Pension Update: Predictions for the Future…Not Thru a Rose Colored Lens
The economy and politics are at an important crossroads at this point in time. There is no solid evidence of a sustainable economy recovery in place, and in November, the balance of political party power will shift from the election outcomes. The public pension funding crisis is “coming front stage”. Pew Center national pension fund underfunded estimates take the potential deficit to $3 Trillion, and that is assuming annual pension fund investment returns of 7-8% annually going forward. The stock market has been flat in performance for 10 years running and the 10-year US Treasury bond yield is only 3% now…half the 6% interest rate in 1999. All the points discussed below all correlate to a nationally “unmanageable” public pension liability condition in the years ahead. Of particular note, see NJ Gov Christie statements about midway thru this report.
But first, let me start by summarizing a few of the most pivotal “points of interest” along our current journey along the highway of Uncertainty…Uncertainty felt by most people about there being a real upside turn on housing values, will there be growth in employment again, will there be an end to massive government deficit spending, and can stocks, after 10 years of flat line performance, rise again into a bull market?
The common thread of all these uncertainties is hinged to one critical factor of great importance to each American household. People are most worried about their “personal financial condition”…can they be financially secure by retirement? Will the economy be supportive to sustain public pension liability payouts? Financial security is the biggest worry facing households today. The outcome of the elections in November and the course of the economy hold the key to household financial security.
For many months, and quarters, we have been advocating “income focused” investing strategy to build household financial security…building sufficient wealth to afford retirement. All past history and logic that supported “growth investing” asset appreciation for wealth building is “out the window” today in this New Economy. The New Economy is one that is prone to more frequent and progressively larger economic and financial market shocks. These “shock” events of the past several years in particular have set the stage for a much slower economic growth trend in the years ahead. The forward-looking business environment is less certain. As people are now more fearful of stock market crashes and financial leverage-induced real estate value meltdowns…there is an exodus from appreciation-oriented risky investments. Pension funds will need to employ more “income asset investments (corporate bonds)” or at least higher dividend equity investments to hit annual hurdle return rates.
The “New Economy” is a very sluggish growth economy, employment recovery will be slow, wage increases will be small, government deficits bigger, and private sector debt deleveraging will diminish consumer spending potential. These are all things that are deflationary. And, deflation means that asset valuations for real estate and stocks will be very slow to expand in the next 3-5 years.
Let’s now look at a series of predictions or projections that I can see as a result of current major conditions in the economy. These are all conditions that have long multi-year cycles of boom-bust-recovery…”mega-cycle” conditions or events. These conditions will inhibit any fast upturn in the economy and recovery in fixed asset and growth stock valuations. Personal wealth growth from an asset appreciation cycle, cannot occur in a deflationary cycle setting. Many of these deflationary conditions will need to run their course of correction and eventual recovery over a 3-5 year period…at least. On the perspective of time for recovery, the Great Recession, which began about 2 years ago on September 15, 2008 when Lehman Brothers filed Chapter 11 bankruptcy, marked the onset of recession…the recession was supposed to have ended about this time last year, yet it still feels very much like we are still “in recession”…employment and GDP growth are stalling.
CMA’s Forward Looking Predictions
1. Housing will continue to remain depressed as the sub-prime bubble created $1Trillion in defaulting mortgage debt. This equals approximately 5 million sub-prime mortgaged homes that will continue going through repetitive foreclosure and short sale for the next 3-5 years, ending only when unemployment recedes to below 6%…3-5 years off.
2. Access to auto financing will stay depressed and annual sales will stay in 9-12 million range far below the 13-15 million unit pre-recession zero interest rate financed production/sales trend. Employment will not grow in the all-important auto/light truck US production industry. Imports continue to take market share.
3. US government debt level has risen by about 40% over the past 3 years, where it will soon hit near 90% of annual US GDP, this will take 1% per year off the US potential annual GDP growth rate.
4. Best guess for State and Municipal fiscal budget deficits for 2011 and 2012 is $300 Billion each year. Spending reductions are needed because weak income tax revenues, sales and property tax collections have produced huge deficits…Illinois is $13 Billion deficit. I estimate near $100 Billion in public sector job spending cuts. At all-in employment cost of approx $70,000 salary/benefit per employee = 1,400,000 reduction in public sector State and Municipal employment work force during 2011 and 2012.
