Absurd expectations

01 January, 2016

Many people, especially pensioners, are shocked that their pension schemes have generated no profits in 2015 – indeed, in not a few cases, they have suffered a loss. I state this not as a proven fact, but as something reported to me a few days ago by a friend who, in turn, was basing himself on a small, random and inherently unrepresentative sample of people to whom he had spoken.


I nevertheless suspect – which is to say I fear – that it is fundamentally true. A significant proportion of pensioners and pensioners-to-be still expect their savings to generate a positive return every year. I find this attitude amazing and unfathomable, because these people are old enough to have been through a few market and economic cycles, yet not old enough to have forgotten 2008 – not to mention 2001, 1994, 1990, 1987 and various other years in which the markets did poorly and their investments lost value.


In short, if there are still people out there who are deluded enough to believe that their pension scheme/ savings/ investment portfolio cannot suffer a bad year, that’s very sad – for them. I can certainly sympathize with the view that people’s pensions ought never to suffer a losing year – if by that they mean that the pension system should be guaranteed by the government in such a way that losses are compensated for.


Let the kids pick up the tab


In practice, that wish could quite easily be realized. It merely requires the taxpayers – the children and grandchildren of the wishful pensioners – to subsidize the pensioners by making good their losses through the public purse. If the oldsters could exert sufficient political pressure on the government to legislate such a scheme, then good luck to them – and more fool the working-age people for being ‘freiers’. Nor is this far-fetched, because it is exactly what is being cooked up in this country by the Treasury and the Histadrut.


However, as we enter 2016, the issue that should be paramount for pensioners and investors of all stripes is not the possibility – in reality, the certainty – that occasionally there will be ‘bad years’. Anyone with a medium-term perspective can appreciate that the occasional losing year has to be seen in the context of a multi-year investment cycle.


Rather, what everyone should be losing sleep over is that we are not in a typical investment cycle – ‘typical’, that is, in a twentieth-century sense. Seven years of unorthodox and extreme monetary policy – in the guise of zero interest rates – have totally distorted the financial markets, generating investment flows that pushed the prices of both shares and bonds to record levels. Although it is possible for prices to rise further, a far more probable outcome is that prices will fall, in many cases considerably.


To a surprisingly large degree that is not a prediction, but a description of what has already happened. The most obvious examples of this are the commodity markets – base metals, precious metals, grains and of course, energy – in all of which prices have fallen sharply in the course of the last year or two, or even four in some cases. Inevitably, the shares of companies in those sectors have been hammered, as well as those of ancillary sectors, such as shipping, railroads, etc.


Indeed, despite the façade presented by the ‘blue-chip’ indices, which have been dominated by a small number of very large companies, share markets have done badly this past year. Even within the S&P500 index – comprising the 500 biggest companies traded in New York – most shares’ prices were down in 2015, some by considerable margins. In the much broader Russell 2000 index, comprised of medium- and small-sized companies, most shares are already in ‘bear markets’, having fallen over 20% from their peak levels.


Bonds are no longer safe and solid

With the US economy weakening noticeably, that trend is likely to continue in 2016. But the equity market is not where investors are most vulnerable. Rather, it is the bond market, which is supposed to be much more solid, safer, less volatile and speculative than equities, where the greater danger lies. This is because bond prices reflect yields to maturity — and yields on all classes of bonds declined to extraordinary levels, even negative ones. Yet in 2015, the trend has changed and prices have fallen. For short-term bonds and/or those issued by financially-sound entities, the fall in price has been negligible, but for ‘junk bonds’ and those from shaky issuers yields has recorded a steep rise and the fall in prices has been correspondingly sharp.


Pension savings everywhere are concentrated in bonds – precisely because these are supposed to be safe and solid. But those old mantras, still piously mumbled by investment advisers and money managers around the world, are obsolete, wrong and hence very dangerous. Seven years of central bank-induced distortions forced pension funds to chase higher yields in a vain effort to generate the profits that would enable them to meet their obligations to their savers. They are now hugely exposed to levels of risk never seen before in the global financial system – not even in 2007.


For investors and pensioners, the run of “good years” engineered artificially by central banks’ intervention in and distortion of the markets lulled them into a la-la-land of false security and false prosperity. They are unaware of their true situation and hence do not realize the need to take protective measures. Ignorance may be bliss in the meantime but awareness, when it comes, is going to be hell.

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