Personal consumption is the largest pillar of U.S. GDP, accounting for 70 percent of the economy.1 Since the 1980s, the Baby Boomer generation—born between 1946 and 1964—has been an enormous engine of that spending.

But as the Boomers pass the torch of “largest generation” to the Millennials, several questions arise: Will the younger generation provide the same engine for GDP growth that the Boomer generation has? Will they have similar spending patterns? And how should investors position their portfolios to make the most of this transition?

Morgan Stanley Wealth Management recently examined the effect that this outsized generation will have on U.S. GDP and specific sectors in the economy, and found several key shifts.

A Challenging Environment

This year, Millennials—born between 1980 and 1996—eclipsed Boomers as America’s largest generation, numbering 83 million.2 However, the two generations came of age in vastly different worlds. Millennials have grown up in the shadow of the Great Recession, are saddled with higher education debt and housing costs, and are forming households later. These factors dramatically affect how Millennials spend.

Educational spending may come to define the Millennials the way owning a house and two-car garage were emblematic of the Boomers. On average, Millennials under 25 use twice as much of their total spending on education as their parents did.3 Higher costs have meant more student debt which has put a damper on spending. From 2005 to 2012, the average amount of student debt for Americans under 30 has nearly doubled from $13,340 to $24,897.4

Worse, although Millennials are the most educated generation in history with 61 percent attending college5, they’ve encountered a more challenging job market. Millennial employment rates plummeted during the financial crisis and still haven’t fully recovered. In addition, more Boomers have opted to stay in the workforce for longer, which may be squeezing Millennials on the career front.6

Employed Population Ages 20-34 (as of May 21, 2016)

Source: Haver Analytics, Census Bureau, Morgan Stanley Wealth Management GIC

Changing Households

Another key differential between Millennials and Boomers: household formation. The oldest Millennials have been marrying later, affecting many related consumer categories such as furniture, appliances, and child care. However, between 2011 and 2015 household formation began trending upward and should accelerate moving forward.7

The housing market has also changed. Home prices have increased 250 percent since 1980 and Millennials under 25 are spending 7.7 percent more of their wallet on housing than the Boomer generation did at that age.3 As a result, the number of non-married people under 35 sharing a home or apartment has grown.

But despite room sharing, 89 percent of current Millennials who rent still plan to buy a home, compared with 77 percent of Generation X.8 As Millennial employment continues to improve and household formations grow, Millennials could fuel new sales in the housing market.

Life-Cycle Spending

Despite these new factors, the younger generation is still subject to the same powerful force as their parents: growing up.

As consumers age, their spending increases, with the U.S. consumer’s peak earnings, spending, and investing years between ages 35 and 55. This increase is most noticeable in housing and insurance, as the next generation settles down and starts families.

Consumption Levels by Age Group 1984-2013

Source: Haver Analytics, Bureau of Labor Statistics, Morgan Stanley Wealth Management GIC. Data are average expenditures in nominal dollars from 1984 to 2014.

In 2016, the first Millennials turn 35 and begin entering this peak spending age. As the rest of the cohort enters their peak spending years, their aggregate spending is expected to increase 25 percent, driving demand for new homes and financial security. College loans may be swapped for home loans and life insurance as this new generation takes on the responsibility of economic growth.

We note, with a more than a little bit of curiosity, that the last secular bull market in U.S. stocks began in 1982—just when the first Boomers turned 35.

Expenditures of People Under 25 as a Percentage of Their Total Spending

Source: Haver Analytics, Bureau of Labor Statistics, Morgan Stanley Wealth Management GIC

Still the Spending Driver

The difference this time is that the Millennial’s parents will still be alive to contribute. When Baby Boomers took the reins of growth in the 1980s, only 12 percent of the population was older than 65. In 2016 that number is 15 percent, and as the rest of the Millennial cohort ages into peak spending through 2046, the 65+ population is forecast to increase even further to 22 percent.9 Boomers also control 70 percent of the nation’s disposable income.10 This is partly driven by accumulated income, but also by longer careers. That means the Boomer generation will still maintain enormous spending muscle. In the next two decades, spending by Americans over 50 is projected to increase by 58 percent, whereas spending by Americans 25-50 will grow by 24 percent.11

That said, the oldest Boomers are past their “peak consumption years”, meaning less spending on key categories like transportation, housing and apparel, with the windfall more than picked up by their children, netting out to about an average 0.77 percent demographic driven annual growth rate across sectors through 2060.12

But perhaps the greatest boom in spending for the Boomer generation will be in health care. Boomers are expected to use 3.4 percent more of their total spending on health care than their parents did, and through 2060 will contribute to a 1.04 percent annual growth rate in this sector by sheer number of new customers alone. This is 35 percent higher than the average demographic dividend across sectors over the same period, and represents possible significant secular outperformance.12

Projected Demographic Driven Growth from 1980 to 2060

Source: Haver Analytics, Bureau of Labor Statistics, Morgan Stanley Wealth Management GIC. Values are relative to the average return across all sectors of approximately 0.77 percent

The Bottom Line

Overall, the U.S. population is growing. As Millennials enter their peak consumption years and Baby Boomers live longer, the two groups will provide a double-barreled boost to consumption, bringing with them increased U.S. GDP.13

Within this overall growth, the changing demographic structure is creating important spending shifts. Watch for relative outperformance of the health Care, housing, and entertainment sectors, and relative underperformance of education, apparel, and transportation as the country matures.

Read Important Disclosures Here

© 2016 Morgan Stanley Smith Barney LLC. Member SIPC. All rights reserved.

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This article was adapted from the Morgan Stanley Wealth Management Client Conversations report “Demographic Destiny: Are Millennials Spending Differently Than Baby Boomers?”

For more Client Conversations reports, talk with your Morgan Stanley Financial Advisor, or find one here.