Saturday, November 16, 2002 8:34:32 PM
John Mauldin's essay for the week. Good read IMO. He'll send it to you free weekly. Interesting thoughts about the future and the boomers.
Text version is below. To view in color or printer friendly .pdf
please visit our website at www.2000wave.com
Will You Be Able To Retire?
Fantasy Island
Social Security Solutions?
Be Honest With Yourself
Deflation? Inflation? Gold?
Harry Dent Is Wrong
Houston, We Have A Party
By John Mauldin
Today we turn our attention to the question of retirement: Will the
Boomer Generation be able to retire on time? Will Social Security go
bankrupt? Is Harry Dent in his book The Roaring 2000s right when he
asserts that we will have a boom until approximately 2008-9 because
Boomers are saving and spending? And then watch as things go bust (an
actual depression) because Boomers start selling stocks and retiring?
We are going to examine a remarkable paper by Rob Arnott (Chairman of
First Quadrant) and Anne Casscells (of Aetos Capital). Arnott is
circulating the paper privately prior to its publication in a
financial journal. He has graciously given me permission to discuss
it. Its long term implications are very critical for all of us to
understand, especially the Boomer Generation, of which I am a part,
and which makes up a large portion of my readership. I think it is one
of the most important reports I have read in a few years.
(There are two caveats to which all must agree prior to reading this:
first, you cannot shoot the messenger [meaning Arnott, Casscells and
especially me]. Secondly, I am distilling a lengthy paper with a great
deal of back-up data into a few pages. Do not hold Arnott and
Casscells responsible for my efforts. As soon as the full paper is
available publicly, I will provide a link to it.)
We will look at the conclusions first, explain why they came to be and
then explore the implications.
First, the good news: the Boomer Generation is going to live longer
and be healthier than any previous generation. Each succeeding
generation, as did our fathers, has lived longer than their parents
and will continue to do so.
The bad news is that Boomers, ON AVERAGE, who are expecting to retire
at 65, will not be able to do so. Your individual situation is up to
you, but the average Boomer will work until he is at least 70, and
probably 72 or 73. The good news, again, is that we are all healthier.
I, for one, do not intend to retire at 70 or even 75. Again, this is
an average, and with proper planning many will be able to retire
earlier.
(Richard Russell, writer of the daily Dow Theory Letters is my hero,
going strong and writing more brilliantly than ever at 78. I shall not
imitate him by getting up at 3 AM, however, even in my dotage. I
consider him one of the most important financial writers of our times.
You can subscribe at www.dowtheoryletters.com . )
Secondly, this delayed retirement is not a financial problem, but a
demographic problem. Thus the solutions are not simply financial, such
as save more money or raise social security taxes.
Third, Social Security is not the primary problem. Long before we get
to the predicted funding crisis of 2017 or 2029 or 2040 (depending
upon which politician you listen to), we have a market driven
demographic crisis.
Finally, I am going to suggest this is not a crisis at all, in the
true sense of the word. It is merely an adjustment in expectations.
It may even be a blessing.
Fantasy Island
Arnott and Casscells contend that the markets will force this increase
in the retirement age. This will happen whether or not politicians
adjust the age for social security benefits. To explain what they
mean by the market forcing the Boomer generation to retire later, I am
going to resort to a simplistic analogy. We will examine the merits
and weaknesses of the analogy afterward. As you read, please know I am
aware of many weaknesses in the story, but am trying to get over a
major point that is critical to this argument. (The numbers I use are
for illustration purpose only, to help you understand the concepts.
They are not meant to be literal.)
Economists like to use an island economy to illustrate a point, and I
will do so as well. Let's assume an island, where 15% of the people
are retired, 65% of the people are working and 20% of the population
are children. The elderly and the children depend upon the workers to
produce the goods and services they need, in addition to the goods and
services the workers need. That means there is a ratio of about two
workers for each dependent. The retired swap assets they have saved
for the services they need.
Now, let's add something to the water that makes workers want to have
more children. Slowly, over time, the number of dependents per worker
goes up. The population now needs even more goods and services. Each
worker can be more productive, and that helps, as they create more
ways to produce goods cheaper and faster. Fortunately, whatever they
added to the water also makes people live longer, so that people can
work a little longer. It is not much longer, just a few years, but it
makes enough of a difference to keep things progressing.
The reason working a little longer makes such a difference is that the
retired population consumes about 3 times as much goods and services
as the children. So even as the percentage of the children in the
population rose, it does not require nearly as much community effort
to produce the needed goods and services for the young as it does to
support a retired person. The combination of increased productivity
and the older working a little longer made for generally increasing
prosperity.
Notice that it is not the amount of money the retired population
saved. The critical factor is that someone had to do the work so that
things and services could bwe bought. Society produces X amounts of
goods and services. If there is more demand for these goods and
services by retired people than actual goods and services produced,
then:
1. The price of these services goes up, or;
2. The value of the assets the retiring generation wants to trade for
services and goods goes down.
The earlier generation had to work just a little longer to have enough
assets to retire on and produce the goods which society needed.
Because they worked longer, they produced more goods and services
which had the effect of holding down prices, and allowed them to save
more for retirement.
