Retiring Boomers Could Trigger Market Meltdown

There’s a new explanation for the decade-long explosion in stock prices: The baby boomers did it.

And they’ll probably keep doing it for another decade or so, according to analysts who believe aging and increasingly savings-minded boomers are propelling the market by pouring billions into mutual funds and 401 (k) plans.

But when baby boomers start retiring, the market could go bust.

Here’s why: When boomers want to sell stocks to finance their retirements, there will be relatively fewer workers who might want to buy. That imbalance could send share prices tumbling by one-third over 15 or 20 years, in the view of experts who have begun examining the potentially lethal combination of demographics and finance.

“I think these salad days are likely to be followed by a decade or more when the returns are less than historical averages,” said John Shoven, dean of humanities and science at Stanford University, and an economics professor who has written several recent papers on the subject.

No one knows exactly when, or even if, profit will turn to pain. The first baby boomers turn 50 this year, and will start retiring in 2011. Looking at the numbers, Shoven thinks share prices will tread water or decline from about 2015 to 2030. But if the theory gains widespread acceptance, stocks could suffer much sooner, as investors shy away in anticipation of later losses.

It wouldn’t be the first time that the baby boomers, 77 million Americans born between 1946 and 1964, have reshaped the United States. In the 1950s and ‘60s, they forced the construction of thousands of schools; in the ‘60s and ‘70s, they jammed colleges; and, as they formed their own families in the ‘70s and ‘80s, they ignited a boom in home construction and housing prices.

Now, the boomers have reached the age when Americans typically reduce spending and start saving. There are no conclusive statistics, but a growing cadre of analysts see the handprints of baby boomers all over the dizzying ascent of the stock market, which has been rising through good times and bad for 15 years.

Their primary vehicles: mutual funds and the 401 (k) plans that have replaced pensions at many companies.

In 1985, Americans had invested about $500 billion in mutual funds, less than one-quarter of that in funds that primarily owned stocks; in a good year, they might add $15 billion or $20 billion to stock funds. Today, mutual funds hold assets approaching $3 trillion. Nearly half, $1.3 trillion, is in stock funds, and money continues to pour into stock funds at a rate of $25 billion a month.

For the first time since the 1950s, Americans together own more stocks - about $5 trillion worth - than the total value of their homes - about $4.5 trillion.

With more purchasers chasing a relatively stable supply of stocks, “the market right now is rigged for growth,” said Lynn Stout, a guest scholar at the Brookings Institution, a Washington, D.C., think tank. “For the next decade, the stock market is going to be the best game in town for demographic reasons alone.”

After that, Stout and others say watch out, because the sellers may start to outnumber the buyers.

With baby boomers in their prime working years, there are now roughly 4.6 working-age Americans for every retiree. By 2025, when most of the boomers are retired - and living longer than current retirees - there will be about three people of working age for every retiree.

To Shoven, the Stanford professor, that means there will be one-third fewer potential buyers for the stocks that baby boomers purchase in the next 15 years. And the trend won’t be confined to stocks. Shoven expects bonds to suffer as well; falling bond prices mean higher interest rates, slowing the rest of the economy.

“It’s not at all clear how one sits this one out,” said Shoven, himself a 48-year-old baby boomer. “I haven’t figured out a personal strategy to deal with this.”

Not all economists agree that baby boomers are fueling the surging stock market. Edward Gramlich, an economics professor at the University of Michigan, notes that Americans’ saving rate, the portion of income not spent, is very low and has not been increasing.

“That’s a difficulty” for the theory, Gramlich says. His thoughts about a potential stock market crash in 2020: “It is a speculation of a bad thing that could happen in 25 years. There are a lot of other bad things that could happen in 25 years.”

To Sylvester Schieber, a Washington, D.C., pension consultant who has collaborated on research with Shoven, it doesn’t matter if baby boomers continue to buy stocks, or if their investments drive up the market. All that matters, he insists, is that in 2025 there will be more sellers than buyers. And that, as always, will drive down prices.

How far? Shoven once predicted a “market meltdown,” but now regrets using that phrase. Both Schieber and Shoven acknowledge a lot can happen between now and 2015 to avert such an outcome.

For one, some of those stocks and bonds could be sold to foreigners, as have an increasing share of U.S. government bonds.

Also, U.S. corporations could cushion the fall by repurchasing some of the stock that would otherwise not find buyers, or by raising dividends to make the stock more attractive.

In the end, Shoven thinks the 2020s might closely resemble the 1970s, when stocks essentially didn’t change in value after accounting for inflation, and bonds lost about 30 percent of their value.

“It was a lousy decade,” he said.