Reader's Question: Are Retiree's Driving Stock Market?

In a recent comment Financial Ruin asked:

Despite the economy's seemingly poor condition, the stock market is moving upward. One of my acquaintances insisits that what is driving the stock market is not economic growth, but the maturing baby-boomer's need to put their money "somewhere". In other words, the retirement money in 401K's by the soon-to-retire population bulge known as the baby-boomers is driving the stocks, not value. Any truth?

My response:  No, not if by that your friend means that the shift in investment funds itself is what is driving the stock price up. 

What drives any stock's price, and thus all stocks' prices, is the market's assessment of the current value of its future profit stream, discounted for risk and time. If a stock's price goes up, this means that the marginal investor expects the firm's profits per unit risk to rise.   It can be due to either firm-specific developments or to economy-wide developments which affect the firm's revenues, costs, or risks.  

Just because there is "more money invested" does not mean that stock prices will rise -- the act of choosing to buy a stock does not make the management of the company smarter, or its production processes better, or its cash flows less risky.  But the belief by the market that the company is smarter, more efficient, or less risky will, when investors trade on that belief, cause its stock price to rise.  

Think about this issue at the level of the individual transaction:  what would make you willing to pay $10 for a share of XYZ, Inc. instead of $9? If you believed that you would get a higher return on  your investment, even after paying a higher price. You see higher profits per unit risk in the future of this company, or you follow the investment strategy of someone who expects good things of this company.  It is the forecast of higher cash flows and/or lower risks that generates the demand and encourages investment, not the size of the pile of money being invested.

Better?  Or still too subtle?

Comments

[senior living long island]

The stock market is very volatile and erratic. I will not advise playing on Wall Street for retirees to burn their funds away. They are better off with a small business.

[Sherry Jarrell]

I appreciate your comment! Both endeavors involve risk; one you control (the small business); the other you experience passively (investing in a portfolio of stocks). Overall, the risk associated with running a small business is probably greater than that from investing in stocks -- but I am talking about both sides of risk -- the risk you may lose AND the risk you may gain. Risk is "uncertainty." Typically, as we approach retirement, we need to limit our risk exposure and maintain capital as we have fewer opportunities and less time to recover from a loss.

[forecast stock market]

I agree. I know of several retirees from the corporate world that are active in the stock market.

[retirement communities New York]

I also believe that the stock market is a little too risky for retirees to venture in unless they have started their investments early on.