← Autodidact Archive · Original Dissent · Walter Yannis
Thread ID: 3574 | Posts: 8 | Started: 2002-11-18
2002-11-18 06:27 | User Profile
Here's an article referenced in Yggdrasil's weekly column "Money and Markets" [www.ddc.net/ygg]
It's from Morgan Stanley, and it contains some very alarming statements. We're about to pay the piper for the baby boom generation's failure to reproduce.
Walter
The transition to a post-bubble era is daunting, to say the least. To the extent that return expectations of consumers, companies, governments, and investors were set during the days of froth, a rude awakening is now in order. That especially pertains to a wide array of contingent liabilities in the system ââ¬â the funding of which was predicated on a pace of asset appreciation we may never see again. The resolution of this mismatch could well be the central challenge of the post-bubble era.
To oversimplify, assets are about today, whereas liabilities are about tomorrow. During the Roaring 1990s, financial assets ââ¬â especially equities ââ¬â were valued as if they would keep yielding bubble-like returns in perpetuity. The actors in the system became true believers in the legitimacy of these valuations. They established liabilities ââ¬â such as pensions, retirement lifestyles, and debt-service obligations ââ¬â that could only be funded if returns held to these new norms. The gap between assets and liabilities was presumed to be closed by a steady stream of reinvestment at high nominal yields. Few ever contemplated what would happen to this equation in a low yield environment. The asset-liability mismatch is all about the New Math of a low-return post-bubble era.
These mismatches are global in scope. They span borders, sectors, governments, and institutions. It is not easy to scale the full dimensions of this problem. A few key factoids hint at the enormity of the mismatch. Japanââ¬â¢s Financial Services Agency has just upped its estimate of the nationââ¬â¢s nonperforming bank loans from Y34 trillion to Y47 trillion. While still probably a serious understatement of the full extent of the problem, it nevertheless underscores the lingering inability of the Japanese banking system to intermediate the future stream of credit demands required to finance economic growth. At the same time, there are signs of distress building in the German life insurance industry; 20 of the countryââ¬â¢s 118 insurance companies are already on a special watch list of Germanyââ¬â¢s financial regulator and one researcher suggests that as much as one-third of the industry will fail over the next 3-5 years. Such a development would effectively devalue the stock of German personal saving. Moreover, much of Corporate America is still building in pension-plan return assumptions of 9% to 9.5% per annum into its earnings calculus ââ¬â well in excess of the returns that can be expected in this post-bubble era. This points to a potential overstatement of earnings and shareholder wealth. According to Steve Galbraith, pension gains in the bull market had been contributing as much as $100 billion annually to "operating income" of the S&P 500. In this bear market, a reversal of comparable magnitude is not out of the question. Steve stresses that cash funding requirements of pension plans are considerably larger, possibly in the $200 billion range annually.
All of these problems have one over-arching characteristic in common ââ¬â a markdown of current asset values in the face of an unchanged stream of future liabilities. An insolvent Japanese banking system, an impaired German life insurance industry, and an earnings-deficient US corporate sector all raise big question marks about future growth prospects in their respective economies. The same, of course, can be said for the unfunded pension liabilities of aging populations in the industrial world. Up until now, this has largely been a theoretical problem, something for the proverbial long run that has little immediate impact. But as bad luck would have it, the retirement of "baby boomers" has commenced at just the point when the post-bubble markdown of asset returns has occurred ââ¬â making an already large pension gap all the more intractable.
Nowhere is that more evident than for American consumers, who have long been net lenders to the rest of the US economy. US Department of Commerce data show that in 2001 US households received some $1,091 billion in interest income, well in excess of the $592 billion they paid in interest expenses. In other words, household sector lenders have nearly twice the exposure as borrowers to the vicissitudes of the interest rate cycle. While low interest rates may help debtors, those dependent on interest income ââ¬â especially aging workers and retirees ââ¬â are hurt. For older baby-boomers (ages 55-64), my colleague John Scowcroft calculates that the median family currently has a negative net worth to the tune of $173,000; for the 9.6 million families in this cohort, that amounts to an aggregate shortfall of $1.7 trillion. Consequently, a post-bubble markdown of asset yields would only compound an already difficult asset-liability mismatch for this key segment of the US population.
