Lack of U.S. Growth Hurting DB Plans

The Atlanta Fed with the highly-tracked GDP estimator, slashed its Q1’16 GDP estimate to 0.1%. As a reminder, this number was as high as 2.7% two months ago – ouch!

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2016 is 0.1 percent as April 8, down from 0.4 percent on April 5. The negative adjustment followed the wholesale trade report from the U.S. Bureau of the Census, the forecast for the contribution of inventory investment to first-quarter real GDP growth fell from –0.4 percentage points to –0.7 percentage points.

The U.S. economy’s on-going struggle to generate consistent and meaningful growth continues to negatively impact U.S. defined benefit plans (DB).  How? Actually the impact is felt in several ways, and it touches both assets and liabilities.  The lack of demand for goods and services is impacting the earnings and profits for corporate America, and it is highly anticipated that S&P 500 earnings will be negative for the third consecutive quarter. As we enter earnings season, it will be quite interesting to see how this unfolds.

Despite the tremendous rebound in equity prices that followed a deep sell-off earlier this year, stock prices do reflect growth in earnings and dividends over time.  A continuing struggle to generate earnings will eventually weigh heavily on stock price performance.

With regard to liabilities, they reflect changes in the interest rate environment, as they are bond-like in nature.  As a reminder, they DON’T grow at the ROA.  As plan sponsors and asset consultants continue to underweight fixed income for fear of rising rates (how long now?), assets and liabilities are heavily mismatched.  With U.S. GDP growth remaining quite low, it is highly likely that the Federal Reserve will work to keep rates low.

Even if we were to see a modest increase in the discount rate at some point this year, it is highly unlikely that longer dated US bonds would see an increase in their yields with the trillions of $s in negative real interest rates trading globally.  U.S. long bonds are quite attractive on a relative basis, and they are likely to generate tremendous interest as Japan and European central banks continue to drive rates lower.

2016 is once again shaping up to be a poor year for DB pension funded ratios and funded status following the difficult 2014 and 2015 years.  Isn’t it time to try something new? Stop focusing on the ROA and all the associated volatility, and begin to de-risk your plan through a strategy that focuses on your plan’s liabilities.  The only thing going up in this environment are contribution costs, and most plan’s can’t afford that reality!

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