GENERATION "Y ME" / THE WALL STREET JOURNAL OP EDITORIAL ( HIGHLY RECOMMENDED READING )

OPINION

JANUARY 22, 2011.

Generation 'Y Me?'

Demographic changes here and abroad mean young Americans face a bleaker investment future than their parents did.
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By MICHAEL CASEY JR.

Times are hard for those of us in Generation Y. After voting two to one for Barack Obama in the heady days of November 2008, the realization that we'll end up working harder than previous generations—and with less to show for it—is descending like a bad hangover.


According to the Pew Research Center, roughly two-fifths of Generation Y (broadly defined as those born in the 1980s and '90s) remain unemployed. Studies by Yale economist Lisa Kahn indicate that those who begin their careers in a recession face diminished lifetime earnings. Moreover, as the national debt and unfunded liabilities grow and future tax burdens reach crippling proportions, the prospects for intergenerational mobility are fading fast.


While policy makers have touched on these issues, they've ignored one key aspect—gloomy long-term financial returns. The conventional wisdom bequeathed to our generation was simple: Buy stocks and hold them for the long run. With the S&P 500 returning nominal compound annual growth rates of 10%-12%, individual retirement accounts (IRAs) and 401(k) plans were thought to offer a sure-fire means to generate wealth over a lifetime. Investment advisers were quick to ignore those ominous lines enclosed with every investment prospectus: "Past performance is not indicative of future results." Rather than viewing those lines as a legal disclaimer, Generation Y should treat them as a statement of fact.


However, the structure of the global economy and financial markets are changing before our eyes, and three developments portend diminished returns for Generation Y.


First, traditional stock valuation is anachronistic. Stock prices often no longer represent the present value of future dividends. Even if they did, the record levels of cash on corporate balance sheets imply a paucity of investment opportunities, meaning reduced future dividends and lower stock prices.


With the proliferation of "dark pools" and algorithmic traders—a recent study by the TABB Group revealed that the latter account for 56% of all U.S. equity trades—fundamentals no longer matter as much as they once did. Gone are the days of equity markets serving as a source of investment for capital formation; stock investors now buy volatility.


Second, in addition to burdening us with onerous Social Security and Medicare payments, baby boomers will deplete Generation Y's wealth through the dynamics of portfolio management. Typically, as investors age, they shift from variable-income securities to fixed-income securities—from stocks to bonds.


As the nearly 80 million baby boomers make this shift, demand for stocks will decrease, implying depressed equity values. As demand and trading volume decrease, existing investors may be exposed to bouts of extreme volatility, as the prices of thinly traded assets fluctuate erratically.


Finally, the cold, hard reality is that the U.S. no longer occupies the privileged position it assumed after World War II. As the nucleus of the Bretton Woods system, the U.S. controlled the world's reserve currency, underwrote global security and economic growth, and served as the consumer of last resort. The easy prosperity attendant with abundant capital inflows, unconstrained monetary expansion, and steadily appreciating asset values is over. Generation Y will need to search elsewhere for yield.

The most promising opportunities will be in emerging markets like Brazil, India and China. Goldman Sachs already estimates that more than half of the global assets under management are outside of the U.S. Savvy young investors likely will allocate greater portions of their portfolios to the stocks of foreign companies and the bonds of foreign governments that are investing in economic growth rather than spending on entitlements. Perversely, U.S. investors will finance the growth of foreign companies instead of American ones—contributing further to American economic decline and reducing U.S. equity returns.


The trends are discouraging, but policy makers can make a difference. Rather than printing money to stimulate consumption and inflate asset values, they should abandon their quixotic attempt to return us to a higher level of comfort on the same downward economic trajectory. Rather than saddling us with more debt to finance entitlements, policy makers should invest in physical and communications infrastructure, adopt competitive tax policies, and offer incentives for foreign investment into the U.S.


Improving the U.S. investment climate will ease America's short-run economic challenges and make us more globally competitive over the long run. Given the dissolution of private pensions and the ballooning tax burden of Social Security and Medicare, attracting investment is the best hope for Generation Y to build wealth and pursue the American Dream.


Mr. Casey is a consultant to private equity, hedge fund and corporate investors in emerging markets.


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