Baby Boomers’ Retirement Won't Be Disastrous for US Equities

(November 5, 2013) — Despite widespread speculation, baby boomers’ retirements are unlikely to damage the US equity markets, according to research from Vanguard.

The report said the assumption that these demographic changes will decrease demand for US equities resulting in low returns is caused by an oversight of various other factors that affect the stock market.

The conjecture derives from beliefs that baby boomers will liquidate their equity assets en masse as they approach retirement—an idea that is “spurious,” according to Vanguard.

“A 2006 analysis by the US Government Accountability Office of S&P 500 Index’s stock market returns from 1948 through 2004 supports our stance, pointing out that demographic variables generally accounted for less than 6% of stock market return variability—far less than macroeconomic, financial, and other unexplained variables,” the report said.

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One of these other factors ignored was that the baby boomer generation spans over almost 20 years, suggesting a gradual asset rotation from US equities. The first of the baby boomers retired in 2011 and the last are expected to retire around 2030.

Baby boomers’ current equities ownership is not unusual, the report said. Equity holdings of 46- to 64-year-olds remained at an average of 48% from 1992 to 2010—a figure very similar to baby boomers’ current holdings of 47% of the US stock market.

“We believe this lack of movement of pre-retiree ownership of US equities undermines the thesis that the current time is different for baby boomers in terms of their ability to influence US equity returns,” the report said.

Also, equity ownership was largely concentrated among baby boomers with higher net assets—96% of all equities were held by the top 20% of boomers. This characteristic implied that the majority of holdings would be kept for the foreseeable to allow for long-term portfolio returns, which will contribute towards estate planning and bequest goals.

The globalization of the US equity market will also provide a cushion to the impact of impending retirements, Vanguard said. Overseas ownership of US stocks has increased to 21% by year-end 2012 from just 7% in 1990. Net purchases continued to grow even during the financial crisis.

Positive growth in US labor force, compared to those of other countries, will help ensure minimal demographic changes’ influence, the report said, adding: “Even a casual glance at the US experience raises doubts about the claims made by some that an aging population is bearish for US stock returns”.

(November 5, 2013) — Gradual increase in bond rates could lead to high returns in fixed-income portfolios and will be beneficial for long-term investors, according to a report from PIMCO.

The bond markets have endured a tough time since May as rumors of tapering took hold. And confidence in the market hasn’t yet been fully restored, said Jon Short, managing director and head of global wealth management at PIMCO—$43 billion exited the fixed income market into cash and money markets between May and August this year.

PIMCO’s own Total Return Bond fund has suffered record outflows over the last six months—$4.4 billion in October alone according to Morningstar data, and a total of $33.2 billion year-to-date. The manager has even lost its title as the world’s largest bond fund to the Vanguard Total Stock Market Index.

However, Short suggested long-term investors should rejoice in future rising rates and have faith in the “core, quality-oriented securities that anchor many portfolios” and their ability to bounce back.

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“Despite the potential for short-term discomfort, rising rates should be welcomed by long-term investors, particularly in this era of historically low yields,” he said.

Interest income, a driver of bond returns, would provide long-term investors with a chance to reinvest in securities with higher coupons, the report found. This strategy would ultimately increase interest income for greater growth potential.

Short argued that there is not much to lose from rising rates, even amid market volatility.

“Even at their most turbulent, bond prices are nowhere near as ‘bubbly’ as stock prices—neither on the upside nor the downside,” he said. They’re rather resilient, he continued—bonds’ sharpest calendar-year price drop was 3% in 1994, while equities sank 38% in 2008 during the financial crisis.

Jumping ship to cash and money markets is not worth it, according to Short’s report. Nominal returns on cash were small at best, with an added potential for negative real returns.

“That’s a steep price to pay for perceived safety,” he said.

PIMCO foresees a “slow and gradual” rise in interest rates as the US Federal Reserve has said it will not raise policy rates until 2016—allowing long-term investors to see higher returns.

“Today’s ‘market of bonds’ is undergoing a sea change, one in which investors will need to de-emphasize duration and tap into other sources of value to boost their portfolios’ return potential,” Short said.

Other sources of value may include premiums from credit quality, yield curve roll down, and currency exposure, the report said.