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.
I have to be careful! I find myself shaking my head so frequently at what is transpiring in Washington DC, that I might suffer permanent nerve damage. It is scary how uninformed our politicians are regarding economics, and specifically the role of federal deficits in generating economic activity.
There are four primary sources of profits at the macro level of the US economy including, consumption (consumer spending), corporate investment (plant, equipment and inventory), net exports (exports minus imports) and net government spending (deficit spending minus tax receipts). Since the great recession, it has really only been the federal spending that has kept corporate profits at all-time highs (averaging > 10% of GDP). The consumer and corporations have kept spending and investment below normal historical levels, and our net exports are nearly -$500 billion. If it weren’t for the fact that the US fiscal deficit was as great as it has been, the economic recovery would have been far more muted, especially in 2010 and 2011.
Remember, the Federal deficit = private savings! Cut back too much on the federal deficit spending without a commensurate pick up in investment and consumption, and we could teeter on the brink of another recession. With employment remaining weak, we need corporations to pick up the slack. We may also benefit by becoming a bigger energy exporter, reducing the negative consequence of being a net importer nation, but that might take years. Until then, we need Washington to stop focusing on the debt ceiling and expend their energy on creating an economic environment that creates jobs and stimulates demand for goods and services.
Much has been written about the growing unemployment crisis for those under 30 in the US, with <50% of that cohort working a full-time job, but there is a secondary effect that hasn’t gotten much notice. With the demise of defined benefit plans as the primary source of retirement income, defined contribution plans are rapidly becoming the only retirement game in town. However, for DC plans to be effective, employees need to fund as much as they can, as early as they can, in order to build a nest egg that will accumulate the necessary assets for a 20-25 year retirement. With the younger workers not entering the workforce until they are in their late 20s, they are missing out on several years of contributions and compounding. Unfortunately, managing a DC plan has proven difficult enough for most of us. We certainly don’t need further impediments exacerbating an already tough situation.