If supply of overall goods and services drops, then prices will rise.
Retirees require goods and services. If there are not enough of them
to meet demand, prices will rise. This will make it difficult for
people to afford to retire on their savings, and thus they continue to
work.
Now, an interesting thing began to happen 18 years or so after the
miracle drug was added to the water. Their kids began to enter the
workforce, and the number of dependents actually fell, as more kids
entered the workforce than the number of people who decided to retire.
The retirement age actually fell slightly even as those retiring lived
longer. This was because there were more workers producing goods and
services.
Then another funny thing happened. Someone changed the water again,
and the Boomer generation stopped having as many kids per family as
their parents. Because there were so many in the Boomer generation,
there were still lots of kids, just not as many per family. Even as
more and more of their parents retired, the ratio of dependents to
workers did not change.
The Boomer generation continued the tradition of their parents and
became increasingly more productive. The amount of goods and services
needed to maintain the population did not get out of proportion to the
number of workers. Things became stable.
The parents of the Boomers, as they retired, exchanged their savings
for goods and services produced by the Boomers and their children. The
workers were willing to take these assets at ever increasing prices
for their products, because there was plenty to go around. This was
partially because there was not a lot of demand from young dependents.
Then it became time for the Boomers to retire. Most of them had been
saving for retirement. Knowing they were going to need their savings
for retirement, they slowly began to get out of riskier investments
long before the time came for them to actually retire. But they still
expected to retire at the age their parents had, or around 65, even
though they expected to live at least 5-7 years longer, and 15 years
longer than their grandparents.
But the Boomers had made one big miscalculation. They forget to have
enough kids to support their retirement. As time went on, the working
population had to produce more goods and services just to keep
everybody supplied. The number of dependents per worker rose by 50%,
until there were 1.5 workers for every retiree/dependent.
The workers saw the time they had to work rise each year, just to
produce everything that was needed. This got old very quickly. The
remaining workers got tired of working 60 hour weeks, instead of the
40 hour weeks their parents had worked, just to produce the same
amount of needed goods and services.
The workers went to the Boomer generation and said, "We want more for
our work. Either give us 50% more money for what we produce, or we are
going to give you 33% less goods and services for what you give us.
But we will not work 60 hours a week any longer for the same amount of
your assets as we once took for only 40 hours. If you don't like this,
you are quite healthy, and can work a little longer before you retire.
Take it or leave it."
The Boomer generation was quite upset. This wasn't the deal they
thought they had. They had been promised by their leaders they could
retire at 65. Now they found they did not have enough assets to pay
for the goods and services they needed. It did not matter how much
they had saved. There were only so many goods to go around, and the
workers set the price of the goods, plus they had control over the
price they were willing to pay for the assets the Boomer generation
had spent a lifetime saving.
There was only one solution, as they needed the goods and services to
live. They had to go back to work.
Supply And Demand is the Main Culprit
Before we can examine the implications of the story and data, you must
get in your mind one main point: this problem is one of supply and
demand. It has nothing to do with how much a generation saves or how
much a generation gets on Social Security.
Crudely, if there are more rabbits than wolves, you will see an
increase in wolves. If there are not enough rabbits, you will see a
decrease in wolves. There is a balance in nature, and there is also a
balance in economics.
Arnott and Casssells show that when you look at the dependency ratio
(the number of workers for each dependent), and adjust for the fact
that it takes more to support a retired person than a child, there is
a strong correlation and in fact a causation between the average age
of retirement and the number of workers still in the work force.
As the parents of the Boomer generation have retired, there have been
less children demanding resources so that the dependency ratio of
workers to children and retirees has been stable. That trend stops in
a few years, and they predict the average age or retirement will begin
to increase, starting in just a few years, and rising to 69 by 2015
and over 70 by 2020, and if the ratio holds, to 73 by 2050.
Literally, if every one of the Boomer generation retired at age 65,
there would not be enough people left in the work force to deliver the
pizzas, provide health care, police services, etc. Ironically, one of
the bright spots of this report is that it means unemployment for the
next generation probably goes down over time as more and more retire,
and someone must take their place.
In places or countries with a shortage of workers, labor costs go up.
That means the labor component of goods and services goes up, which
raises prices and/or lowers profits.
This process will play out over the next 4 decades. It will be slow
and inexorable.
The Boomer generation will demand goods and services, and because
there are not enough workers, the economy will not be able to supply
enough and workers will demand more of the saved assets of retirees
for what they produce. This can come as increased prices for the
production, or as a drop in the value of the saved assets or both.
If today one share of Cisco will buy you a meal at Denny's, will it
buy you a meal in 2020? People investing in Cisco today hope that the
price of those shares will rise to where it will buy several meals.
They expect stocks to rise 7% a year. However, in 2020 when there are
not enough workers to produce everything that retirees wants, the Law
of Supply and Demand means that it will take more Cisco shares to buy
a dinner than we currently plan on. Unless, of course, we can find
more workers.
What Happens If You Don't Compound at 10% Over the Next 10 Years?
Let's look at it another way. If I am right and we are in a long term
secular bear market, and the average stock does not rise over the next
8-10 years, let alone at 7-9% year, then how many people will be able
to retire on schedule?
