Mish's Global Economic Trend Analysis

Posted: 28 Aug 2015 03:53 PM PDT

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.

Annual Update

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.

Analysis

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.

Drawdowns Kill!

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.

Negative Flow

My friend Don Campbell 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 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 have 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.

Imagination

I have a musical tribute to imagination in regards to pension finances, especially imagination in Illinois.

link if video does not play: Creedence Clearwater Revival - Lookin' Out My Back Door

Illinois Non-Answer

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.

The only way out of this mess is a pension restructuring coupled with municipal defaults.

Mike "Mish" Shedlock

Fed Queen Race: Personal Income Rises 0.4% as Expected; Good for Rate Hikes? GDP?

Posted: 28 Aug 2015 09:59 AM PDT

Personal income for July rose as expected in today's Personal Income and Outlays report. Consumer spending rose nearly as expected, led of course by auto sales. Price pressure was nonexistent.

There's no hurry for a rate hike based on the July personal income and outlays report where inflation readings are very quiet. Core PCE prices rose only 0.1 percent in the month with the year-on-year rate moving backwards, not forwards, to a very quiet plus 1.2 percent. Total prices are also quiet, also at plus 0.1 percent for the monthly rate and at only plus 0.3 percent the yearly rate.

On the consumer, the data are very solid led by a 0.4 percent rise in income that includes a 0.5 percent rise in wages & salaries which is the largest since November last year. Other income details, led by transfer receipts, also gained in the month. Spending rose 0.3 percent led by a 1.1 gain in durables that's tied to vehicle sales. The savings rate is also healthy, up 2 tenths to 4.9 percent.

The growth side of this report is very favorable and marks a good beginning for the third quarter. This at the same time that inflation pressures remain stubbornly dormant. And remember this report next month will reflect the August downturn in fuel prices. With the core PCE index out of the way, next week's August employment report looks to be the last big question mark going into the September 17 FOMC.

Favorable Beginning for Third Quarter GDP?

Let's investigate the above Bloomberg claim "The growth side of this report is very favorable and marks a good beginning for the third quarter."

Today's GDPNow Forecast

The Atlanta Fed GDPNow Forecast sees it this way:

"The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2015 is 1.2 percent on August 28, down from 1.4 percent on August 26. The forecast for real GDP growth in the third quarter decreased by 0.2 percentage points following this morning's personal income and outlays report from the U.S. Bureau of Economic Analysis. The slight decline in the model's forecast was primarily due to some weakness in real services consumption for July, which lowered the model's estimate for personal consumption expenditures from 3.1 percent to 2.6 percent for the third quarter."

GDP Now Model

GDP By Quarter

2015 Q1: 0.6%
2015 Q2: 3.7%
2015 Q3: 1.2% GDP Nowcast

Fed Queen Race

Consumer spending is supposedly humming along. GDP is not doing much of anything.

This reminds me of the Red Queen Race, an incident in Lewis Carroll's Through the Looking-Glass that involves the Red Queen and Alice constantly running but remaining in the same spot.

"Well, in our country," said Alice, still panting a little, "you'd generally get to somewhere else—if you run very fast for a long time, as we've been doing."

"A slow sort of country!" said the Queen. "Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!"

Clearly we need to sell twice as many autos to get GDP where the Fed wants it to go.

Mike "Mish" Shedlock

Economy News

28.8.15

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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