rise to over-pricing of equities and a general decline in the investment merit of much of the holdings of Baby Boomers (See: “[7] Buybacks and Options“); and

• The deindustrialization of the United States, the decline in the number of engineering graduates compared to MBAs, and easy money as the result of the dollar’s position as the leading world currency (See: “[8] The Almighty Dollar” and “[9] MBAs and Ethics“)

Demographic change, leadership quality, taxation, and securities market regulation are probably more important to the health of a capital market than changes in productivity and technology.

For example,

Since Africa began to throw off colonial rule after World War II, that continent has seen an increase in poverty, war, accompanied by a decline in health standards and general bad times for most of the population.

However, throughout these long dismal decades Africa has had access to the same advances in technology that have benefited the rest of the world. The difference between Africa and the modern world has been the abysmal quality of its political leadership. Bad leaders trump technology gains every time!

The Old-sell-to-the-young Fallacy

Whereas Chairman Milken declared his belief in the magic of productivity and technology, Professor Siegel based his more pessimistic analysis on the belief that the economic well-being of the elderly always has always been dependent upon their ability to sell assets to younger people eager to pay full price.

If this old-sell-to-the young model is true and if the number of younger people is declining relative to their elders (as indeed is happening), then it follows that the Baby Boomers will be in for hard times over the next decades.

Professor Siegel is not alone in accepting the old-sell-to-the-young model of inter-generational economics.

Timothy Cogley, Senior Economist at the Federal Reserve Bank of San Francisco, wrote in an article, “[10] The Baby Boom, the Baby Bust, and Asset Markets“, published in the June 26, 2020 FRBSF Newsletter, as follows:

… But what happens when population growth isn’t steady and the economy’s age distribution isn’t stable? In particular, what happens when the old-age dependency ratio rises, and there are proportionally fewer young savers to buy up the assets of the older retirees?

In this case, by the law of supply and demand, one would expect the price of assets to fall. As aging baby boomers begin to sell their financial assets, they will presumably be selling to the next waves of savers, the so-called Generation Xers and Yers, which are significantly smaller population cohorts. With relatively fewer buyers than in the past, boomers may find themselves selling into a weak market when they retire.

The major problem with the old-sell-to-the-young model of inter-generational economics is that it does not now conform, nor has ever conformed, to behavior in the real world.

• A large part of savings of the elderly consists not of equities that must be sold to others in order to be converted into cash, but instead, are in the form of fixed-income financial assets, like bonds, money market funds, annuities, pensions, and bank deposits. Fixed-income investments have the contractual promise of issuers to repay principal and interest, rather than requiring the investor to cash out by selling to third parties on the market.

• In the United States, a large part of the savings of the elderly is in the form of home equity, which is “spent” by simply living in the home, which also, perhaps may serve as a guarantee for home-equity loans or reverse mortgages that will not need to be repaid while the retirees are still living.

• Historically, much of the financial support of the elderly has come from their children and relatives, who provided room and board for an aging parent in recognition of their filial duty to repay their parents for their providing sustenance and educational benefits when they were children. (Admittedly, the decline of the American family, a waning sense of filial duty, and increasing ego-centrism of the younger generation, has weakened this form of support for the aging.)

• For over one hundred and fifty years, prior to the 1960s and “[11] Workers’ Capitalism“, dividend yields on commons stock averaged 120% of current yields on AAA bonds. If they had not followed blindly the “[12] Common Stock Legend” promoted by Professor Siegel and many others, but had stuck with the investment behavior of their grandparents, the Baby Boomers would have a far less worrisome prospects when they retire:

1. Their stock portfolios would yield higher cash returns than bonds and they would have less motive to sell in order to generate income;

2. Their stocks would trade at values much closer to intrinsic value than today, with greater likelihood of finding liquidity without the need to offer discounts of 40-50%, as Professor Siegel suggests.

Looking for Mr. Good Fool!

Professor Siegel’s model of the-old-sell-to-the-young, when combined with the requirement that Baby Boomers must not suffer the 40-50% devaluation in stock prices that would be necessary to bring equity prices into the historical alignment between dividend and bond yields, requires truly massive cohorts of young fools willing to buy vastly over-priced equities from the old folks.

Professor Siegel states it would take half a billion new immigrants to absorb the over-priced assets of the Baby Boomers. (It is not clear how Professor Siegel arrives at this number.)

Ruling out massive immigration as the salvation of the Baby Boomers who were so foolish as to believe in the Common Stock Legend, Professor Siegel concludes that hope lies in the seething masses of young people in China and India. Surely, there must be enough Greater Fools among these vast populations to save the retirement plans of America’s Baby Boomers!

Anyone who witnessed the hysterical buying of equities in Shanghai in the early 1990s, when the Chinese stock markets re-opened after the long night of communism, might conclude that, indeed, China might be the mother lode of Mr. Good Fools.

Unfortunately, however, by just mentioning in a public forum the need for American Baby Boomers to sell large quantities of assets to younger people in China and India, Professor Siegel has already fouled the waters of this hoped-for ocean of Greater Fools.

The buying frenzy in Shanghai in the early 1990s was caused by a perceived shortage of equities. Once the word is out (as it certainly is now) that there will be a surplus of sellers of American stocks for years to come, aging Baby Boomers will find that the supply of Greater Fools has dried up overnight.

But Wait! There’s Hope

Today, those Baby Boomers who realize the risk of depending on mutual fund equity investments for a comfortable retirement, may still have time to get out of the market before the stampede of their cohort begins.

Right now, the largest group of highly motivated buyers of massive quantities of U.S. equities consists of corporate executives using their company’s cash reserves to buy back stocks in order to jack-up the value of their stock options.

Most Baby Boomers with equity mutual funds in 401k plans have not yet caught on that stock buybacks are a fraud that deprives them of value, now and for years to come.

Corporate executives behind the stock buyback movement constitute a dream market of Greater Fools, here and now. It is not necessary (or wise) to join Professor Siegel in waiting for salvation in the younger generations of China and India.

The smarter Baby Boomer still may join executives exercising stock options, and sell their equities now held in 401k and IRA plans before the corporate cash cow runs dry

Baby Boomers may also get out of stocks with extreme price-earnings ratios and low cash yields, switching into diversified portfolios of asset-heavy, higher-yield stocks, like REITs that invest in income-producing, quality real estate.

Of course, as long as Wall Street continues to promote the Common Stock Legend and pitch articles in personal investing magazines, most Baby Boomers will not wake up in time to make a prudent reallocation of their holdings.

However, there are other possible changes in the market and society, not involving technology, increased productivity, or future Asian appetites for U.S. equities, that could save the Baby Boomers, but I will leave these for a future article.

See also: [13] Baby Boomers, [14] Post-Colonial Africa , [15] Retirement