How many people go to their financial planner and assume a 7-8% or
more growth in their stocks so that they can afford to retire? What
happens to the forecast if the growth rate is only 2-3%? We will find
people coming to 65 and finding they need to work and save a few more
years.
In the same way that our grandparents had to work a few more years (on
average) than our parents, our Boomer generation will have to do the
same.
You see, the part of the story where our kids come to us and want 50%
more for their work doesn't happen. We never get there, because
slowly our generation, on average, is forced to work longer. Supply
and Demand balance the scales slowly. There is no crash into the wall,
no strike by the younger workers forcing an abrupt change. The market
adjusts things slowly.
The data Arnott and Casscells show is that this adjustment is in the
retirement age. Will it be forced by a rise in costs or inflation? Or
will it be forced by a fall in the price of assets? Or some
combination of both?
I can make a cogent argument for all three, although I would choose
the combination scenario, which fits into my Muddle Through scenario.
What Could Make a Difference?
One factor which could totally alter this scenario is that we
dramatically increase immigration. A selective and aggressive
immigration policy could make a big difference. But it would have to
be at a level much larger than today's one million or so immigrants.
The paper suggests that at the height of Boomer retirement, we would
need 4,000,000 immigrants per year.
Right now, that is politically impossible. But in 15 or 20 years I can
imagine a set of circumstances which would favor more open
immigration.
Another thing that could change would be emigration, or an exodus of
retirees from the US. If you are living on a fixed income, and can
double your lifestyle by moving to sunnier climes, then I think more
and more of the adventurous will choose to do so. There will be plenty
of people who will be able to retire far before 70, when they are
capable of an active life, and will choose to do so in Costa Rica,
Mexico, New Zealand or any of a score of countries that offer good
services and low costs. With modern communications and cheap travel,
there is no reason not to put that into your personal equation.
I do not understand how anyone can retire on a Social Security income
alone. It is simply not enough anywhere in the US. But that same
income goes a long way north of Puerto Vallarta in communities filled
with retirees. Right now, Social Security income will buy you a lot in
Argentina or Brazil.
Social Security Solutions?
I assume you know by now there is no Social Security lockbox, except
in the rhetoric of politicians. Social Security is a transfer program.
It transfers income from workers to retirees. When you pay into Social
Security, you get nothing but a government promise. You do not own
any assets, as opposed to what you own in your 401k.
Do I believe that politicians will honor that "guarantee?" Of course.
They wouldn't be politicians otherwise. But I think the terms of the
deal will change on the margins. They will slowly raise the age of
retirement and probably do some sort of means testing. Further, the
dependency ratio tells us that current Social Security payments won't
be enough (surprise, surprise!)
We all know that there is a "crisis" coming in 2030 or thereabouts.
But as the dependency ratio rises, costs of services, especially those
in demand by retirees will rise faster than Social Security increases.
(See my argument on health care a few weeks ago.)
If they raised Social Security taxes enough to allow retirees to
afford to retire, the percentage of income would be huge. It is not
politically possible. The solution is that retirement ages will rise
over time, pure and simple.
Or politicians may punt and let the market do it for them. Let's say
Social Security is privatized. If Arnott and Casscells are right, then
the market returns on the money saved would not be enough to retire
on, so people would need to work longer. The fact that retirement
costs more makes the retirement age rise, without politicians having
to do anything. The more cynical part of me suggests that this may
happen, so that the current generation of politicians, who will "fix"
the system, will already be retired when the problem becomes apparent.
Be Honest With Yourself
The most important implication of this study is that the average
retirement age will rise because it will cost more to retire. When you
are planning for your retirement, you need to factor in a reduced
return on your stocks and investments and an increased cost in terms
of your assets for what you want to buy.
If you are expecting investment returns like those of the 90's to get
you to your desired retirement income level at a specific age, you are
probably dreaming. You are going to be disappointed. You are going to
get to that hoped for retirement age, and still need to save some more
and work longer.
But that is not all that bad. Average life expectancy is rising 3
months for every year over the last part of the century. That means in
the last 28 years, life expectancy has grown 7 years, and by over 14
years since WWII. The quality of that life has increased dramatically
as well. If our generation gets to live a lot longer, and if one of
the conditions for that increased lifespan and quality of life is
working a little longer than our parents, then that is a trade I make
very day.
In fact, studies show working a little longer is good for you.
Retirement is bad for your health.
As I have written for the last three years, stock market returns,
especially from one way mutual funds, are going to be dismal for this
decade. If you have not done so, you need to begin to adjust your
portfolio to absolute return type strategies. Bonds, of course, come
to mind, but I am also referring to dividends, certain types of hedge
fund strategies and other income opportunities which offer guaranteed
income. The returns from these may be less spectacular than what you
want, but they will be steady. Making risky investments or hoping that
the stock market will come back so you can make your retirement goals
is not healthy. "Reaching for Yield" is often a ticket to
disappointment.
It is better to put a realistic plan together, and either save more or
plan to work longer. If you already have enough, then don't let some
stock broker tell you that you must be in the stock market. Secular
bear markets are times to be conservative. As Dick Russell says, "He
who loses least in a bear market wins."
