Are you thinking that another major equity market decline isn’t possible? That we are once again entering into a new paradigm (remember 1999) casting all previous ideas on market fundamentals out the window? If yes, I implore you to think again! Market fundamentals still matter. Sure, value is always in the eye of the beholder, but eventually value does in fact matter. It is difficult to identify today any asset class exhibiting cheapness or fair value when looking at the landscape of potential investments for pension plan sponsors and their advisors. Please don’t forget the significant damage that was inflicted on pension plans and E&F’s during the Tech Bubble bear and the Great Financial Crisis when the bull markets went poof! Market declines of roughly -48% and -52%, respectively, were generated.
We recently pointed out the fact that in both of those bear markets the S&P 500 registered a low at the bottom of the bear markets near 760. Given the S&P 500s current value, a -50% decline would bring the S&P 500 to a price of 2,265. Should a retest of the lows of the last 20-years be in the cards, the return would be roughly -83.1%. Come on, Russ, when have we seen declines of that magnitude? Well, students of the markets don’t have to go back too far to remember that the NASDAQ declined -76% when the tech bubble burst. Also, as the chart below highlights, the S&P 500 fell nearly -85% in 1932. I can just hear the roar from the crowd chanting the mantra once again that “it is different this time”. Maybe, but maybe this will prove once again to be another chapter in the normal cycles of equity market performance.
I bring this concern to your attention because pension America – private, public, and multiemployer – have benefited tremendously from the equity market rally since the bottom achieved on March 9, 2009. Please don’t continue to subject this wonderful improvement in funding to the whims of the markets. I have no clue when the next correction will come, but I do know that one will come. Based on the market’s current valuations, I don’t think that the impact will be tamer than the usual bear market experience, which has produced an average -37% correction in the previous 20 bear markets! Ouch! Take risk off the table, ensure that you have the proper liquidity necessary to meet benefits/expenses during the downdraft by building a cash flow matching portfolio to meet those projected outflows, as traditional bonds will not preserve capital in a potentially rising interest rate environment. This strategy will allow your equities and other risk assets the time necessary to work through any turbulent market environment.