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Much has been opined on the impact of the increasing middle class in emerging market economies on global GDP and the growth of equities markets. Less has been reported on the generational shift in the U.S., as Millennials replace Baby Boomers as the largest group of investors. 

However, more recently a number of studies have considered how the greying U.S. population may affect GDP and stock markets. The conclusion may not be what the financial services industry and investors want to hear: Namely, that a marked contraction in U.S. equities price/earnings (P/E) multiples is highly possible over the next 10-15 years.

Baby boomers and Millennials are different investor personalities, with boomers more likely to own stocks as a hjgher percentage of their net worth than Millennials. In addition, Millennials possess a high degree of distrust for the finance industry.

Consider the Baby Boomer retirement problem, which poses a major headwind for equities markets.

The Baby Boomer population hump will create a retiree hump in a few years. According to the U.S. Census Bureau, in 2000, the country's largest demographic group was between the ages of 35 and 40. Today, this group is between 50 and 55, and the largest demographic group are Millennials born between 1980 and 2000.

As time progresses, Baby Boomers owned equities during what Bill Gross called a Golden Era of investing from 1982 to 2007 will soon become net sellers.

The Boomer generation's formative investing years were the greatest period of stock market returns in U.S. history. Boomers are the largest believers in a financial system from which they benefited. Their experiences trading equities was more positive than for other generations. 

Boomers embraced stocks as a much higher percentage of their net worth than previous generations or Europeans. But was the boomer experience the benchmark for generations to come? Or was the investing period of 1982-2007 an outlier? In a recent Fortune magazine piece, Bill Gross referred to the period as a "Black Swan," with above average returns on stocks and bonds that face a low probability of repeating. 

In 2012, economists, Robert Arnott and Denis Chaves published what's considered by some to be the largest study ever on the effect of changes in age distribution on economic growth, stock and bond market returns. The objective was to assess whether changes in the age composition of the population significantly affected equity and bond returns and/or on economic growth. The study's conclusion was that a 1% higher concentration of 50-54-year-olds would lead to an increase in annual excess equity returns of approximately 1%. Likewise a 1% higher concentration of the 70-plus age group would lead to a decrease in annual excess equity returns of about 2%.

In addition, in 2011 the Federal Reserve Bank of San Franciscofound a compelling relationship between the age distribution of the U.S. population and equity market valuation, measured as the P/E or price-to-earnings ratio. Using what they call the M/O ratio, which measures the middle-aged group (those 40-49 years old) to the older age group (those 60-69 years old), they concluded declining equity valuations out to the mid-2020s, with a resulting U.S. P/E ratio bottoming out at eight to nine times earnings. 

Furthermore, the McKinsey Global Institute in 2012 found that U.S. households reduce equity exposure in a meaningful way as they age, a study that buttresses Arnott's and Chaves' conclusion that large groups of 70-plus year olds bode ill for future equity returns. Equities investments drop to a 27% allocation for those over 65 from 47% for 35-65 year olds. 

Millennials might be inheriting far less of their boomer parents wealth than they think. That is not only because of the understandable liquidation of assets but also because of unprecedented, health-related costs. This comes at a time that has seen the fastest acceleration of health care costs in American history.

Boomers are burning more of their retirement nest eggs on medical costs than any previous generation. A study published Feb. 4 online by the Journal of the American Medical Association (JAMA) Internal Medicine, found that Boomers were less likely to report excellent health and participation in regular exercise, and more likely to suffer from obesity, hypertension, diabetes, and other maladies than other generations. The report found that Boomers were twice as likely to use a "walking assist device," such as a cane. Aging baby boomers are fatter and sicker than their predecessors were at the same age. 

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The combination of these trends is deeply concerning, particularly given that according to a Goldman Sachs report, the market already ranks in the top 85% to 100% in overvaluation.  

But the situation may only worsen, given the investing tendencies of Millennials. 

Millennials didn't experience the investing Golden Age of 1982-2007 as described by Gross. Instead, they have lived in a period of frequent crisis. Current 35-year-olds graduated into the internet/Enron/Worldcom massacre of 2000-2001. Current 26-30-year-olds graduated college in the housing/black swan crisis of 2008.

Scandals, large market drawdowns, and billion dollar finance industry legal settlements have built Millennials' distrust in equity markets. Since 1998, the following events have occurred:

  • the Enron and Worldcom bankruptcies of 2001-2
  • the Nasdaq market maker price fixing scandal among dealers
  • the tainted internet sell-side research scandal that led to a 2003 settlement worked out by then New York Attorney General Elliot Spitzer. 
  • the housing crisis and mortgage scandal of 2009 fueled by the structured credit/synthetic CDO controversy so famously epitomized by the "Fab Fabrice" of Goldman Sachs;
  • leading more recently to the libor rigging scandal of 2015 and the more current currency market making investigation.

In a 2015 survey conducted by the Harvard Institute of Politics, just 14% of 18-29 year olds said they trust Wall Street.

Millennials are less loyal to historical American brand names, and less confident in American consumer culture. Millennials are far less attached to ownership of things like houses and cars, and perfectly comfortable with access via renting rather than owning. In addition, a recent UBS report found that Millennials seek lower risk investments than older generations. Millennials are surprisingly more focused on a shorter investment horizon, and thus stick to lower risk portfolios.

This lack of trust in the finance industry has become accepted so widespread that it's even referenced in popular comedy shows geared toward Millennials. In June of this year, HBO talk show host John Oliver of "Last Week Tonight" mocked a string of popular commercials for major financial institutions touting financial advisors and their capabilities. Oliver comically dissected key products like annuities, a large part of the investing vocabulary of Boomers, as well as the fact that broker-affiliated Advisors could legally collect commissions on the sale of investments without disclosing the compensation arrangement.

The demographic shift will mean a change in how clients invest their assets.

First of all, the myth of consistent, dependable 7% long run returns on U.S. stock indices, a metric often plugged to investors to get them to embrace traditional financial planning products, will not hold. A new period of lower, long-run average returns of equities, or even zero returns, is more likely.

Secondly, active management will return to favor if we enter a period like 1967-1982, where the S&P 500 equity index was flat over 15 years. Passive investing, or long only buy and hold, will end. This counters conventional wisdom that investors will be less likely to embrace active management because of its higher fees for often uninspiring returns relative to indices. Instead, stock picking and alpha generation will be key. That is, the search for lower fees won't necessarily mean passive investing. 

Finally, in the lower fee environment, investors will need to discard the traditional hybrid commission advisor model, where advisors earn 1-2% wrap fees in addition to undisclosed commissions on the sale of investments. All-in fees in the hybrid model can average 3-5%, a level of cost that could consume all annual investment returns.

This will require a departure from high-cost, conflicted, commission-oriented advisors, and a move towards fee only, non-broker affiliated fiduciaries. Investors will no longer be able to afford paying the high fees associated with the traditional broker-advisor model.

In the aftermath of the 2008 banking crisis, major financial services firms have placed more emphasis on asset management. The changes resulting from the aging of the baby boomer population and rise of Millennials could dramatically impact bank earnings over the next decade -- if not beyond.