Deflation? Inflation? Gold?
In the short term, I still believe deflation is the issue confronting
us. I sat with Wayne Angell, the former Fed Vice Chairman, at lunch in
San Francisco this week, prior to his speech to the Public Pension
Funds Forum. Angell, who for 8 years had his office next to Alan
Greenspan's, probably knows his mind as well as anyone. He now makes
his living trading interest rate futures and doing some consulting. He
believes we will see long term rates fall further, and thinks long
term rates for treasuries will drop below 4%. He told the conference
that deflation would be a serious problem, but that he believes the
Fed will do whatever it takes to make sure we do not slip into serious
deflation.
These efforts should bring back inflation at some point, and when it
does, the Fed will raise rates. But that is not in the cards for the
near future. Angell says that Greenspan is not through cutting rates
if the economy stays soft. (I leave to another time the discussion as
to whether it will do any good.)
While the retirement data does not mean we will definitely see
inflation rise over time, I think it is likely, as the dollar falls
over the next few decades and demand outstrips supply on local
services. But not this year, and not next year. A reversal of the
deflationary pressures in the world is going to take a long time. It
is not altogether clear when this will happen, so investments in one
way funds (those that depend on the market going up, like mutual
funds) is an aggressive investment strategy.
This also argues for gold over the long term, as it has been a stable
store of value. Your Cisco share might not buy a meal at Denny's but
your gold will probably buy the same dinner and maybe even dessert.
Whither the Stock Market?
Let's look at a few themes I have written about this year. Earnings
quality is poor, and we are becoming more conservative about how we
calculate earnings. Valuation, which we touched on last week, is still
far above the average. The risk premium of stocks over bonds is
getting better, but is still far from average. Deflation from overseas
pressures is still a huge factor in the profit picture, creating
little pricing power for US corporations. Capacity Utilization is
poor, dropping another 0.8% this month to 74.4%, which is quite weak.
This means there is little capital spending by business.
On top of this, Boomers who are nearing retirement are not going to
wait until they retire to begin to sell stocks, especially if the see
them as increasingly risky. All of this taken together means more
downward pressure on stocks. We are still a long way from the bottom,
both in absolute terms and in terms of time.
Harry Dent May Be (Probably Is) Wrong
Finally, I promised an analysis of Harry Dent's main proposition that
the growth in the Baby Boomer generation was the reason consumer
spending and the stock market rose. He says this trend will continue
until 2008, when the Boomers start to retire. He shows lots of charts
which show a high degree of correlation.
But correlation is not causation. The price of butter in Bangladesh
can be highly correlated with the S&P 500, but there is no fundamental
connection. The reason spending went up was that Boomers had fewer
kids, and thus more discretionary money than their parents. They also
had more to save, which boosted the price of assets.
Thus, in my opinion, the correlation should be with the dependency
ratio that Arnott and Casscells present us with. That means that,
looking at their graphs and data, the negative effect from the Boomer
Generation does not wait until 2008 but is beginning now, or at the
most a few years from now.
The Economy is Not the Market
Once again, I need to emphasize that the economy and the stock
market are not correlated over time. There are plenty of
periods where the economy grows and the stock market is
stagnant. We are in one now. This decade will see growth in
GDP over time, although we will likely have another recession
or two. This is the Decade of the Muddle Through Economy.
Investors can make decisions today that will allow them to
prosper through this decade. No one is holding a gun to your
head to make you take a buy and hold strategy in your mutual
funds or stocks. You need to buy stocks which will pay you to
hold them (dividends) or public funds which can go both long
and short like David Tice's Prudent Bear Fund (BEARX), which I
have written about in the past, or certain types of hedge fund
strategies which do not depend on a bull market to make money,
if you qualify as an accredited investor.
Houston, We Have A Party
I leave in a few minutes for my Rice University 30th Class reunion. I
remember being an undergraduate and seeing those guys who graduated
in the 1940's and thinking how old they looked. I am sure I will be
shocked to see how my guy friends have aged just like those old guys
from 1942 did. The ladies will still look as lovely as ever, thank
you.
On Sunday morning at an obscene hour, I leave for New York to analyze
yet another hedge fund, and then Monday will do the keynote luncheon
address at the Hedge Fund Investments Styles and Strategies
conference. My speech is called "Getting Absolute Returns in a Secular
Bear Market." I will then come back and not leave until I finish my
book-in-slow-progress, Absolute Returns, except for a vacation or two
with my wife. I will be posting draft chapters as I finish them at
www.absolutereturns.net .
Late next week, subscribers to my free Accredited Investor E-letter
(on hedge funds and alternative investments) will get a new edition.
If you are an accredited investor (basically $1,000,000 net worth, but
complete definitions are available on my web site), you can go to
www.accreditedinvestor.ws and subscribe for free. The letter is
growing rapidly in popularity as we continue in this secular bear
market, and if you qualify, I strongly suggest you subscribe. If you
would like to know more about me, you can go to www.johnmauldin.com
which ahs a link to all the above sites.
Have a great week, and think about how much fun it will be to get
older if you invest in friends and family, where there are real
dividends and no taxes.