5. Consumer household debt deleveraging. In 1980s and 90s the Household Debt/Household Income percent ratio equaled near 80%, it peaked at 136% in 2007, and is currently near 120% of household income. Consumer annual savings rate doubled to near 6% currently, should take 5 years to bring debt burden percent level back down to 90% range…near normal…weak future consumer spending as a result.
Read report by Baily & Lund:
www.international-economy.com/TIE_Su09_BailyLund.pdf
6. Federal Reserve Zero interest rate policy will stay intact for another two years. This is a hardship penalty to retired population that “are not risk investors”. CD rates at 1-2% will continue to retard retiree discretionary spending, which will continue to retard US economic growth from an expanding retiree population base.
7. As US government treasury securities interest rates will stay at half the interest rate level of 10 years ago, public pension funds will continue to become more underfunded due to low interest income returns…60% of pension assets are in US Treasury and Agency debt securities. Pension payout benefits will eventually be reduced, as retiree pension incomes fall, and public sector retiree discretionary spending will fall. Public pension system funds are near $3 Trillion underfunded today. There is no quick fix…reduce payout benefits…or pension fund insolvency. ( 9/15/10 NJ Gov. Chris Christie yesterday proposed a sweeping pension and health benefit reform package that would ultimately shift billions of dollars in costs from state and local budgets to current and retired teachers, police, firefighters and government workers.
While the Christie administration did not provide detailed numbers, the higher pension and benefit contributions proposed by Christie would be tantamount to a 7 percent pay cut for most teachers and government workers, and about a 4 percent reduction for police and firefighters phased in over the next three years, based on preliminary NJ Spotlight calculations.
The Christie plan also would significantly lower pension checks for future retirees by rolling back the 9 percent pension increase approved by a Republican governor and Legislature in 2001 and by eliminating all future cost-of-living increases for retirees.)
8. On global trade, the US dollar is staying artificially high due to its “reserve currency status” and US exports continue to be over-priced on comparative trade advantage with the rest of the world. China, Japan, Western Europe all have undervalued currencies relative to the US dollar. Japan’s yen looks “overvalued” according to the Japanese, yet they run a chronic “trade surplus” with US of about $80 Billion/year…Yen needs to higher to the dollar, not lower. US will continue to suffer a near $500 Billion annual trade deficit of goods and services (Primarily with China.) that equals 3-4% of US GDP. More US manufacturing and services jobs will continue to leave the US…or, US unskilled wages will fall, that lowers household income and purchasing power.
9. Between now and November elections, most major business capex and hiring expansion plans are “on hold”. Why? If republicans have a winning streak in Senate and House, a broadly “conservative political mentality” a majority, will curtail fiscal deficit stimulus spending going forward…and the potential for a stimulus-induced economic recovery in 2011 and 2012 will not exist.
10. President Obama will continue to lose political popularity. He has created inflated expectations that government stimulus programs can cure the extreme down business cycle correction of very high unemployment and an implosion in residential real estate valuations. As it has been said: “It’s the Economy stupid” that has traditionally influenced multi-term presidential popularity. He will be a one-term president. Unemployment will not see a meaningful decline until after 2012…too late in his game.
All of you reading this are probably pretty depressed by now, maybe on your second martini. Sorry…what I am predicting is not of my own unique fascinations…me looking through a depressing lens, not a rose colored one, to the future. People much smarter and perceptive than I: Nouriel Roubini, Pat Choate, Bill Gross, Mohammed Al-Arian see very similar visions of unfavorable reality ahead. It is all a part of the wonderful world of capitalism…boom and bust.
Governments cannot cure the “busts” or materially shorten the pain of a “bust”. They only put “Band Aids” on them…soften the blow, push the real fixes off into the future…let the next generation or political administration worry about it. I dwelled on that in one of my recent CMA Updates…”Fixing the Unfixables”. Capitalism…The Best of the Worst economic systems on the planet.
Summary: None of us can change or influence current ”uncertainty” or distressing economic conditions we face now and likely over the next 3-5 years. I do highly encourage you, as investors and pension fund managers & trustees, to take heed and invest conservatively. All of the CMA portfolio models on corporate bonds, preferreds, high dividend common stocks, MLPs and REITs are focused on one mission: preserve your wealth, pension asset values, and produce very predictable high annual investment income streams. If you are not a client of CMA, I invite you in for an assessment of your financial objectives and to learn about the many CMA portfolio options available to you. Take the time, make the effort, and assure your personal financial security and that of your pension fund.
Chuck Dushek