Tom Petty likely didn’t have U.S. economic growth in mind when he penned his song by the same title in 1989 for his debut album but it more than aptly describes what is happening at this time. According to the Atlanta Federal Reserve Board and their GDPNow forecast, the U.S. economy grew at an annual rate of 0.2% in Q1’17. You might want to think about that for a moment. Yes, the U.S. annual growth is forecast at 0.2%. This is happening at the same time that U.S. equity markets continue to near or exceed all-time records, and while the U.S. Federal Reserve is considering further tightening.
This most recent estimate (revised today) reveals a drop in the growth rate of 0.5% from April 14th’s forecast. However, the Model initially estimated growth at roughly 3.5% in January. Talk about free falling!
We are pleased to share with you the KCS Q1’17 quarterly update. As you will read, there was a lot going on for KCS in the quarter, as well as for Pension America. Funded status improved, as assets advanced while liabilities were basically flat as interest rates remained fairly steady.
KCS continues to produce many articles and posts through our blog, Fireside Chat series, and occasionally as a guest writer for various newsletters. In addition, we continue to participate in multiple conferences throughout the country, all with the goal of providing education on important pension-related topics.
As always, we hope that you will find our insights helpful. Please don’t hesitate to reach out to us if we can be of further assistance to you.
The following snippet was sent to me by an industry acquaintance – thank you, Chris – and I’m happy to share it with you. This quote was part of a Bloomberg interview with Larry Fink.
“We don’t spend enough time as a society understanding how bad the retirement system is in this country. I think so much of the anger in this past election is based on people’s fear of their future. People are frightened; they know they haven’t saved enough money for retirement. They’re going to be highly dependent on Social Security—which, if that’s the only source of income, means living in poverty. In addition, the bigger problem many of our cities and states are facing is that their retirement plans are defined benefit plans. Their liabilities are so large, and increasing, especially as we transform deadly diseases into chronic ones. That translates into greater longevity, and—you’re witnessing it every day as an American—underspending on our infrastructure. It’s a direct cause of the financial positions of state and local governments. And it’s only going to get worse.
I believe the recognition of our precarious retirement position is one of the most underappreciated future crises in this country. I think this crisis is going to be much bigger than health care. Health care is immediate. If you don’t have proper health care, it is today’s problem. But as you know—investing, the whole concept of compounding—if you’re not building your nest egg year after year after year, you’re not going to have enough savings to retire with dignity.”
It is refreshing to finally see some recognition of the crisis that is unfolding. At KCS we’ve been highlighting the likelihood of profoundly negative social and economic consequences that will occur as a result of our failure to prepare our employees for retirement since our inception, nearly 6 years ago.
Where we depart from Mr. Fink is blaming defined benefit plans for the lack of financial resources within various U.S. states to meet social and infrastructure needs. I blame the actuarial, investment management, and consulting industries for their focus on the wrong objective. DB plans should be managed with a cost objective and not a return focus. Too much volatility has been injected into the process.
We need to start managing these critically important plans with the right focus, and if we can, we are likely to get more stable contribution costs and funded ratios. As we’ve said before, we are one equity market crash away from absolute devastation of DB plans. How comfortable are you that this won’t happen after 8 years of a bull market combined with weak U.S. and global growth? Remember, we already have examples of public DB plans being frozen. We can’t afford to have this “trend” become a tsunami.
We are always pleased to share the Ryan ALM quarterly Pension letter.
Regular readers of the KCS quarterly piece will know that we highlight liability growth versus asset growth (borrowed from Ron Ryan) to indicate whether pension funding is improving or deteriorating. Fortunately, strong asset growth and flat yields propelled defined benefit plans to improved funding during the first three months of 2017.
However, don’t get too complacent, as yields have fallen fairly significantly so far in April, while assets have been flat to down. The nice gains could be eroded fairly quickly.
We, at KCS, are on record stating that we don’t believe that US interest rates are going to rise quickly, as we don’t see much growth in either the US or abroad. Plan sponsors and their asset consultants that move aggressively to further reduce the fund’s fixed income exposure are deepening the asset/liability mismatch that is prevalent in most public and multi-employer plans.
Ron’s work to preserve and protect DB plans should be embraced. You’ll get a feel for how unique his insights are through these quarterly letters – enjoy!
Last night I had a wonderful opportunity to participate on a panel at Fordham University. The event was managed by the Fordham Graduate Finance Society (they did a great job), and our panel was to provide an outlook related to the “new” financial landscape.
There were several topics discussed that created a lot of good, healthy debate. The moderator completed his line of questioning by asking each member of the panel what risk they feared that might not necessarily be a focal point for the financial press. I volunteered that I was very concerned with Italy’s banking system because I believe that it has the potential to take down the Euro and Eurozone.
There is a terrific article/note that I want to share that addresses the current situation among Italy’s roughly 500 banks. Basically, more than 20% of the Italian banks have Texas Ratios >100%, effectively rendering them failed. Although many of the banks are small, several of Italy’s largest banks are struggling under the stresses of non-performing loans.
Brexit may have dinged the Eurozone’s armor, but the Euro remained unscathed. A failure of Italy’s banking system will be a frontal assault on both the Eurozone and the Euro from which there may not be a recovery. Remember how the markets reacted after the UK vote last June? There was immediate global pain followed by a fairly quick recovery. Should Italy not be able to rescue its banking system, we suggest that the pain will be more severe and recovery may take far longer to manage.
There is a lot of hand-wringing surrounding the possible move by the U.S. Federal Reserve as it considers how and when to begin to unwind the $4.5 trillion in debt on the balance sheet. The discussion centers around the speed of the unwinding and the potential consequences to the bond market under each scenario.
Well, we have good news for you. Since the U.S. Government owns both the asset and liability, they could effectively “retire” the debt without any consequence to the private sector. Will they do this? We doubt it since we haven’t heard this discussed as a possible solution.
In order to effect this transaction, all that would have to happen would be for the Treasury to take a credit and the Fed a debit, and these securities would be gone with no impact on the private sector. Nice and clean! We’ll just have to wait and see what they decide to do, but let’s hope that their actions don’t create unnecessary volatility within the bond market.
It is our pleasure to provide you with the latest version of the KCS Fireside Chat series. In this article, we share the highlights from four of our most recent KCS blog posts. The common threads among these posts are the social and economic implications that our citizens are facing today and the likely impact that they will create on the funding of a defined contribution retirement program.