Your not even thinking about retiring at 70 analyst,
John Mauldin
John@2000wave.com
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Will You Be Able To Retire?
Fantasy Island
Social Security Solutions?
Be Honest With Yourself
Deflation? Inflation? Gold?
Harry Dent Is Wrong
Houston, We Have A Party
By John Mauldin
Today we turn our attention to the question of retirement: Will the
Boomer Generation be able to retire on time? Will Social Security go
bankrupt? Is Harry Dent in his book The Roaring 2000s right when he
asserts that we will have a boom until approximately 2008-9 because
Boomers are saving and spending? And then watch as things go bust (an
actual depression) because Boomers start selling stocks and retiring?
We are going to examine a remarkable paper by Rob Arnott (Chairman of
First Quadrant) and Anne Casscells (of Aetos Capital). Arnott is
circulating the paper privately prior to its publication in a
financial journal. He has graciously given me permission to discuss
it. Its long term implications are very critical for all of us to
understand, especially the Boomer Generation, of which I am a part,
and which makes up a large portion of my readership. I think it is one
of the most important reports I have read in a few years.
(There are two caveats to which all must agree prior to reading this:
first, you cannot shoot the messenger [meaning Arnott, Casscells and
especially me]. Secondly, I am distilling a lengthy paper with a great
deal of back-up data into a few pages. Do not hold Arnott and
Casscells responsible for my efforts. As soon as the full paper is
available publicly, I will provide a link to it.)
We will look at the conclusions first, explain why they came to be and
then explore the implications.
First, the good news: the Boomer Generation is going to live longer
and be healthier than any previous generation. Each succeeding
generation, as did our fathers, has lived longer than their parents
and will continue to do so.
The bad news is that Boomers, ON AVERAGE, who are expecting to retire
at 65, will not be able to do so. Your individual situation is up to
you, but the average Boomer will work until he is at least 70, and
probably 72 or 73. The good news, again, is that we are all healthier.
I, for one, do not intend to retire at 70 or even 75. Again, this is
an average, and with proper planning many will be able to retire
earlier.
(Richard Russell, writer of the daily Dow Theory Letters is my hero,
going strong and writing more brilliantly than ever at 78. I shall not
imitate him by getting up at 3 AM, however, even in my dotage. I
consider him one of the most important financial writers of our times.
You can subscribe at www.dowtheoryletters.com . )
Secondly, this delayed retirement is not a financial problem, but a
demographic problem. Thus the solutions are not simply financial, such
as save more money or raise social security taxes.
Third, Social Security is not the primary problem. Long before we get
to the predicted funding crisis of 2017 or 2029 or 2040 (depending
upon which politician you listen to), we have a market driven
demographic crisis.
Finally, I am going to suggest this is not a crisis at all, in the
true sense of the word. It is merely an adjustment in expectations.
It may even be a blessing.
Fantasy Island
Arnott and Casscells contend that the markets will force this increase
in the retirement age. This will happen whether or not politicians
adjust the age for social security benefits. To explain what they
mean by the market forcing the Boomer generation to retire later, I am
going to resort to a simplistic analogy. We will examine the merits
and weaknesses of the analogy afterward. As you read, please know I am
aware of many weaknesses in the story, but am trying to get over a
major point that is critical to this argument. (The numbers I use are
for illustration purpose only, to help you understand the concepts.
They are not meant to be literal.)
Economists like to use an island economy to illustrate a point, and I
will do so as well. Let's assume an island, where 15% of the people
are retired, 65% of the people are working and 20% of the population
are children. The elderly and the children depend upon the workers to
produce the goods and services they need, in addition to the goods and
services the workers need. That means there is a ratio of about two
workers for each dependent. The retired swap assets they have saved
for the services they need.
Now, let's add something to the water that makes workers want to have
more children. Slowly, over time, the number of dependents per worker
goes up. The population now needs even more goods and services. Each
worker can be more productive, and that helps, as they create more
ways to produce goods cheaper and faster. Fortunately, whatever they
added to the water also makes people live longer, so that people can
work a little longer. It is not much longer, just a few years, but it
makes enough of a difference to keep things progressing.
The reason working a little longer makes such a difference is that the
retired population consumes about 3 times as much goods and services
as the children. So even as the percentage of the children in the
population rose, it does not require nearly as much community effort
to produce the needed goods and services for the young as it does to
support a retired person. The combination of increased productivity
and the older working a little longer made for generally increasing
prosperity.
Notice that it is not the amount of money the retired population
saved. The critical factor is that someone had to do the work so that
things and services could bwe bought. Society produces X amounts of
goods and services. If there is more demand for these goods and
services by retired people than actual goods and services produced,
then:
1. The price of these services goes up, or;
2. The value of the assets the retiring generation wants to trade for
services and goods goes down.
The earlier generation had to work just a little longer to have enough
assets to retire on and produce the goods which society needed.
Because they worked longer, they produced more goods and services
which had the effect of holding down prices, and allowed them to save
more for retirement.
If supply of overall goods and services drops, then prices will rise.
Retirees require goods and services. If there are not enough of them
to meet demand, prices will rise. This will make it difficult for
people to afford to retire on their savings, and thus they continue to
work.
