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[UNLOCKED] Early Look: The Retirement Reality Check

Editor's Note: The Early Look below was written by Hedgeye Financials analyst Josh Steiner on April 21st. "The bottom line is that very difficult choices will need to be made by pensions, courts and politicians in the coming 10 years, and it seems unavoidable that pension promises will be broadly reworked," Steiner writes. "Either Americans will slowly awaken to the fact that they don’t have enough saved for retirement..."

 

A thought-provoking read...

 

*  *  *  *

 

“Everybody talks about the weather, but nobody does anything about it.”

– Mark Twain

 

Yesterday, I was asked to write the Early Look – the topic suggested was US Housing. To paraphrase my colleague, Christian Drake, the most remarkable feature of the recent housing data is probably the abject lack of anything remarkable. With that in mind, I chose a different topic.

 

The American retirement crisis has arrived, and it poses a long-term structural millstone on domestic growth for years to come.

 

The Washington Post ran an article yesterday entitled One of the nation’s largest pension funds could soon cut benefits for retirees.

 

[UNLOCKED] Early Look: The Retirement Reality Check - protests

 

Back to the Global Macro Grind

 

The pension fund requesting a benefits cut turns out to be the Members of the International Brotherhood of Teamsters, and counts among its members more than a quarter million truckers from Texas, Michigan, Wisconsin, Missouri, New York and Minnesota. Notwithstanding its notorious ties to organized crime in the 1960s/70s, the Central States Teamsters is not unlike many DB pension plans; in 1980 they counted 4 active participants for every retiree, today there are 5 retirees for every active participant.

 

While the worker/retiree pyramid inversion is the proximate cause of today’s problem, the catalyst is a law passed in late 2014 that allowed multi-employer pensions like the Central States Teamsters to request permission from Treasury to cut benefits in order to maintain longer-term solvency of the fund. For reference, over 10 million Americans have their pensions through multi-employer pension plans.

 

The Teamsters asked for a 23% reduction in benefit payments, but some will be more affected than others. The article describes a husband and wife – both Teamsters – whose benefits will be reduced by 57%. Without the cuts, the pension argues it will be insolvent within 10 years. With them, it has a 50% chance of surviving another 30 years.

 

Private Corporate Defined Benefit Pensions look better, but are they really?  Based on data from Milliman, one of the largest providers of actuarial products and services in the world, the picture isn’t pretty.

 

Milliman maintains an index that tracks the top 100 corporate US pension funds (HERE). Here’s where the index stood on 3/31/16: $1.37 trillion in assets and $1.76 trillion in liabilities producing a shortfall of $390 billion and a funded ratio of 78%. There’s a widely-held myth in pension accounting that plans funded at 80% are in good shape. This is simply not true – pensions need to be funded at 100% (for more on why, see HERE).

 

What I found surprising was that the $390 billion funding deficit is close to its all-time high even though the S&P 500 is just inside of its all-time high. 

 

Equally surprising are the assumptions embedded in future returns. In order to reach 100% funded status, the funds will need to earn returns of +11.2% per annum going forward. The base case, just to stay at the current ~80% funding level, would require +7.2% returns per annum, while their bear case assumes positive returns of +3.2% and would result in funding levels declining to 65%.

 

Now consider the longstanding relationship described by Cliff Asness between current CAPE ratio levels [aka Shiller PE] and forward 10yr market returns (HERE). What he shows is that there’s a near perfect relationship between forward 10yr returns on the S&P 500 and starting CAPE ratio multiples over the last 85 years (see table below).

 

The market is currently trading at a CAPE ratio of 26.4x, which puts it in the 10th [the most expensive] decile. Forward 10yr real returns from this decile have averaged just +0.5% per year over the 1926-2012 period. The best period saw returns for this decile of +6.3% per year, while the worst saw losses of -6.1% per year. In other words, the base case pension return scenario (+7.2% per year) is 1% higher than the best return ever observed in the last 85 years of market history starting from this level of market valuation, and that’s just for those plans to stay at 80% funded status!

 

What about the States and Local Government Pensions? Two things are clear.

 

First, the sacrosanctity of state and local government pension obligations has already frayed. The NY Times (HERE) describes the precedent-setting cases of Detroit, where a judge ruled that public pensions could be reduced in bankruptcy, and Stockton, where pension giant CalPERS came under judicial fire for insisting no adjustments could be made to the pension side of the liabilities in Stockton’s bankruptcy. 

