I have written numerous articles about pensions and how many are underfunded (some drastically) even though stock and bond markets are at all-time highs. I have theorized that many, particularly public pensions, made promises that would be very hard to keep even if all things fell into place.
Of course, in many cases votes were bought and it was anticipated that as the bills came due it would be someone else’s problem. That day has now arrived.
Private pensions have been changed from defined benefit plans to defined contribution plans or 401ks as the cost of carrying a guaranteed benefit became too expensive for virtually all companies. The public sector seems to still be in denial but their plans do not appear to be sustainable. Bills that can’t be paid don’t get paid. It’s just that simple. You can demand all you want but you can’t get blood from a stone.
Many states, including Pennsylvania, are still in denial and issuing bonds (that cost us interest- maybe more than our returns at times) to make contributions to state and local pension plans. This is just throwing good money after bad in my opinion. Change appears to be being brought forward-possibly by years and maybe even decades because of the recent actions of the world’s central banks. Because of their “money printing” and asset purchases interest rates are virtually non-existent.
This has been a boom for the governments who have been able to issue debt to pay interest due, pay bills, retire old debt and keep providing freebies without having to raise taxes. Unfortunately- for me, you and all soon to be retirees these actions have deprived us of the one thing that we came to expect throughout our lives.
That one thing is that if we work hard and save we can make a deposit, earn interest and we can collect a lot more than we deposited because of COMPOUND INTEREST.
In the not too distant past a prudent person could make a deposit, get a decent return in a product as safe as a CD and watch their money grow with no fear of loss. Even in a “normal” time a return of 6% would not be out of the question for a 5-year CD. This would allow you to double your money every 12* years with virtually no risk.
Today, that same product may pay 1.5% which means your principal will only double every 48 years. * Quite a difference when you are planning for future retirement needs. It also puts more pressure on your other assets to perform to make up for these lacks of returns.
Pensions, which invest mainly in stocks, bonds and real estate have seen two major crashes in the past 17 years with, in my opinion, another one right in front of us. These type of gyrations wipe out years of gains in a matter of days and weeks. It takes years to make up these type of pullbacks.
How have the averages been doing in the 21st. century?
The Dow, since the year 2000 has an average annual return of 5.5% as of 8-3-2017.
The S&P, since the year 2000 has an average annual return of 3.9% as of 8-3-2017
The Nasdaq, since the year 2000 has an average annual return of 1.7% as of 8-3-2017
Gold has an average annual return since the year 2000 of 24.6% as of 8-3-2017.
Has CNBC ever brought this information to your attention? Of course not- it doesn’t fit their advertiser’s storylines.
While the last few years have favored stocks- mainly because central banks are “printing” money and buying stocks and bonds while capping the price of gold and silver with naked shorts (Dr. Paul Craig Roberts, David Stockman, etc) the biggest problem as I see it right now is that the booms and busts have been getting exponentially larger since around 1987. Higher highs in the booms and lower lows in the busts. This only makes sense when we consider the amount of manipulation that is taking place to produce the latest boom.
While the short-term returns look pretty good the overall performance of the stock markets have not been that good since the year 2000. Why? BOOMS and BUSTS.
This makes it EXTREMELY hard to hit the 7-8% target that these pension funds have projected for yearly gains.
Even last year, when markets were fairly healthy the average public pension (fiscal 2016) was 1.5%. This does not bode well for the next time we have a major correction- which by the way is overdue in the context of history.
Of course, even without this problem, the effect of ZIRP (Zero Interest rate policy) –even negative rates in many areas has led to sub-par returns in many pension plans and endowments.
Most of those in fiduciary positions have been getting paltry returns for a few years now because of a lack of investments that appear to have a prudent risk profile. It appears that all traditional asset classes could be classified as being in a bubble. Being defensive has not paid off so far but it likely will at some point in the near future.
It appears that those who have disregarded all of the signs of instability have won the game. So far, they probably have. I have one question for them. Where is the cliff? Probably very few, if any, can answer that question which leads me to believe that those taking prudent risks, while underperforming short-term will be proven right yet again as they were in 2000-2002 and 2008-2009.
One thing that is certain to me is that the current situation is unsustainable. Without trillions of dollars, yen, euros, etc. being created out of nowhere we would have already had an epic crash. Of course, we would also likely be on the path of a sustainable recovery instead of a debt-induced stupor that we are experiencing now.
What would profits be without government spending in food, drugs, etc.? What would GDP actually be without these same government transfer payments which multiply throughout the economy? Since we are currently running a $5 trillion annual deficit using generally accepted accounting principles- how long before it all hits the fan? (US Debtclock.org) I don’t know when. All I know is that it could just be a question of not if- but when.
For those unprepared there are likely some large surprises coming your way shortly.
Believe it or not, there are still opportunities out there that will allow you to take advantage of compound interest without a fear of loss. You just need to look past the boom and busts of the stock market, the overvaluations in the bond markets and the overvaluations in real estate markets.
Since I cannot discuss any specific investments in this note you can feel free to call me to discuss what I am mentioning here in more detail.
As a Princeton professor told me when I asked about the overvaluation of these assets and trying to get mandated returns “They have to find something else to invest in”. Sometimes thinking outside the box just might pay off!
Mike Savage, Financial Advisor
2642 Route 940 Pocono Summit, Pa 18346
Securities are offered through Raymond James Financial Services, Inc. Member FINRA/SIPC. Investment Advisory Services are offered through Raymond James Financial Services Advisors, Inc.
Any opinions are those of Mike Savage and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. The information contained in this report does not purport to be a complete description of securities, markets or developments referred to in this material.
The information has been obtained from sources considered to be reliable but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.
Commodities are generally considered speculative because of the significant potential for investment loss. Commodities are volatile investments and should only form a small part of a diversified portfolio. There may be sharp price fluctuation even during periods when prices are overall rising. Precious metals, including gold are subject to special risks, including but not limited to: price may be subject to wide fluctuation, the market is relatively limited, the sources are concentrated in countries that have the potential for instability, and the market is unregulated.
*These calculators are hypothetical examples used for illustrative purposes and do not represent the performance of any specific investment product. Rates of return will vary over time, particularly for long term investments.
Investments offering the potential for higher rates of return also involve a higher degree of risk of loss. Actual results will vary. The rule of 72 is a shortcut to estimate the number of years required to double your money at a given annual rate of return. The rule states that you divide the rate, expressed as a percentage, into 72. This assumes a consistent rate of return (such as a CD) over the entire period of time, and reinvestment of the entire amount, which are not applicable to all investments. Interest rates generally vary over time.