Itââ¬â¢s not easy to get a handle on the overall magnitude of these mismatches. Again, the anecdotes provide some hints. The numbers are huge, especially when it comes to pensions. Trevor Harris notes that in 2001 the total pension obligation for the S&P 500 amounted to $1.1 trillion. Moreover, a recent OECD study suggests that publicly funded old-age pension spending (i.e., state pension plans) for the nine largest industrial countries will have to rise by at least $350 billion between now and 2050 in order to keep benefits constant at current levels (see "Ageing and Income: Financial Resources and Retirement in 9 OECD Countries," 2001). These estimates are fuzzy at best ââ¬â and probably far too low, according to Trevor Harris. Any such calculations are highly dependent on unchanged demographics and productivity of the work force. Longer life expectancy and lower productivity growth, for example, would significantly boost pension obligations. Conversely, pushing out retirement ages ââ¬â a key focus of Germanyââ¬â¢s reform debate ââ¬â would lower pension obligations.
Nor can the cross-border ramifications of the asset-liability mismatch be ignored. This shows up most clearly in the extraordinary current-account disparities that have opened up in the world over the past decade. In particular, the funding of Americaââ¬â¢s massive current account deficit has led to ever-rising purchases of dollar-denominated assets by foreign investors. The International Monetary Fund estimates that 18.3% of all US long-term securities were foreign owned at the end of 2001; that works out to roughly $4.9 trillion in dollar-based assets held overseas, or 23% of the non-US portion of world GDP. By way of comparison, foreign holdings of US assets totaled just $1.5 trillion at the end of 1994, or only about 8% of non-US world GDP. During the bubble, foreign investors developed a voracious appetite for dollar-denominated assets and the sharply elevated longer-term returns they were presumed to offer. This "buy America" campaign was presumed to be a surefire recipe to help close the foreign asset-liability mismatch. That presumption is now drawn into serious question in this post-bubble era of lower returns. Needless to say, a decline in the value of the dollar from its present lofty levels would only compound the shortfall arising from the diminished ability of existing US assets to fund a future stream of foreign liabilities. Consequently, not only do foreign countries suffer from asset-liability mismatches of their own, but they have imported the American strain as well.
All this underscores the intertemporal aspects of the asset-liability mismatch. Liabilities are basically a given ââ¬â largely determined by the unrelenting ticking of the demographic clock and the social contract between governments, companies, and individuals. While it is possible to buy some extra time ââ¬â mainly through higher productivity growth and/or deferred retirement ââ¬â there can be no escaping the endgame. To the extent that pension liabilities ââ¬â both public and private ââ¬â to say nothing of retirement lifestyles, have been based on unrealistic growth expectations, the asset-liability mismatch underscores a new set of macro tensions. The choices are rather stark: Either policy makers reflate in order to boost nominal returns, or aging populations accept a wholesale markdown of future living standards. My bet is with the former. Squeezing an ever-burgeoning class of retired workers is the stuff of political upheaval ââ¬â an unacceptable outcome for the powers that be. By default, reflation may then be the only way to finesse the growing asset-liability mismatch. But even thatââ¬â¢s a delicate balance. Reflationary efforts that go too far result in high inflation ââ¬â an outcome that has an equally corrosive effect on individual lifestyles. In the end, itââ¬â¢s probably not that black and white. I suspect that weââ¬â¢ll probably see a combination of both policy reflation and reduced standards of living.
There is, however, one critical complication to the potential resolution of this mismatch ââ¬â the limits of conventional policy to fix it. With risks increasingly skewed toward deflation, the odds of a reflationary tilt to stabilization policies are high and rising, in my view. Itââ¬â¢s already happened in Japan. And now a similar drill seems to be unfolding in the United States ââ¬â 525 bp of monetary easing and a four percentage point swing in the federal budget balance as a share of GDP over the past two years. There is good reason to believe that Europe will probably be next to join the anti-deflation brigade. One small problem is that these policies may not work. A lack of policy traction is the rule, not the exception, once deflation has taken hold. Japanese authorities have long been "pushing on a string." And there is reason to fear that a similar phenomenon might unfold in the United States; the three sectors where policy traction is most likely ââ¬â consumer durables, residential construction, and business capital spending ââ¬â have all gone into a zone of excess that may not be responsive to counter-cyclical measures. To the extent that reflationary initiatives simply donââ¬â¢t bite, the asset-liability mismatch would then have to get resolved the politically incorrect way ââ¬â by tampering with the lifestyles of voters. Thatââ¬â¢s when the story could really get ugly.