 

Second, the current benefits promised are, in many places, simply untenable.  Let’s take NY as an example. As a NY resident, I’m always curious when I see the local town/school budget information and was genuinely shocked by a report I read a few years back on retirement spending at the NY County/Local level in 2011, 2012 and 2013. For those interested, the data can be found in this second tab of this excel file (HERE), but allow me to summarize a few of the highlights.

 

  • Suffolk and Nassau counties each had direct retirement expenditures of $300mn in 2011. By 2013, those same counties saw direct retirement spending balloon to $481mn and $491mn, respectively. Those are increases of 61% and 64%, respectively over just two years.
  • Westchester saw its payments increase from $275mn in 2011 to $439mn in 2013, a 60% increase.
  • Other large NY counties look similar: New York (Manhattan): +51%, Kings (Brooklyn): +52%, Erie (Buffalo): +54%, Onondaga (Syracuse): +60%, Monroe (Rochester): +57%. In fact, from 2011 to 2013, the 61 counties of New York saw an average increase in direct retirement spending of 59% (median: 60%).
  • Consider how much the growth in that one line item crowds out other areas of local budgets. When revenues and most spending categories are growing at 2-4% per year, it’s simply not possible to absorb 30% annual growth in retirement costs on an ongoing basis without either enormous tax increases or other expenditures seeing profound declines.

 

At the state level, things are just as bad. On paper (HERE), New York is considered a “Top-10” state for pension funding with ~93% funding vs its actuarial liability estimate. Compared with CT, which has just 55% of its actuarial liabilities funded (Bottom 10), or Illinois – the worst in the country – at just 43%, New York seems to be in good shape. The overall funding ratio for all the states is 73% based on the official reporting.  Not great, but not terrible.

 

Digging a bit deeper, however, the State level problem appears more serious. Once again, the culprits are the assumptions for asset returns and liability discount rates. The fiscally conservative think tank, State Budget Solutions, a non-profit out of Virginia, has run the same analysis using a market-valued liability (HERE) and found that the 73% funded status system-wide drops to 39% once a little reality is injected. Using their methodology, New York’s funding status drops from 93% funded to just 47%, leaving a funding hole of $260 billion, the fourth largest in the country behind California ($640bn), Ohio ($287.4bn) and Illinois ($287.0bn).

 

The Big Kahuna, of course, is Social Security. Not to be outdone, in its latest annual long-term financial outlook, the Board of Trustees for Social Security projected the fund will run out of money by 2034, at which time only 79% of benefits will be payable. This one irks me the most, as it’s the only one I’m personally eligible for. By then, I’ll be 60 and will have paid into the system for 40 years. I’m pretty sure I’ll never see a dime of money in return.

 

What about Private Retirement Savings? In short, there’s no reason to expect it to fill the gap for the vast majority of Americans. A few facts to consider, from the Government Accountability Office (GAO):

  • 29% of Households headed by someone 55 or older have ZERO pension or retirement savings
  • Among those with savings, Households headed by 55-64 year olds, have median savings of $104k and those 65-74 years old have median savings of $148k. This level of savings would produce an inflation-protected annuity of just $310/mo and $649/mo, respectively.
  • A TransAmerica survey done in 2015 found that 401k savers in their 20s had median balances of $16k, those in their 30s had $45k, and those in their 50s had $117k. 60 year olds had saved a median of $172k.

 

So, what can be done?

There’s no silver bullet here, but a partial solution will likely be that Americans will increasingly tap into their accumulated home equity, either through cash-out refinancing, reverse mortgages or downsizing.

 

The most recent Fed data (4Q2015) shows total US Owners’ Equity in Real Estate reached $12.54 trillion, up from $6.35 trillion in mid-2011.  For reference, a little over half that wealth (~$6.75 trillion) is held by the ~30% of homeowners who own their homes free and clear. These households are fortunate in that they have a sizeable, monetizable asset.

 

The median US existing home ($223k) currently sells for roughly 4.25x the median US household income ($52k). Retirement guidelines call for saving ~8x your income, meaning that around 1/3 of homeowners could in theory tap the equity in their homes to cover ~1/3-1/2 of their retirement needs – in reality, of course, they still need somewhere to live, so the offset is somewhat less. For the other 2/3 of homeowners who are still encumbered, they’ll have some cushion, but it’s no panacea.

 

The bottom line is that very difficult choices will need to be made by pensions, courts and politicians in the coming 10 years, and it seems unavoidable that pension promises will be broadly reworked.

