The stock market has topped as US employment growth stalls. There is little in catalyst for a quick US economic recovery this year or next. Zero US short term interest rates are having virtually no effect at expanding bank lending to small and midsize businesses. So, with the stock market played out on upside and US Government bond interest yields at record lows, pension funds have very little potential for asset growth and interest income in traditional portfolio investments now being used. The changes advocated below can shift annual pension fund investment returns from about 2% now to a steady to rising base return rate of 7% annually. Read below, for the strategy to help solve the under funded public pension fund crisis we are in.
The employment report for May was quite telling, “the entire new job growth of 400,000 for May was from new part-time US Govt census workers”, with no job growth in the private non-govt sectors. The market was expecting about 400,000 “private sector” job expansion. The stock market sold off over 300 DOW points on this major disappointment.
In the Illinois Public Pension area, we clearly see that investment returns per year are averaging far below the needed 8% “Hurdle Return Rates” to achieve just an even-keeling of pension fund asset levels. The typical mix of equity investments to fixed income investments is 40% common stocks and 60% fixed income. Common stocks, the low dividend types used in mutual funds by pension fund consultants and managers, have had a “negative return” for past 10 years. The 5 year US Treasury bond, benchmark for pension fund fixed income, is only yielding 2% today and has averaged only 3.5% yield since 2000. At this point in the economy, US Treasury interest rates will stay very low for 2010 and 2011. The stock market is down 3% year to date in 2010.
In following the developments in public finance for State of Illinois, the State is in a huge intractable current year deficit of $13 Billion, and owes $5 Billion in unpaid bills. The only money to fund the Illinois public pension deficit, which is estimated to be $60 to 80 Billion, is likely to come from a new $4 Billion borrowing by the State.
This puts the State even more at risk in the future for debt credit rating downgrades, and eventual fiscal insolvency. The current estimate of total Illinois public sector debt is $130 Billion. The State has a 13 million population base. So, Ill State debt equals $10,000 per resident. The annual tax revenue income to the State is approx $30 Billion. State insolvency or bankruptcy is a pressing reality.
How does that affect Illinois public pension fund resources? There is not enough in “tax cash flow” to support the viability of the pension fund system. As annual pension fund investment returns stay well below the 8% annual hurdle return rate, the State’s pension funding deficit gets bigger and bigger.
Pension fund Trustee focus on pension fund investing must be to try and achieve hurdle return rates near 8%. You can do this by using high dividend common stock portfolios…not growth stock portfolios as is being done now.
Also, you need to contact your local State Senator and let him know you support a change in the Illinois Public Pension Code that would allow for the use of Investment Grade Corporate Debt in place of lower yielding US Government debt obligations. This will allow Fire and Police pension funds to go from 2% interest returns on the fixed income allocation of 60% of assets in US Government debt securities to an approx 7% annual interest return in corporate debt obligations.
Send a brief email to Senator Chris Lauzen (chrislauzen@lauzen.com ) he is preparing a Bill to expand the use of Corporate Debt of Investment Grade Quality for Ill Pension Funds.
What happens if police and fire funds continue to have annual investment returns below the 8% hurdle rate? A) Your municipality will have to keep making larger annual employer contributions, which they cannot afford anyways; B) More Police and Fire officers will be laid off, which adversely lowers the employee contributions to pension funds; C) Your fund experiences an acceleration in the decline in its Net Assets towards Zero as annual pension payouts exceed the sum of employee, employer and investment return inflows, and D) If A, B and C prevail, then pension fund will likely be taken over by the State, which is already technically bankrupt under any normal credit evaluation technique. Illinois is in a Zombie insolvent financial position.
As a money manager, CMA is guiding pension Trustees on proper investments for the “reality” of the economy we are in. If the US economy cannot have a normal recovery (and it is not showing one now), like it has enjoyed from past recession-recoveries…the “V” bottom, then the current recession we are in has low predictability towards an end.
Owning and profiting from growth stocks and stock mutual funds for pension funds needs consistent GDP and job growth…not the case today. Income investing, in stocks with high dividend yields (6-8%) is a better alternative for the times we are in.
There is a “reality factor” in our face…with this recession. It is likely the “Mother of All Bad Recessions”. It did not materialize from the peaking out of a normal business cycle that overheated. This recession was precipitated by a gigantic housing bubble bust, then a banking sector bust, now a commercial real estate market bust, now with the highest level of unemployment and household debt burdens since the Depression.
The Recession is rolling across multiple economic sectors with major force: housing, commercial real estate, banking, manufacturing, most small and midsize businesses (due to contraction of bank credit to them). Europe’s current economic decline takes a “Big Engine of Growth” out of the global growth potential, and the Euro currency rate decline will weaken US GDP growth prospects by approx 1% per year in our estimation for 2010 and 2011.
Basically all of the economic expansion has occurred from massive government stimulus spending on roadway infrastructure improvements, cash grants to States to help offset some of their massive fiscal budget deficits, and extended unemployment benefits that run for “2 years” now. None of this stimulus has lasting impact to “fundamentally” turn the US economy upwards out of recession, and create much progress in new “permanent private sector” jobs.
“Invest for Income Only”…This is a strategy of both “Offense and Defense” for pension funds. For the last 10 years the US stock market has been sideways to down in major trend…a Lost Decade of stock value growth. S&P 500 = 1500 in year 2000 and is 1073 Today. The index has only a 2% dividend yield…same as most stock mutual funds, especially those in pension plans. The net result for past 10 years…S&P 500 and most growth stock mutual funds have lost money. Without steady and predictable GDP growth in the US economy…low dividend stocks falter in wealth creation.
Perhaps the US economy is stalling out for a number of years to come before what is called “animal spirits”, the natural course of Capitalism…booms following busts…can take root and produce the beginnings of a natural recovery without massive Govt stimulation. The evidence of this possibility, a naturally occurring economic recovery, is not apparent today.
“Invest for Income Only”…is the obvious Lifeboat for a pension fund to be floating in at this time. Income is Defensivebecause corporate bonds, preferreds and high dividend common stocks are not dependant on US economic growth to create a return…they pay income of 7% or more. They have lesser risk than common growth stocks that follow the business cycle for most of their returns. Income is Offensive investing because at a 7% annual income return, annual compounding via reinvestment will double a pension fund’s assets in 10 years…it is a Lifeboat with a 7% propeller income engine, to get your pension fund to a safe and fully funded financial destination in the future.
The Administration and Congress do not have the right answers to return the economy to the prosperity of just a few years ago. They have lost their way. They presided over the housing and banking collapse. They (Presidents and Congress) are unlikely the ones to fix it. Debt deleveraging across an economy may take the same amount of time to correct itself as it took build “the debt bubble” from 2001 thru 2007. The same case is true for Illinois politics and responsible fiscal management.
If you would like CMA to speak to your Pension Board or selected Trustees, please hit Reply and send me their names and email address and/or phone number….Thanks
To learn more about high income investing…the strategy and illustrations, please click to www.CMAHighDividends.com
Sincerely,
Chuck Dushek
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