[url=http://www.morganstanley.com/GEFdata/digests/20021115-fri.html#anchor0]Morgan Stanley[/url]
2002-11-18 18:13 | User Profile
The "insolvent" Japanese banks supposedly own $600 billion in bad debts with many informed guesses at 2 to 3 times that. The Japanese own something like $600 billion in US Treasury bills with some informed guesses stating they own 2 to 3 times that in other notes. Does this seem somewhat odd? Why should Japan shoulder a decrepit economy by themselves when some recovery is possible from selling American assets? I suspect if that starts to occur, we may see some startling changes in the world economy.
Some 13 years ago the Japanese stock market index (the Nikkei) approached 40,000 and has dropped more almost 80%. A great factor internally for the Japanese malaise was at that time young Japanese realized they could work an entire career at Mitsui, Mitsubishi or other great Japanese company and could not afford to buy a house unless they made the very top.
Young Americans may soon start to experience much the same.
2002-11-19 13:02 | User Profile
Originally posted by edward gibbon@Nov 18 2002, 18:13 **The "insolvent" Japanese banks supposedly own $600 billion in bad debts with many informed guesses at 2 to 3 times that. The Japanese own something like $600 billion in US Treasury bills with some informed guesses stating they own 2 to 3 times that in other notes. Does this seem somewhat odd? Why should Japan shoulder a decrepit economy by themselves when some recovery is possible from selling American assets? I suspect if that starts to occur, we may see some startling changes in the world economy.
Some 13 years ago the Japanese stock market index (the Nikkei) approached 40,000 and has dropped more almost 80%. A great factor internally for the Japanese malaise was at that time young Japanese realized they could work an entire career at Mitsui, Mitsubishi or other great Japanese company and could not afford to buy a house unless they made the very top.
Young Americans may soon start to experience much the same.**
[url=http://www.ddc.net/ygg]Yggdrasil[/url] has a great piece on the demographics of the stock market. It's must reading.
The basic idea is that in terms of demographics, America is now where Japan was about 12 years ago - Japan had its baby boom in the pre-war era instead of after the war as we did. Japan had a baby dearth, just as we did, but shifted ahead of us by about 12 years.
Ygg shows that these demographics translate into greatly reduced demand as people begin to retire and spend less. He also shows that the usual remedies such as slashing interest rates don't work, as retirees living on interest income react perversely to interest rate cuts by cutting consumption further.
It's 50 years of family-destroying Jewish Culture of Critique and its effects on our reproduction coming home to roost.
And they're ain't squat anybody can do at this point to stop it.
Walter
2002-11-19 20:26 | User Profile
Originally posted by Walter Yannis@Nov 19 2002, 07:02 **Japan had a baby dearth, just as we did, but shifted ahead of us by about 12 years.
It's 50 years of family-destroying Jewish Culture of Critique and its effects on our reproduction coming home to roost.**
Walter:
Then how did it happen in Japan? I mean, they're not over there (at least in any discernible presence) Why did Japan do this before us...all on their own?
-J
2002-11-19 21:41 | User Profile
Interestingly, the Japanese government has recrently started efforts to increase the birthrate while trying to keep Japan racially pure. Compare to the US that is making no real effort to increase the birthrate of native American whites but instead is importing Hispanics by the millions.
Why would the Japanese birthrate be so low? There's a lot of western influence in Japan, such as the feminist attitude that women should be wage slaves rather than mothers. Also, the population density of Japan is THIRTY times higher than in the US. This means that more people will feel the land is over populated and in the past the Japanese government certainly worked to discourage reproduction. Thus, Japan is now having the problems associated with a rapidly aging population.
In other words, I think Japan's problem started as population control efforts and now they are fighting against western influence.