 

Either Americans will slowly awaken to the fact that they don’t have enough saved for retirement and will choose to save more, which will suppress growth today, or they won’t, which will suppress growth down the road. Most likely, we’ll see a mix of the two. It’s hard to see American economic growth sustainably re-accelerating to 3-4% in the coming decade in the face of this.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.69-1.87%

SPX 2036-2118

Nikkei 15583-17448 

VIX 12.82-18.40
USD 93.77-95.18

Gold 1225--1269

 

Yours in risk management,

 

Josh Steiner
Managing Director

 

[UNLOCKED] Early Look: The Retirement Reality Check - Cliff Asness Guide to CAPE implied future returns

Source: Cliff Asness, AQR (An Old Friend: The Stock Market’s Shiller P/E)


Daily Market Data Dump: Thursday

Takeaway: A closer look at global macro market developments.

Editor's Note: Below are complimentary charts highlighting global equity market developments, S&P 500 sector performance, volume on U.S. stock exchanges, and rates and bond spreads. It's on the house. For more information on how Hedgeye can help you better understand the markets and economy (and stay ahead of consensus) check out our array of investing products

 

CLICK TO ENLARGE

 

Daily Market Data Dump: Thursday - equity markets 6 2

 

Daily Market Data Dump: Thursday - sector performance 6 2

 

Daily Market Data Dump: Thursday - volume 6 2

 

Daily Market Data Dump: Thursday - rates and spreads 6 2

 

Daily Market Data Dump: Thursday - currencies 6 2


INSTANT INSIGHT: U.S. Dollar, Japanese Equities Crashing & Fed Rate Hikes

Takeaway: The U.S. Dollar was down in the last two days of trading sending commodities up and Japanese equities down.

INSTANT INSIGHT: U.S. Dollar, Japanese Equities Crashing & Fed Rate Hikes - dollar crumbled

 

The simple summary of the last two days of trading goes like this:

 

Dollar Down = Reflation Up

 

It's that easy...

 

Here's additional analysis via Hedgeye CEO Keith McCullough in a note sent to subscribers earlier this morning:

 

"All it took was 2 down days for USD to ramp reflation, but this time to lower-highs for both the CRB Index (TAIL risk resistance = 192) and Oil – anything in the area code of consensus on jobs “probably” (her word) gives the Fed the greenlight they want on a rate hike (i.e. rate of change in labor market will still be slowing into that hike, which would be USD bullish from here)" 

 

INSTANT INSIGHT: U.S. Dollar, Japanese Equities Crashing & Fed Rate Hikes - rate hike cartoon 12.16.2015

 

Meanwhile, in Asia...

 

Yesterday it was China flash crashing. Today it's Japan getting smoked. Again, down Dollar is at play, this time wreaking havoc on Japanese equities. McCullough writes:

 

"No likey the Down Dollar, Up Yen move, eh? For your friends who think stocks can’t go down anymore, the Nikkei just lost another -2.3% overnight and -3.9% in 2-days, taking it right back into #crash mode at -21% since July. Into the jobs report, I say you book some gains on the short side of Japanese Equities, especially if USD Index holds this 94-95 level." 

 

 

Where does the U.S. Dollar go from here?

 

 

With future Fed rate hikes tethered to "improvements" in the labor market, all eyes are on tomorrow's Jobs Report. To be clear, barring some truly massive ramp in the non-farm payroll numbers, the trend in the jobs market will continue to fall off its February 2015 peak in rate of change terms.

 

Not that this matters to the linear, labor economists at the Fed. A headline beat would "probably" (Janet's own words) justify a rate hike in the coming months. And the simple summary goes like this:

 

Rate Hike => Dollar Up

More to be revealed


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Do we need a terrible jobs report to keep reflation going?

Client Talking Points

USD

All it took was 2 down days for USD to ramp reflation, but this time to lower-highs for both the CRB Index (TAIL risk resistance = 192) and Oil – anything in the area code of consensus on jobs “probably” (her word) gives the Fed the greenlight they want on a rate hike (i.e. rate of change in labor market will still be slowing into that hike, which would be USD bullish from here).

 

Japan

No likey Down Dollar, Up Yen move, eh? For your friends who think stocks can’t go down anymore, the Nikkei just lost another -2.3% overnight and -3.9% in 2-days, taking it right back into #crash mode at -21% since July. Into the jobs report, we say you book some gains on the short side of Japanese Equities, especially if USD Index holds this 94-95 level.

