Aggregate U.S. Pension Data Shows Grim Outlook
Editor’s Note: This analysis by economics blogger Mike Shedlock clearly shows why government employee pensions are taking an awful risk by continuing to forecast annual investment returns of 7.0% or more per year. In his first chart Shedlock points out how between 2008 and 2014 the aggregate value of state and local government worker pension system assets only increased 12.7% – a return of 1.9% per year. If one extends the horizon back to 2003 – i.e., if one backs up to include the stock market run-up from 2003 through 2008 – that annual return improves, to a still paltry 4.3%. The headwinds facing global investment portfolios include an aging population, which means there will be a higher percentage of retirees selling their assets which drives down prices and returns, as well as interest rates, everywhere, now at historic lows, which means that debt stimulated economic growth is more problematic than ever. What do the pension systems intend to do, if they can’t hit their 7.0% per year annual returns over the next several years? The answer to-date is to raise every tax and fee in sight to feed the pension systems, which along with incremental benefit adjustments is claimed to be sufficient. But only if 7.0% returns are forthcoming. What if they are not forthcoming? What then?
One of my constant themes over the past few years is the underfunding of state and local pension plans. Illinois is particularly bad, but let’s look at some aggregate data.
The National Association of State Retirement Administrators (NASRA) provides this grim-looking annual picture in their most recent annual update:
State and Local Defined Benefit Plan Assets at Year-End
2003-2014 ($ = Trillions)
Between the end of 2007 and end of 2014, pension plan assets rose from $3.29 trillion to $3.71 trillion. That’s a total rise of 12.76%.
Plan assumptions are generally between 7.5% to 8.25% per year!
S&P 500 2007-12-31 to 2014-12-31
In the same timeframe, the S&P 500 rose from 1489.36 to 2058.90.
That’s a total gain of 590.54 points. Percentage wise that’s a total gain of 40.22%. It’s also an average gain of approximately 5.75% per year.
- In spite of the miraculous rally from the low, total returns for anyone who held an index throughout has been rather ordinary.
- The first chart is not a reflection of stocks vs. bonds because bonds did exceptionally well during the same period.
To be fair, the first chart only shows assets, not liabilities, but we do know that pensions in general are still enormously underfunded, with Chicago and Illinois leading the way.
Reader Don pinged me with this comment the other day: “Nearly all public pension funds have a negative cash flow, meaning they pay out in benefits each year more than they receive in contributions. For all public pension funds, the negative cash flow is approximately 3% of assets, which means an average fund needs to produce an annual return of 3% to maintain a stable asset value.”
That’s fine if assets have kept up with future payout liabilities and plans are close to fully funded.
However, it is 100% safe to suggest that neither condition is true.
So here we are, after a massive 200% rally from the March 2009 low, and pension plans are still in miserable shape.
And plan assumptions are still an enormous 8% per year. Let me state emphatically, that’s not going to happen.
Stocks and junk bonds are enormously overvalued here.
GMO Investments Forecast
“The chart represents real return forecasts for several asset classes and not for any GMO fund or strategy. These forecasts are forward‐looking statements based upon the reasonable beliefs of GMO and are not a guarantee of future performance. Forward‐looking statements speak only as of the date they are made, and GMO assumes no duty to and does not undertake to update forward‐looking statements. Forward‐looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual results may differ materially from those anticipated in forwardlooking statements. U.S. inflation is assumed to mean revert to long‐term inflation of 2.2% over 15 years.”
Over the next 7 years GMO believes US stocks will lose money (on average), every year. Those are in real terms, but returns are at best break even, assuming 2% inflation.
Bonds are certainly no safe haven either. I strongly believe GMO has this correct.
Assume GMO Wildly Off
Even if one assumes those GMO estimated returns are wildly off to the tune of four percentage points per year, pension plans needing 8% per year will be further in the hole with 4% per year annualized returns.
Illinois house speaker Michael Madigan and Chicago governor Rahm Emanuel believe tax hikes are the answer.
Both are sorely mistaken. Here are a few viewpoints to consider.
- Beware, the Tax Man Has Eyes on You: Potential Hike for Illinoisans is Staggering
- Emanuel Fiddles While Chicago Burns; Public Schools Over the Edge; 9% Cloud Tax on Data Streaming; Emanuel Eyes Property Tax Hikes
- CNBC’s Santelli and Mish Discuss Municipal Bonds; Egan-Jones on Chicago; S&P Blames Moody’s; Message to Bondholders
The only way out of this mess is a pension restructuring coupled with municipal defaults.
* * *
Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education, and a senior fellow with the Illinois Policy Institute.