2002-11-20 00:18 | User Profile
4 years ago I read a Bloomberg News Service piece that stated that US housing boom, the continuing upward spiral of housing costs was spurred by immigrants, not domestic American citizens.
How would all this impact that factor?
2002-11-20 13:01 | User Profile
"Demographics support an ongoing Big Shift of household financial assets into equities - and does so for another dozen or more years." Edward Kerschner, Paine Webber Investment strategist, WSJ 07/06/99 p C1
Hmm!
Wonder if he is right! Has he done his homework, or is he just eyeballing it?
I begin this statistical exercise with a bias that many of the things discussed in the financial media concerning stock valuations - things such as earnings, interest rates, etc - are not predictive of long term trends.
Rather, the critical element in determining stock prices is financial flows - money flowing into stocks versus money flowing out. The bull market of the 1980s and 1990s has been propelled by demographics. A huge cohort of "baby boomers" born between 1945 and 1964 began reaching age 35 - an age at which serious saving and investing typically begins - in 1980. Two years later, the great bull market began.
The demographics of the baby boom have driven the dividend yield on the S&P 500 down to 1.2%. A retiring boomer with a $1,000,000 account will receive only $12,000 per annum in dividends. For Boomer stockholders to live at anything like their current lifestyles, they are going to be net sellers throughout their retirement years.
The question is, when does this process begin?
In the past, I have speculated that selling pressure from retiring boomers will not be felt until about 2007. But is that accurate?
First, a few facts.
The typical corporate retirement plan allows early retirement at age 55 with full vesting. Defined benefit plans also typically allow early retirement at age 55 with significant subsidies for early retirement. Because of favorable reduction factors, the early pension has a greater present value than the normal retirement benefit typically provided at age 65.
For purposes of funding, the typical corporate defined benefit plan assumes an average retirement age of about 58 years. This means that the average dollar of pension liability walks out the door at age 58.
The earliest age at which Social Security benefits are payable is age 62. The average age at which Social Security benefits actually commence is age 63.5.
So the question is, when does the ratio of Americans aged 60 through 64 begin rising relative to the working age population age 35 through age 60.
As a first stab at this, I gathered the Census Bureau 1999 population projections by age for 1996 and later years. Although the Census Bureau provided projections through 2010 for ages 60 to 64, the nearest to a working age population that they provided was the age 15 to 45 group.
As the table below demonstrates, the age 60 to 64 group grows relative to the 15 to 45 group in every year, with a marked accelleration beginning in 2001, and an even steeper accelleration starting in 2005, when the oldest baby boomers hit age 60.
Retiree to Work Force Ratios Census Bureau 1999 Projections Age Groups in Thousands Year Age 60-64 Age 15-44 Ratio 1996 10001 119626 0.0836 1997 10062 119854 0.0839 1998 10261 120022 0.0854 1999 10508 119998 0.0875 2000 10654 119969 0.0888 2001 10925 119915 0.0911 2002 11310 119691 0.0944 2003 11938 119501 0.0998 2004 12383 119417 0.1036 2005 12807 119428 0.1072 2006 13085 119453 0.1095 2007 14233 119463 0.1191 2008 14772 119490 0.1236 2009 15453 119551 0.1292 2010 16215 119728 0.1354
But I was disturbed by the fact that the Census projections in the above table showed the ratio growing even in 1996. I was expecting to see a decline in this ratio throughout the 1990s market rally.
I suspected that the 1999 Census projections might be distorted by immigration, and in particular, the addition of a million or more minimum wage persons each year who will not factor into the stock market investment equation over the next 10 years.
Further, I found the totals for the age 15 to 45 group puzzling given the low mortality of this group and the huge legal and illegal immigration of nearly 2 millions per annum. The stagnant number of from 119 to 120 millions each year implies huge out-migration from the United States or far higher mortality than any reasonable mortality table would show.
Therefore, I decided to obtain the raw 1990 census data by 5 year age groups, and then adjust that data forward for the next 20 years, reducing the number in each group each year by the healthy female mortality from the PBGC tables published under section 4062 of ERISA for the oldest year in the 5 year group. This amounts to a unisex mortality assumption of the female table set forward 2.5 years. It should be an excellent assumption for the portion of our population that invests in common stocks and mutual funds.
