John Mauldin’s latest Thoughts from the Frontline adeptly summarizes the financial markets and prospective losses facing those holding equity and corporate bond portfolios and funds today. There is a way through this mess, but few people are proactively positioned to survive and thrive. See Everything is Broken, here’s a snippet:
Millions of Baby Boomers are approaching what they thought would be a comfortable retirement age and instead finding they’re nowhere near ready. Worse, many believe themselves ready when in fact they aren’t. They will realize it only when markets show them what reality looks like.
The many reasons for this mostly trace back to the above-mentioned broken bond market. Retirement investing used to be easy. Save money, park it in interest-bearing instruments, and live off the income, with Social Security and maybe a job pension to help. Not complicated and it worked well for decades.
But about the time the oldest Boomers began reaching their mid-60s, this thing called “interest” mostly disappeared as committees and politicians decided to favor borrowers by keeping rates ultra-low. And just like that, retirement broke. The old method stopped working.
This left retirees and pre-retirees little choice but to “stretch for yield” in riskier assets. Indeed, that was the plan. The Federal Reserve under Bernanke, Yellen, and now Powell explicitly wants investors to take more risk. It’s the other side of their desire to encourage borrowing. This is also called “financial repression.”
So now we have retirees with far too much in stocks, junk bonds, or other risk-heavy assets. And not just individuals; the same is true for large pension funds. Their trustees are truly trapped: contractually obligated to pay certain benefits and unable to do so without robbing future beneficiaries.
…What happens when you force investors into an asset class they don’t especially want or understand? Well, price comes from supply and demand. Artificially generated demand leads to artificially higher prices, and that is what we see in the stock market today. A survey in the year 2000 shows that investors expected future returns from the stock market would be 15% per year. I think current investors have similar expectations. They think stocks only go up, because the Fed will intervene if they don’t.
I reviewed stock valuations in more detail a few weeks ago (see here) and everything I said then still applies. Anyone who owns passive index funds will endure a major drawdown at some point. I can’t say exactly when but it’s going to hurt. And who holds those funds? Investors who don’t really want to be in stocks in the first place and/or don’t understand the risks, or institutions that have little choice. Both categories are being forced by circumstances to make decisions they wouldn’t make in an otherwise “normal” market.
At the same time, managers of many listed companies aren’t making the greatest decisions, either. Many are responding to short-term incentives that encourage them to load up on debt, boost their share prices via buybacks, and profit by suppressing competition instead of innovating.
This is a stock market in which, much like bonds, prices bear little resemblance to fundamental reality. But more broadly, the equity markets are broken. I am all for making them accessible to everyone. Unfortunately, the regulatory and educational structure hasn’t kept up. So what we’ve really done is empower people to do risky things without preparing them for the consequences. It’s not going to end well.
;