OIL

Is the new intermediate-term risk range $46-56 or $36-50? The Saudis have a major drill program underway and Iran isn’t budging (our Energy Policy analyst Joe McMonigle is at the OPEC meeting); the Fed tightening into a slow-down matters in trying to answer the question on what the risk ranges are across durations – currently the immediate-term range = $46.87-49.99 WTI.

Asset Allocation

CASH US EQUITIES INTL EQUITIES COMMODITIES FIXED INCOME INTL CURRENCIES
6/1/16 77% 0% 0% 6% 11% 6%
6/2/16 80% 0% 0% 4% 8% 8%

Asset Allocation as a % of Max Preferred Exposure

CASH US EQUITIES INTL EQUITIES COMMODITIES FIXED INCOME INTL CURRENCIES
6/1/16 77% 0% 0% 18% 33% 18%
6/2/16 80% 0% 0% 12% 24% 24%
The maximum preferred exposure for cash is 100%. The maximum preferred exposure for each of the other assets classes is 33%.

Top Long Ideas

Company Ticker Sector Duration
MCD

For some perspective on the Macro environment and why we favor companies like McDonald's (MCD), here's an excerpt from the Early Look written by Hedgeye CEO Keith McCullough:

 

Taking a step back, don’t forget where US Consumers (70% of GDP) were at this time last year:

 

  • US Employment Growth (NFP) was putting in a cycle peak
  • US Consumer Confidence was putting in a cycle peak
  • US Consumption Growth was putting in a cycle peak

 

Peak. Peak. #Peak!

 

And what happens when you start to lap the cycle peak? Well, instead of crappy Baby Boom capacity putting up mediocre (barely positive) same store sales at the peak, they look even crappier on the back side of the cycle."

 

That's why we like large-cap, low-beta, liquid companies like McDonald's in this tumultuous market environment. Case in point, earlier in the week, MCD hit an all-time high. Since we added the company to Investing Ideas, it is up almost 30%.

 

Stick with it. Restaurants analyst Howard Penney reiterates his "road to $150" call, implyling more than 15% upside from here.

TLT

Credit markets are one of the major beneficiaries (maybe the largest) of the reflation trade since February. While yield spread compression has been a positive for Long Bonds (TLT, ZROZ), a perceived monetary policy shift and a collapse in bond market volatility expectations have been a positive for Junk Bonds (JNK), but we don’t expect it to continue.

 

With growth continuing to slow alongside consensus positioning broadly, downside deflation risk is on the table. As we’ve highlighted on a daily basis, consumption growth and labor market growth peaked in Q1 2015 and both are slowing alongside a continued corporate profits slowdown. This mix:

  • Smells like incremental deflation on the margin;
  • Is a huge risk for high yield credit (JNK)

 

GLD

Our Macro team’s proprietary Growth, Inflation, Policy Model (GIP Model) is a proven model that accurately front-runs the second derivative direction of inflation-adjusted growth. The most important call-out is that our growth estimates for 2016 (year-over-year) remain WELL BELOW Wall Street and Central Bank consensus forecasts:

 

  • Hedgeye: +1.4%
  • Bloomberg Consensus: +1.8%
  • Central Bank: +2.2%

 

In conclusion, the Fed remains out to lunch with their expectation for growth, and once they come around the Hedgeye view, the policy playbook calls for incremental easing on the margin.

Three for the Road

TWEET OF THE DAY

McMonigle: Why $50 Oil Is Likely Temporary app.hedgeye.com/insights/51329… … via @JoeMcMonigle on #oil at #OPEC meeting pic.twitter.com/cRHFPAQMOa

@Hedgeye

QUOTE OF THE DAY

"I didn't get over 1300 walks without knowing the strike zone."

-Wade Boggs

STAT OF THE DAY

Jeff Bagwell hit 449 HR's during his 15 year career.


The Macro Show with Keith McCullough and Joe McMonigle Replay | June 2, 2016

On a special edition of The Macro Show, Joe McMonigle reports from Vienna to discuss today's OPEC Meeting.

 

CLICK HERE to access the associated slides.

 

An audio-only replay of today's show is available here.


CHART OF THE DAY: What The Fed's December Rate Hike Did To High Yield Spreads

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye CEO Keith McCullough. Click here to learn more.

 

"... How about the credit cycle? Oh right – another true but unimportant factor for weekly chart-chasers to consider until it matters again… What happened to High Yield Spreads last time (i.e. the only time in modern history) that the Fed tightened into a slow-down?"

 

CHART OF THE DAY: What The Fed's December Rate Hike Did To High Yield Spreads  - 06.02.16 EL Chart


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