The table below presents the results of that study for each year from 1990 through 2010, providing the ratio of ages 60-64/35-59, 60+/35-59, and the ratio of 60+/25-59.
As I had guessed, all three ratios declined throughout the 1990s, indicating upward pressure on savings and stock prices. The low points for each ratio, 1999, 2000 and 2000, respectively, are marked with asterisks on the chart below.
Retiree to Work Force Ratios - 1990 Census
YEAR Ratio of ages
60-64 to 35-59 Ratio of ages
60+ to 35-59 Ratio of ages
60+ to 25-59 ICI Stock Mutual
Fund Inflows
1990 0.1447 0.5707 0.3592 19
1991 0.1388 0.5610 0.3585 42.7
1992 0.1333 0.5507 0.3571 75.2
1993 0.1282 0.5399 0.3551 92.2
1994 0.1236 0.5288 0.3525 77.2
1995 0.1194 0.5172 0.3493 120.1
1996 0.1177 0.5096 0.3486 206.5
1997 0.1162 0.5017 0.3475 229
1998 0.1148 0.4934 0.3459 159.8
1999 0.1135 0.4849 0.3439
2000 0.1139 0.4761 0.3416*
2001 0.1158 0.4780 0.3449
2002 0.1191 0.4794 0.3478
2003 0.1224 0.4802 0.3503
2004 0.1196 0.4804 0.3524
2005 0.1227 0.4801 0.3541
2006 0.1271 0.4928 0.3631
2007 0.1339 0.5049 0.3717
2008 0.1406 0.5163 0.3797
2009 0.1472 0.5270 0.3873
2010 0.1450 0.5368 0.3943
So does this mean that the market will turn?
Absolutely, and no later than September of 2003.
The exact timing of when retiree selling will begin to effect price depends, in part, on the dynamic effects of today's high prices.
What happens when people win $20 million in the lottery? Uniformly, they find a reason to quit their jobs within a few months after winning. Wealth makes people retire earlier.
Thus, the enormous wealth generated by this historic bull market could be provoking early retirements in sufficient number to affect cash flows into stocks right now.
In fact, the narrowing of the market signaled by the topping of the NYSE advance-decline line in July of 1998 might be the first indicator of declining liquidity. Despite the new record highs in the popular indices, fewer and fewer stocks are particpating. The fall in mutual fund inflows in 1998 over 1997 might also be an indicator, but I would reserve judgment on this because of the August, September 1998 price decline.
The practical answer is that from now through May, 2002, each of you should be invested in stocks and mutual funds from Nov 1 through April 30, and out of the market entirely from May through October of each year. But beginning with May, 2002 onward, every time the market gives a 10-week rsi oversold reading and signals a momentum loss, you should invest in a short fund such as Prudent Bear (BEARX), Rydex Ursa (RYURX), Rydex Arktos (RYAIX) or Fleckenstein's fund. Before 2010, there will be 2 or more spectacular declines that will make you nearly as much money as you could have made riding the S&P up from 1990.
The question, then, is what could make cash flows into stocks slow down even before retirement selling begins in earnest?
To answer that question we must first explore what those flows are.
Below is a chart showing the sources of supply and demand for Corporate equities from the Federal Reserve's Z1 releases from 1990 through 1998.
First the demand:
Sources of Demand for Stocks Federal Reserve Z-1 Dollar Flows in Billions Year Households Purchases by Foreigners Bank Trusts Life Insurance Private Pensions Public Pensions Mutual Funds Other 1990 -26.3 -16 0.05 -5.7 -4.1 13.2 14.4 -13.7 1991 -33 1O.4 -8.6 17 6.9 31.2 48.5 5.1 1992 24.8 -5.6 -37 24.4 30.8 17.7 59.8 0.4 1993 -57.5 20.9 -55.2 36.3 16.9 44.3 115.3 16.7 1994 -159.8 0.9 -8.8 61.8 -1.7 29.3 100.8 1.9 1995 -192 16.6 1.6 18.6 5.9 41.3 87.4 17.4 1996 -291.5 11 -17.3 46.7 -9.6 52.2 193 6.7 1997 -521.8 64.2 72.3 86.3 -16.1 53.5 166.8 1.3 1998 -527.1 42.5 39.1 107.4 -52.7 70.8 143.3 -15.5
Notice that the biggest source of expected demand, households, is in fact the biggest source of supply.