Now, an interesting thing began to happen 18 years or so after the
miracle drug was added to the water. Their kids began to enter the
workforce, and the number of dependents actually fell, as more kids
entered the workforce than the number of people who decided to retire.
The retirement age actually fell slightly even as those retiring lived
longer. This was because there were more workers producing goods and
services.
Then another funny thing happened. Someone changed the water again,
and the Boomer generation stopped having as many kids per family as
their parents. Because there were so many in the Boomer generation,
there were still lots of kids, just not as many per family. Even as
more and more of their parents retired, the ratio of dependents to
workers did not change.
The Boomer generation continued the tradition of their parents and
became increasingly more productive. The amount of goods and services
needed to maintain the population did not get out of proportion to the
number of workers. Things became stable.
The parents of the Boomers, as they retired, exchanged their savings
for goods and services produced by the Boomers and their children. The
workers were willing to take these assets at ever increasing prices
for their products, because there was plenty to go around. This was
partially because there was not a lot of demand from young dependents.
Then it became time for the Boomers to retire. Most of them had been
saving for retirement. Knowing they were going to need their savings
for retirement, they slowly began to get out of riskier investments
long before the time came for them to actually retire. But they still
expected to retire at the age their parents had, or around 65, even
though they expected to live at least 5-7 years longer, and 15 years
longer than their grandparents.
But the Boomers had made one big miscalculation. They forget to have
enough kids to support their retirement. As time went on, the working
population had to produce more goods and services just to keep
everybody supplied. The number of dependents per worker rose by 50%,
until there were 1.5 workers for every retiree/dependent.
The workers saw the time they had to work rise each year, just to
produce everything that was needed. This got old very quickly. The
remaining workers got tired of working 60 hour weeks, instead of the
40 hour weeks their parents had worked, just to produce the same
amount of needed goods and services.
The workers went to the Boomer generation and said, "We want more for
our work. Either give us 50% more money for what we produce, or we are
going to give you 33% less goods and services for what you give us.
But we will not work 60 hours a week any longer for the same amount of
your assets as we once took for only 40 hours. If you don't like this,
you are quite healthy, and can work a little longer before you retire.
Take it or leave it."
The Boomer generation was quite upset. This wasn't the deal they
thought they had. They had been promised by their leaders they could
retire at 65. Now they found they did not have enough assets to pay
for the goods and services they needed. It did not matter how much
they had saved. There were only so many goods to go around, and the
workers set the price of the goods, plus they had control over the
price they were willing to pay for the assets the Boomer generation
had spent a lifetime saving.
There was only one solution, as they needed the goods and services to
live. They had to go back to work.
Supply And Demand is the Main Culprit
Before we can examine the implications of the story and data, you must
get in your mind one main point: this problem is one of supply and
demand. It has nothing to do with how much a generation saves or how
much a generation gets on Social Security.
Crudely, if there are more rabbits than wolves, you will see an
increase in wolves. If there are not enough rabbits, you will see a
decrease in wolves. There is a balance in nature, and there is also a
balance in economics.
Arnott and Casssells show that when you look at the dependency ratio
(the number of workers for each dependent), and adjust for the fact
that it takes more to support a retired person than a child, there is
a strong correlation and in fact a causation between the average age
of retirement and the number of workers still in the work force.
As the parents of the Boomer generation have retired, there have been
less children demanding resources so that the dependency ratio of
workers to children and retirees has been stable. That trend stops in
a few years, and they predict the average age or retirement will begin
to increase, starting in just a few years, and rising to 69 by 2015
and over 70 by 2020, and if the ratio holds, to 73 by 2050.
Literally, if every one of the Boomer generation retired at age 65,
there would not be enough people left in the work force to deliver the
pizzas, provide health care, police services, etc. Ironically, one of
the bright spots of this report is that it means unemployment for the
next generation probably goes down over time as more and more retire,
and someone must take their place.
In places or countries with a shortage of workers, labor costs go up.
That means the labor component of goods and services goes up, which
raises prices and/or lowers profits.
This process will play out over the next 4 decades. It will be slow
and inexorable.
The Boomer generation will demand goods and services, and because
there are not enough workers, the economy will not be able to supply
enough and workers will demand more of the saved assets of retirees
for what they produce. This can come as increased prices for the
production, or as a drop in the value of the saved assets or both.
If today one share of Cisco will buy you a meal at Denny's, will it
buy you a meal in 2020? People investing in Cisco today hope that the
price of those shares will rise to where it will buy several meals.
They expect stocks to rise 7% a year. However, in 2020 when there are
not enough workers to produce everything that retirees wants, the Law
of Supply and Demand means that it will take more Cisco shares to buy
a dinner than we currently plan on. Unless, of course, we can find
more workers.
What Happens If You Don't Compound at 10% Over the Next 10 Years?
Let's look at it another way. If I am right and we are in a long term
secular bear market, and the average stock does not rise over the next
8-10 years, let alone at 7-9% year, then how many people will be able
to retire on schedule?
How many people go to their financial planner and assume a 7-8% or
more growth in their stocks so that they can afford to retire? What
happens to the forecast if the growth rate is only 2-3%? We will find
people coming to 65 and finding they need to work and save a few more
years.
