The following blog entry (entitled “The Baby Boom Butterfly Effect”) was originally posted on The Social Security Blog.
Butterfly Effect - The idea that small and seemingly insignificant variations in the initial conditions of a complex system ultimately have the potential to produce large and often radical variations in the final outcome of that system.
While many people assume that stocks increase in value when there are more buyers than sellers, this is actually a common misconception. In reality, the number of buyers and sellers is always the same, because for every person who sells a share of stock, there can be one and only one person who buys that share. In other words, a person cannot buy or sell anything unless there is another person to complete the transaction. So when stock prices go up, it is not necessarily that there are more buyers than sellers, but that buyers are much more willing to buy than sellers are willing to sell. The forces of supply and demand are in constant interaction.
It should be noted that there are a fixed number of shares for each and every publicly traded company. In other words, the supply of shares is fixed. However, the demand for these shares is variable, and changes in demand cause stock prices to rise and fall.
The Baby Boom generation was much larger than its preceding generation, and it is also much larger than its succeeding generation. As members of the Baby Boom generation began investing in the stock market, their collective numbers created a surplus of demand, and this excess demand caused stock prices to increase at a much faster rate than that warranted by normal economic growth. A quick look at a stock chart will reveal that stock prices did not begin to explode in value until members of the Baby Boom generation began careers and started investing en masse.
The stock market functions much like an auction. No matter how many bidders there are for a particular item, there can be only one buyer, and the auction is simply a practical means of figuring out what someone is truly willing to pay for an item. And when there are many potential buyers, sellers can usually demand higher prices.
It is important to realize that while the Baby Boom generation created a surplus of available investors, these investors will soon begin to retire. And when they begin liquidating portfolio assets in order to fund their retirements, they will be selling stock at a rate much faster than the next generation will be able to buy it. There will be a comparative shortage in the supply of investors, and this shortage will create a significant decline in the demand for stocks.
As this decline in demand begins to negatively affect stock prices, people will be less likely to make new investments, and this in turn will create even less demand for stocks. This does not mean that the stock market is headed for a crash. However, there will be several factors working heavily against stock returns in future years, and while there will always be good opportunities for investment in individual companies, overall stock market growth will likely slow quite considerably.
Now is not the time to start investing Social Security assets in the stock market.