And now the traditional sources of supply:
Sources of Supply for Stocks Federal Reserve Z-1 Dollar Flows in Billions Year Non-Financial Corporations U.S. Purchase of Foreign Financial Corporations 1990 -63 7.4 17.9 1991 18.3 30.7 28 1992 27 32.4 44 1993 21.3 63.4 53 1994 -44.9 48.1 21.4 1995 -58.3 50.4 4.8 1996 -69.5 60 0.8 1997 -114.4 41.3 -5.6 1998 -267 75.9 6.3
Notice once again that Corporations are the normal source of supply. Corporations are supposed to issue new stock and use the stock market as a source of capital. Now they are doing the opposite. They are buying back their stock, net of new issues, in record quantities at record high prices.
The two charts above scream at anyone willing to see and think. What we have is the household sector (consisting of founders, executives selling stock acquired on exercise of their stock options, and retirees selling long held stocks to support themselves in retirement) disposing of stock at unprecedented rates.
What you see above is a massive inter-generational transfer of cash from the Baby Boomers and the Corporations that employ them to founders, option eligible executives and to wealthy retirees.
A cynic would argue that the executives are looting their corporations of cash to prop up the value of executive options. In the high tech sector, companies sell puts on their own stock and buy calls, all on inside information. They use the proceeds to finance stock buy-backs, thereby forcing the call writers to cover. Dell has raised over $3 billions in the last two years playing this game. Microsoft does it too. All growth funds need do to out-perform the market is track option prices and volumes on these tech stocks and buy when puts are plentiful and cheap. After all, the biggest writer gets to peek at the company's order book!
It is unprecedented in human history.
I should note parenthetically, that the above tables should also make clear why new companies (less than 15 years of public trading) will outperform old ones heavily owned by 80 year old widows.
The $500 billions of cash being pulled from the market each year is an enormous amount of money. Can it countinue? Which sources of inflow are the least stable?
The answer is relatively obvious. The $267 billions in corporate buy-backs are the least stable flow. These corporate buybacks of listed companies exceeded profits net of taxes and net of dividends for 1998 of all corporations by $55 billions. Public corporations are borrowing money to buy back their stock. A recession would crumple the buy-backs. So will rising interest rates driven by rising inflation.
The increasing popularity of corporate buy-backs from 1994 through 1998, the truly manic phase of this bull market, tells us that the most manic and optimistic of all investors are the CEOs of public corporations.
In August and September of 1998, corporate CEOs stepped in massively and bought in the face of the sell off. In the Q3 they bought at a $308 billion annual rate and in Q4, at a $491 billion annual rate. They did it because their own businesses looked reasonably good and interest rates were plunging to record lows. Borrowing to finance buy-backs was cheap.
It was the CEOs of the fortune 500 who bailed out the stock market in 1998. Alan Greenspan was only a bit player who encouraged the banks to lend them the money to do it.
They are the wild optimists, and anything that sours their mood will cause a quick spill in the market. A rising dollar - rising interest rates - a serious economic slowdown - banks worried about declining credit quality, any of these could cause CEOs to become much more cautious about buy-backs.
The CEOs will continue this behaviour only if they think that it will produce a higher market and higher option values later. If they become convinced that the market is headed down, they are not about to throw good money after bad. Given the incentives, they buy high and sell low.
Recognize the enormous leverage in the flows. We have $500 billions in supply at these prices. If demand from buy-backs disappears, we have a $200 billion or so deficit in demand. Prices would have to fall a long way to bring the $500 billion supply down to equal that lower demand.
Ultimately, the stagnant work force projected by the Census department, and the swelling number of retirees with stock to sell will put an end to the corporate buy back game. Once the corporate CEOs recognize the demographic reality, they will not even try to prop up their stocks. Instead, they will begin to respond to retirees calls for higher cash dividends, persuade their consultants to begin pushing cash bonus plans tied to dividend increases, and lobby to have cash salaries in excess of $1,000,000 made deductible to the corporation once again.