In the same way that our grandparents had to work a few more years (on
average) than our parents, our Boomer generation will have to do the
same.
You see, the part of the story where our kids come to us and want 50%
more for their work doesn't happen. We never get there, because
slowly our generation, on average, is forced to work longer. Supply
and Demand balance the scales slowly. There is no crash into the wall,
no strike by the younger workers forcing an abrupt change. The market
adjusts things slowly.
The data Arnott and Casscells show is that this adjustment is in the
retirement age. Will it be forced by a rise in costs or inflation? Or
will it be forced by a fall in the price of assets? Or some
combination of both?
I can make a cogent argument for all three, although I would choose
the combination scenario, which fits into my Muddle Through scenario.
What Could Make a Difference?
One factor which could totally alter this scenario is that we
dramatically increase immigration. A selective and aggressive
immigration policy could make a big difference. But it would have to
be at a level much larger than today's one million or so immigrants.
The paper suggests that at the height of Boomer retirement, we would
need 4,000,000 immigrants per year.
Right now, that is politically impossible. But in 15 or 20 years I can
imagine a set of circumstances which would favor more open
immigration.
Another thing that could change would be emigration, or an exodus of
retirees from the US. If you are living on a fixed income, and can
double your lifestyle by moving to sunnier climes, then I think more
and more of the adventurous will choose to do so. There will be plenty
of people who will be able to retire far before 70, when they are
capable of an active life, and will choose to do so in Costa Rica,
Mexico, New Zealand or any of a score of countries that offer good
services and low costs. With modern communications and cheap travel,
there is no reason not to put that into your personal equation.
I do not understand how anyone can retire on a Social Security income
alone. It is simply not enough anywhere in the US. But that same
income goes a long way north of Puerto Vallarta in communities filled
with retirees. Right now, Social Security income will buy you a lot in
Argentina or Brazil.
Social Security Solutions?
I assume you know by now there is no Social Security lockbox, except
in the rhetoric of politicians. Social Security is a transfer program.
It transfers income from workers to retirees. When you pay into Social
Security, you get nothing but a government promise. You do not own
any assets, as opposed to what you own in your 401k.
Do I believe that politicians will honor that "guarantee?" Of course.
They wouldn't be politicians otherwise. But I think the terms of the
deal will change on the margins. They will slowly raise the age of
retirement and probably do some sort of means testing. Further, the
dependency ratio tells us that current Social Security payments won't
be enough (surprise, surprise!)
We all know that there is a "crisis" coming in 2030 or thereabouts.
But as the dependency ratio rises, costs of services, especially those
in demand by retirees will rise faster than Social Security increases.
(See my argument on health care a few weeks ago.)
If they raised Social Security taxes enough to allow retirees to
afford to retire, the percentage of income would be huge. It is not
politically possible. The solution is that retirement ages will rise
over time, pure and simple.
Or politicians may punt and let the market do it for them. Let's say
Social Security is privatized. If Arnott and Casscells are right, then
the market returns on the money saved would not be enough to retire
on, so people would need to work longer. The fact that retirement
costs more makes the retirement age rise, without politicians having
to do anything. The more cynical part of me suggests that this may
happen, so that the current generation of politicians, who will "fix"
the system, will already be retired when the problem becomes apparent.
Be Honest With Yourself
The most important implication of this study is that the average
retirement age will rise because it will cost more to retire. When you
are planning for your retirement, you need to factor in a reduced
return on your stocks and investments and an increased cost in terms
of your assets for what you want to buy.
If you are expecting investment returns like those of the 90's to get
you to your desired retirement income level at a specific age, you are
probably dreaming. You are going to be disappointed. You are going to
get to that hoped for retirement age, and still need to save some more
and work longer.
But that is not all that bad. Average life expectancy is rising 3
months for every year over the last part of the century. That means in
the last 28 years, life expectancy has grown 7 years, and by over 14
years since WWII. The quality of that life has increased dramatically
as well. If our generation gets to live a lot longer, and if one of
the conditions for that increased lifespan and quality of life is
working a little longer than our parents, then that is a trade I make
very day.
In fact, studies show working a little longer is good for you.
Retirement is bad for your health.
As I have written for the last three years, stock market returns,
especially from one way mutual funds, are going to be dismal for this
decade. If you have not done so, you need to begin to adjust your
portfolio to absolute return type strategies. Bonds, of course, come
to mind, but I am also referring to dividends, certain types of hedge
fund strategies and other income opportunities which offer guaranteed
income. The returns from these may be less spectacular than what you
want, but they will be steady. Making risky investments or hoping that
the stock market will come back so you can make your retirement goals
is not healthy. "Reaching for Yield" is often a ticket to
disappointment.
It is better to put a realistic plan together, and either save more or
plan to work longer. If you already have enough, then don't let some
stock broker tell you that you must be in the stock market. Secular
bear markets are times to be conservative. As Dick Russell says, "He
who loses least in a bear market wins."
Deflation? Inflation? Gold?
