long-term market themes (iv): Millennials vs. Baby Boomers

In a population of roughly 300 million in the US, about a quarter consists of Baby Boomers, born in the years immediately following WWII.  Another quarter are Millennials, born in the 1980-90 period.

During virtually my entire career, the economic behavior of Boomers has had the most important demographic impact on the stock market.  But the leading edge of this group is already entering retirement–and being gradually pushed off the Wall Street stage by Millennials who are just entering the workforce in force.

This phenomenon is already having an impact on the stock market, I think.  But we’re probably only in the early stages of what will be an increasingly important change.

Two thoughts:

short-term

1.  The standard economic toolkit for dealing with recession is to shift economic power away from savers (Boomers) and toward spenders (Millennials).

To some degree, this influence has been offset in the first post-Great Recession years by the difficulty Millennials have had in finding jobs as they finish school.  But employment is becoming progressively easier to come by.  And we know the Fed is planning on keeping an emergency recession-fighting regimen in place for at least the next few years.

Speaking in over-simple terms, the emergency plan of any central bank is to make interest rates negative in real terms.  During the emergency (we’re now ending year five) the elderly and the wealthy, who tend to save rather than spend and who have a strong preference for fixed income, lose out in a serious way.  Their wealth diminishes in real terms as they receive interest payments on their  savings that are less than the amount that inflation subtracts from their purchasing power.

Younger, less affluent people, on the other hand, get free lunch.  They can borrow at very low rates, sometimes less than the rate of inflation.  In the latter case, they get free money.  They can also easily be in the situation where, say, the condo/house they buy goes up in value, while the real value of their mortgage shrinks’

By taking money away from savers and putting it into the hands of people who have a strong tendency to spend, the government spurs economic growth.  Not fair, maybe, especially to Boomers, but that’s the way the system works.

Advantage:  Millennials.

the longer term

2.  Younger people want different things from what their parents have.

Some of this is, depending on your perspective, either the perversity of youth or boldly striking out in a new direction.  My parents lived in the suburbs, so I’ll live in the city.  They have PCs and flip phones (ugh!), so I’ll use tablets and smartphones–and I’ll become a social media guru.  They read newspapers, I’ll use the internet…

There’s also a stages of life component to this.

–Twenty- or thirty-somethings buy houses, furniture…, cars and suits (or other work clothing).

–Sixty-somethings buy jewelry and cruises.  They downsize their houses and move to low-tax warm-weather locales.  Or maybe they retire to the vacation house they bought ten years ago.

For my entire investment career, the changing purchasing patterns of Baby Boomers have been perhaps the most important factor in figuring out how to play the Consumer Discretionary sector–which is arguably the single most important one for a portfolio manager to outperform the S&P 500.

I think it’s still possible to hitch your star to the Baby Boom and outperform.  But not for much longer, as the Boom wanes and Millennials wax.

Baby Boomers: wounded by the Great Recession

Yesterday I wrote about Tyler Cowen’s semi-apocalyptic vision (if semi-apocalyptic is possible) of the US in the upcoming years.  His bottom line is that a small minority of tech-savvy Millennials will prosper while everyone else stagnates, distracting themselves all the while with their smartphones and video games.

A bit over the top?   …probably.  But maybe I should be nicer to my children, just in case.

There is, however, a much more straightforward way in which the economic environment since 2008 has been damaging to the Baby Boom and beneficial to Generation X and to Millennials.

It’s monetary policy.

When times are good, savers/lenders get a positive real return on their money.  That is, they receive interest income that compensates them for the effects of inflation + an extra percentage point to three or more, depending on how long the loan is or how creditworthy the borrower is.  When times are bad, the central bank steps in and pushes interest rates down below the rate of inflation to encourage borrowing and spending.  So returns on loans shrink, both in real and nominal terms.

Put another way, the central bank stimulates economic activity by taking money out of the hands of people who are loathe to consume and putting in into the hands of ardent spenders.  Senior citizens and the wealthy get dinged; the young and the willing-to-become-indebted have a field day.

That’s just the way macroeconomics works.  The elderly suffer for the greater good of the overall economy.

Three things are unusual–and unusually damaging to the Baby Boom generation–about the Great Recession:

1.  the biggest is the length of time fixed income yields have been depressed.  In a garden variety recession, the pain lasts a year or so.  But we’re now in year five of depressed interest interest rates, with the prospect of normal returns not reappearing until 2018.  Ouch!!!   That’s a decade of the old subsidizing the young.

2.  there’s also the amount by which yields have been depressed.  On the 10-year bond, it’s 300 basis points; on the 2-year note, it’s 350+bp.

3.  finally, there’s the fact that short-term rates have been reduced to zero.

Yes, arguably a real return of negative 2% is a real return of negative 2% whether the nominal return achieved is 3% (meaning inflation is 5%) or zero.  But there’s at least a sharp psychological difference between getting a monthly check for $2500 and one for $20.  And I’m not sure how people generally feel or behave when they’ve got to sell assets to meet living expenses–whether people can mitigate the negative effect on well-being by making substitutions.   Certainly you can’t substitute your way into making $20 go as far as $2500.

My point?

The money policy consequences of the Great Recession are just one more factor hastening the changing of the guard, in economic and stock market terms, away from the Baby Boom, and toward younger consumers.