The above chart is from the Federal Reserve Bank of New York publication that was last updated for the second-quarter 2018.
As the picture clearly reveals, non-housing debt is becoming a bigger chunk of overall household debt, as auto loans, credit cards, and student loan balances rise faster than mortgage debt (>$9 trillion). Job growth and shrinking savings rates have offset flat wage growth allowing for personal consumption to continue to rise, as was reflected in the latest GDP release.
However, how sustainable is this trend? What is the impact on saving for retirement? As we ask more from our workforce to fund, manage, and disburse a retirement plan (DC), is this rapid rise in consumer debt restricting one’s ability to put a few dollars away for later in life?
According to a PlanSponsor article the Melbourne Mercer Global Pension Index (MMGPI), which is now in its 10th year, shows that the U.S. retirement system enjoyed a slight improvement this year scoring a 58.8, up from 57.8 in 2017. The Index evaluates countries on the adequacy, sustainability, and integrity of the retirement income system. The study evaluated 34 pension systems and rated the Netherlands (80.3) and Denmark (80.2) as the two strongest pension/retirement systems.
The U.S. would show further improvement with these suggested changes:
- raising the minimum pension for low-income pensioners;
- adjusting the level of mandatory contributions to increase the net replacement for median-income earners;
- improving the vesting of benefits for all plan members and maintaining the real value of retained benefits through to retirement;
- reducing pre-retirement leakage (401(k) loans and premature withdrawals) by further limiting the access to funds before retirement;
- introducing a requirement that part of the retirement benefit must be taken as an income stream;
- increasing the funding level of the Social Security program;
- raising the state pension age and the minimum access age to receive benefits from private pension plans;
- providing incentives to delay retirement and increase labor force participation at older ages; and
- providing access to retirement plans on an institutional group basis for workers who don’t have access to an employer-sponsored plan.
We’ve written posts/articles on a number of these issues, especially as it pertains to the inadequacies of a defined contribution plan as a true retirement program. In addition, we are fully supportive of “retirees” working in some capacity, but the fact is that roughly 1/3 of Americans older than 65-years old would like to work, but only about 14% do. Furthermore, as the remaining Boomers turn 65, demand for job opportunities will only increase, but it is likely that the supply of age-appropriate jobs won’t.
I happened to see this comment in an email earlier today (thanks, Rob):
About 83% of U.S.-listed IPOs in 2018’s first three quarters involve companies that lost money in the 12 months leading up to their debut, according to data compiled by University of Florida finance professor Jay Ritter. That is the highest proportion on record, according to Mr. Ritter, an IPO expert whose data goes back to 1980. Source: Wall Street Journal
I asked how those stocks were performing this year and here’s the response:
The stocks of money-losing companies listing in the U.S. (in 2018) have gone up 36% on average from their IPO price through last Thursday, according to the article (IPO Market Has Never Been This Forgiving to Money-Losing Firms – Wall Street Journal)
That does happen to be better than the 32% return for IPO stocks with earnings and the 9% gain for the S&P 500 index year-to-date. Amazing? Incredible? Outrageous? Unsustainable?
Managing a DB is not an easy job. Focusing on the ROA as the primary objective has made it more challenging, especially given the greater market volatility needed to cobble together a combination of assets that might just meet that return target. Throw in the fact that low quality names are leading the market higher makes it even more challenging. Given this environment, we believe it is critical that DB plans begin to de-risk.
I had the distinct pleasure to once again participate in the IFEBP annual conference. This event had me traveling to New Orleans where it was incredibly warm and humid. There were times during the trip that had me feeling as if I were in a frying pan. Ironically, public pension systems should be feeling the heat at this time, too, as allocations to equity-like products now represent about 70% of the average portfolio which is up more than 30% from just a couple of decades ago.
My presentation was on the “Key Factors in the Long-term Sustainability of Defined Benefit Plans”, and one of the points that I was making is the fact that public pension sponsors and their consultants are injecting a ton more risk into their asset allocation in an attempt to achieve the “Holy Grail”, I mean the return on asset assumption (ROA).
Twenty years ago, states needed only to exceed the yield on a 30-year Treasury bond by 1% in order to meet their investment targets. Currently, the typical state would need to outperform a 30-year Treasury bond by nearly 4.5% to meet its now-lower investment assumption. That reality has forced plans to take on higher levels of investment risk and at a time when U.S. equity markets have enjoyed a historic bull market run.
KCS and Ryan ALM have been encouraging plans to take a different path at this time. We want plans to get their arms around the plan’s specific liabilities and to use that output to drive investment structure and asset allocation decisions. We believe that DB plans need to be sustained, but doing the same old, same old in this environment will prove devastating to funding levels once the next correction occurs.
Sponsors needed to be thinking about this strategy in 2006 and not in 2009 after the market collapsed. Well, are you thinking about de-risking your plan now? If not, why not? It might just be too late in another three to four years.
OUCH! 2018 is certainly not the year to be global in one’s asset allocation, but I certainly have been, and I suspect that many DB plans and DC participants are, too. As the chart above reflects (as of Friday, October 19th), the U.S. is one of only four equity markets to have declined by less than 10% from their all-time high close. Unfortunately, market action since Friday will have the U.S. equity market getting closer to that -10% mark.
Is the U.S. performance justified at this time? Are we an island in the sea of weak country performance or are we kidding ourselves that the U.S. can continue to produce strong corporate earnings, jobs, economic growth, and increased demand for goods and services despite what might be happening outside our boarders? I don’t believe that the U.S. is on the cusp of a recession at this time, which is what we normally need in order to see a significant pull-back in equity prices. However, given the disparate results among the various equity markets, it might just be time to lighten up on the U.S. equity exposure and reallocate some to both developed and emerging markets overseas. What do you think?
As a lifelong resident of NJ, who appreciates the Garden State for more than its proximity to NYC, I don’t appreciate, but I can understand, the chart below that highlights NJ’s out-migration issue. We aren’t alone, but misery doesn’t like company in this case. There is almost no place like NJ’s beaches, but that alone is clearly not enough to keep people here, as NJ’s taxes, particular property taxes are making life here almost unaffordable. Money Magazine has NJ’s overall tax burden at only #9 among the 50 U.S. states (NY is #1), but the recent Federal tax changes will burden NJ’s residents to a greater extent because of the cap on the SALT deduction.
Unfortunately, NJ’s plight, and that of many other states, might continue to worsen when one looks at the current pension funding deficits. NY, IL, CT, NJ, and ND “lead” the way in out-migration, and the pension systems of CT, IL, ND, and NJ all have funding deficits below 70% (actually, CT, IL, and NJ are <60% funded). New York is the rare exception among the out-migration cohort with a 90%+ funded status. The poor funded status and growing contribution expense will continue to burden the residents of these states.
The economic activity that is produced annually from the benefits received from plan participants is incredibly important to local economies and businesses, as roughly 85% of the net benefit is spent locally. Obviously, these DB plans need to be maintained, but continuing to strive to achieve an inflated ROA is not the answer. We need to go back to the future and a return to the basics, and manage these systems with an eye toward each plan’s specific liabilities before the markets break once again, which will set these plans and states back even further.