In the short term, I still believe deflation is the issue confronting
us. I sat with Wayne Angell, the former Fed Vice Chairman, at lunch in
San Francisco this week, prior to his speech to the Public Pension
Funds Forum. Angell, who for 8 years had his office next to Alan
Greenspan's, probably knows his mind as well as anyone. He now makes
his living trading interest rate futures and doing some consulting. He
believes we will see long term rates fall further, and thinks long
term rates for treasuries will drop below 4%. He told the conference
that deflation would be a serious problem, but that he believes the
Fed will do whatever it takes to make sure we do not slip into serious
deflation.
These efforts should bring back inflation at some point, and when it
does, the Fed will raise rates. But that is not in the cards for the
near future. Angell says that Greenspan is not through cutting rates
if the economy stays soft. (I leave to another time the discussion as
to whether it will do any good.)
While the retirement data does not mean we will definitely see
inflation rise over time, I think it is likely, as the dollar falls
over the next few decades and demand outstrips supply on local
services. But not this year, and not next year. A reversal of the
deflationary pressures in the world is going to take a long time. It
is not altogether clear when this will happen, so investments in one
way funds (those that depend on the market going up, like mutual
funds) is an aggressive investment strategy.
This also argues for gold over the long term, as it has been a stable
store of value. Your Cisco share might not buy a meal at Denny's but
your gold will probably buy the same dinner and maybe even dessert.
Whither the Stock Market?
Let's look at a few themes I have written about this year. Earnings
quality is poor, and we are becoming more conservative about how we
calculate earnings. Valuation, which we touched on last week, is still
far above the average. The risk premium of stocks over bonds is
getting better, but is still far from average. Deflation from overseas
pressures is still a huge factor in the profit picture, creating
little pricing power for US corporations. Capacity Utilization is
poor, dropping another 0.8% this month to 74.4%, which is quite weak.
This means there is little capital spending by business.
On top of this, Boomers who are nearing retirement are not going to
wait until they retire to begin to sell stocks, especially if the see
them as increasingly risky. All of this taken together means more
downward pressure on stocks. We are still a long way from the bottom,
both in absolute terms and in terms of time.
Harry Dent May Be (Probably Is) Wrong
Finally, I promised an analysis of Harry Dent's main proposition that
the growth in the Baby Boomer generation was the reason consumer
spending and the stock market rose. He says this trend will continue
until 2008, when the Boomers start to retire. He shows lots of charts
which show a high degree of correlation.
But correlation is not causation. The price of butter in Bangladesh
can be highly correlated with the S&P 500, but there is no fundamental
connection. The reason spending went up was that Boomers had fewer
kids, and thus more discretionary money than their parents. They also
had more to save, which boosted the price of assets.
Thus, in my opinion, the correlation should be with the dependency
ratio that Arnott and Casscells present us with. That means that,
looking at their graphs and data, the negative effect from the Boomer
Generation does not wait until 2008 but is beginning now, or at the
most a few years from now.
The Economy is Not the Market
Once again, I need to emphasize that the economy and the stock
market are not correlated over time. There are plenty of
periods where the economy grows and the stock market is
stagnant. We are in one now. This decade will see growth in
GDP over time, although we will likely have another recession
or two. This is the Decade of the Muddle Through Economy.
Investors can make decisions today that will allow them to
prosper through this decade. No one is holding a gun to your
head to make you take a buy and hold strategy in your mutual
funds or stocks. You need to buy stocks which will pay you to
hold them (dividends) or public funds which can go both long
and short like David Tice's Prudent Bear Fund (BEARX), which I
have written about in the past, or certain types of hedge fund
strategies which do not depend on a bull market to make money,
if you qualify as an accredited investor.
Houston, We Have A Party
I leave in a few minutes for my Rice University 30th Class reunion. I
remember being an undergraduate and seeing those guys who graduated
in the 1940's and thinking how old they looked. I am sure I will be
shocked to see how my guy friends have aged just like those old guys
from 1942 did. The ladies will still look as lovely as ever, thank
you.
On Sunday morning at an obscene hour, I leave for New York to analyze
yet another hedge fund, and then Monday will do the keynote luncheon
address at the Hedge Fund Investments Styles and Strategies
conference. My speech is called "Getting Absolute Returns in a Secular
Bear Market." I will then come back and not leave until I finish my
book-in-slow-progress, Absolute Returns, except for a vacation or two
with my wife. I will be posting draft chapters as I finish them at
www.absolutereturns.net .
Late next week, subscribers to my free Accredited Investor E-letter
(on hedge funds and alternative investments) will get a new edition.
If you are an accredited investor (basically $1,000,000 net worth, but
complete definitions are available on my web site), you can go to
www.accreditedinvestor.ws and subscribe for free. The letter is
growing rapidly in popularity as we continue in this secular bear
market, and if you qualify, I strongly suggest you subscribe. If you
would like to know more about me, you can go to www.johnmauldin.com
which ahs a link to all the above sites.
Have a great week, and think about how much fun it will be to get
older if you invest in friends and family, where there are real
dividends and no taxes.
Your not even thinking about retiring at 70 analyst,
John Mauldin
John@2000wave.com
Copyright 2002 John Mauldin. All Rights Reserved
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