Economics - General

The upcoming stock market crash?

In 5 years, the oldest baby boomers will hit 65 years old.  As the boomers begin to retire, this enormous cohort will start to sell off their financial assets in order to finance consumption in their non-working years.  One begins to wonder if there will be a stock market crash since equities demand may drop significantly. 

Stock Market crash: YES

  • Lower demand for equities will depress the price.  The U.S., EU and Japan make up about 50% of the world economy in purchasing power parity terms and almost 80% of the world economy in official foreign exchange terms.  All of these countries are facing an aging population.  It is unlikely that the developing world will be able to save the necessary capital to keep equity prices propped up.
  • Brooks (2002) believes that as people age, they will seek less risky investments.  Thus they will shift from stocks to bonds.  If this were to occur on a large scale, the phenomenon would drive down the price of equity.
  • Because of less efficient capital markets, money from economic growth in Latin America and Asia will not be invested in U.S. and European stocks on a large scale.  Higher transaction costs may convince developing world investors to keep their money invested at home. 

Stock Market crash: NO

  • In open economies, stock market returns should equalize across countries.  If investors are foresighted, then any future decrease in equity demand is already priced into the current stock valuations. 
  • Capital from economic growth in Latin America and Asia will be invested in U.S. and European stocks, thus keeping their prices high. 
  • Most people do not sell off their assets during retirement:
    • Poterba (2001, 2004) analyzes the empirical relationship between an aging population and the prices/returns for US stocks using the Survey of Consumer Finances (SCF).  He finds that financial assets peak to $32,000 at age 55 and fall to $25,000 by age 75. This means the average investor sells $350 of financial assets per year, a small amount.
    • According to Mitchell, et al. (2006), median retirement wealth in the US was about $340,000 in 1992.  Of this amount, however, 40% comes from owner-occupied housing and defined benefit pension, and another 40% comes from Social Security benefits.  We see that little of the savings of the majority of individuals comes in the form of financial assets. 

Mitchell, Olivia; Piggott, John; Sherris, Michael; and Yow, Shaun; (2006); “Financial innovation for an aging world” NBER Working Paper No. 12444.

Brooks, Robin (2002); “Asset-market effects of the baby boom and Social-Security reform,” American Economic Review, Vol 92(2), pp. 402-406.

Poterba, James (2001) “Demographic Structure and Asset Returns,” The Review of Economics and Statistics Vol 83(4), pp. 565-584.

Poterba, James (2004); “The impact of popluation aging and financial markets,” NBER Working Paper, MIT.