Until then, investing is a game of guessing at how optimistic the corporate CEOs are.
Upon seeing the above two tables, I began to realize how anomalous the fund flows must be from a historical perspective. Markets simply could not function at all over the long term with the normal sources of supply and demand reversed in this way.
And the thought of asking corporate employees to put their retirement savings into stocks priced by such unsustainable flows seems criminal.
We have lots of excellent studies on the net analyzing the market in terms of PE ratios, price to book ratios, price to sales ratios and similar measures. For one of the best see Alan M. Newman. We have excellent valuation models like the federal Reserve's own model which you can see at Dr. Ed Yardeni's Economics Network. An excellent historical PE range chart can be seen at Decision Point.
But excessive valuations have had no predictive value in this market.
This is a new era all right. But the newness has nothing to do with technology, the internet, valuations or inflation. It is a new era because money flows have been warped beyond recognition.
And to see how truly unique the 1990s have been, I prepared a similar chart of demand and supply from the nine years of 1954 to 1962, a period of dramatically rising stock prices.
First, a picture of typical bull market demand flows:
Sources of Demand for Stocks Federal Reserve Z-1, 1954-1962 Dollar Flows in Billions Date Households Purchases by Foreigners S&Ls Insurance Companies Private Pensions Public Pensions Mutual Funds Closed End Funds Other 1954 0.3 0.5 0.1 0.5 0.7 0 0.3 -0.6 -0.1 1955 0.4 0.1 0.1 0.3 0.7 0 0.4 -0.3 0 1956 1 0.3 0.1 0.1 0.9 0 0.5 0.2 -0.2 1957 0.5 0.1 0.1 0.1 1.1 0.1 0.7 0.9 0.2 1958 0.3 -0.1 0.1 0.2 1.4 0.1 1.1 0.8 -0.5 1959 -1 0.4 0 0.5 1.7 0.1 1 0.1 0.1 1960 -1.2 0.2 0 0.7 1.9 0.1 0.8 0.6 0 1961 -1.1 0.3 0.1 0.8 2.3 0.2 1.3 -1.4 -0.4 1962 -2.7 0.1 0.1 0.6 2.2 0.2 0.9 0.1 0
And now a more typical picture of bull market supply.
Sources of Supply of Stocks Federal Reserve Z-1, 1954-1962 Dollar Flows in Billions Year Non-Financial Corporations U.S. Purchase of Foreign Financial Corporations 1954 1.6 0.3 -0.3 1955 1.7 0.2 -0.2 1956 2.3 0.1 0.6 1957 2.4 0 1.3 1958 2 0.3 -0.4 1959 2.1 0.2 0.5 1960 1.4 0.7 1.1 1961 2.1 0.8 -0.9 1962 0.4 1 0.3
In the above charts, capital markets operate as we expect. Households buy stock and corporations issue it.
The truth is that the stock market can only operate as an inter-generational cash transfer mechanism during periods when we have a falling ratio of retirees to workers.
As soon as a static or declining pool of workers detects selling pressure from retirees in the form of flat or falling prices, they will stop investing until dividend yields compensate them for the risk of rising retiree sales. Once Joe SixPack goes on strike, the buy-back bravado of the CEOs in the face of market sell-offs will quickly disappear.
Don't expect foreign investment dollars to bail out our stock market. Indeed, the demographics for the G7 nations are worse than ours. See the graphs at the end of Urban Institute Research Paper.
Protect yourselves!
Yggdrasil-
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2002-11-21 02:04 | User Profile
Why? Dividends are taxed at the investor's personal rate. Capital gains are taxed at only 20% (much lower than many incomes)
Now, you say "Well aren't retirees bringing in no income, so therefore they want dividends?" Not true. Sizeable investment income will push them into high brackets. Income of only 50K will get them 33% rates, whereas that's way higher than the capital gains rates.
Plus, there are lots of policy changes that can and will affect the market. What if Congress drops the cap-gains rate to 0%? Not even the damnest fool retiree would want dividends in that case.
Congress can also implement social security changes whereby young workers can invest in stocks. That'll prop the market too. Lots of options exist.
-J