-- Published: Monday, 4 May 2015 | Print | Disqus
By Daniel R. Amerman, CFA
Confidence in retirement investing is once again soaring among the general public. According to a recent survey, those who own retirement accounts are feeling almost twice as confident about their ability to retire and what their standard of living will be in retirement than they were two years ago.
At the same time, a well known and highly sophisticated investment executive has recently semi-retired at age 56. And now that this Oxford economics PhD is managing his own retirement portfolio instead of being CEO of one of the largest investment companies in the world, he isn't buying stocks, he isn't buying bonds – and indeed he is running away from conventional retirement investments as fast as he can.
Now where things get really interesting and also ironic is that the source of the general public's newfound optimism is the same factor that is driving this economics expert to take his own money and run – that being record stock market prices. The extreme contrast comes down to the degree of understanding about why prices for stocks and bonds have moved so high. It's not what the public thinks it is, and for those on the inside and in the know, it is why they're running.
Public Confidence Surges
The results of the 25th annual Retirement Confidence Survey were recently released. Conducted by the Employment Benefit Research Institute (EBRI), the study showed that over the last two years there has been a dramatic change in attitudes for both current workers and current retirees. Highlights include:
The percentage of current workers with retirement plans who are confident they will have a comfortable retirement has increased from 14% in 2013 to 28% in 2015.
The percentage of current retirees who are very confident their retirement will be financially secure has increased from 18% in 2013 to 37% in 2015.
There has been very little if any change in confidence among those who do not have retirement accounts.
The increased confidence is not coming from saving more, because most people aren't.
Rather, one of the co-authors attributes the dramatic gain in confidence to statistics showing that 401(k) plans increased in value in a range from 19% to 47% in the single year of 2014.
In other words, the dramatic surge in retirement confidence seems to be almost entirely linked to investors who own stocks in their retirement accounts, and who are feeling really, really good about the strong results produced by those investments in recent years.
A Starkly Contrasting Perspective
Dr. Mohamed El-Erian is the former CEO of Pacific Investment Management Co (better known as PIMCO), the very well known $1.7 trillion investment firm, and he recently gave an interview with his local newspaper, the Orange County Register (link here). While the interview covered many topics, his answers to a few key questions were particularly notable:
Q. Where is your money? Stocks? Treasuries? Bonds?
A. It is mostly concentrated in cash. That’s not great, given that it gets eaten up by inflation. But I think most asset prices have been pushed by central banks to very elevated levels.
Q. So we’re nearing a bubble?
A. Go back to central banks. Central banks look at growth, at employment, at wages. They are too low. They don’t have the instruments they need, but they feel obliged to do something. So they artificially lift asset prices by maintaining zero interest rates and by using their balance sheet to buy assets.
Why? Because they hope that they will trigger what’s called the wealth effect. That you will open your 401k, see it has gone up in price, and you’ll spend. And that companies will see their shares are going up and they will be more willing to invest. But there is a massive gap right now between asset prices and fundamentals.
And then there's the following:
Q. Why write a book on central banks?
A. This is a historic period in which central banks are the only game in town when it comes to policy. But central banks do not have the tools to deliver what the global economy needs. We need more potent reinvigorated growth models.
What El-Erian admitted in his newspaper interview was something fairly astounding from a financial expert's perspective. He said he was keeping his money in cash knowing full well that once inflation is taken into account he was going to incur losses by doing so.
Why on earth would a financial expert accept losing money on his own investments?
The answer, of course, is to avoid losing much more money elsewhere.
The Knowledge Gap & The Surreal Triangle
Having begun the formal study of finance and economics as an undergraduate in 1977, I've been immersed in these subjects for what is getting close to 40 years now. Over that time I have seen tremendous changes in the markets, from bull markets to bear markets, to bubbles forming, to bubbles popping, with great wealth being both created and lost – but I've never before seen anything like the current situation.
And what I mean by that is that I am seeing the greatest gap in my professional lifetime between what the general public understands about savings and investments, as opposed to the quite different understanding that is shared on a global basis among the people making policy decisions and running the major institutions.
To understand just how extraordinarily wide this gap has become, consider the three informational points below, each of which exist simultaneously, and each of which became public in April of 2015. Taken together, they form an almost surreal triangle of sorts, where almost nothing about investment reality is working the way that most people believe it does.
1) The US economy just strongly surprised to the downside again, growing at a paltry 0.2% pace in the first quarter – with no growth at all if we make any of several possible adjustments to that, such as removing the spectacular surge in inventories, or allowing for even a slightly higher real rate of inflation. It's a continuation of going on eight years of major underperformance by the economies in the US and other nations.
2) Simultaneously, confidence among retirees and retirement investors is soaring because their stock portfolios are performing so fantastically well.
3) An insider's insider, who also just happens to be the current chairman of President Obama's Global Development Council, just stated in a casual interview with his local newspaper:
"Central banks ... artificially lift asset prices by maintaining zero interest rates...
...Why? Because they hope that they will trigger what’s called the wealth effect. That you will open your 401k, see it has gone up in price, and you’ll spend...
...But there is a massive gap right now between asset prices and fundamentals."
In other words, the Federal Reserve is quite deliberately causing 401(k) balances to inflate far above what would be justified by current economic fundamentals, so as to change the behavior of conventional retirement investors.
And this intentionally-created illusion has been wildly successful (see #2 above).
Yet the goal for this manipulation, the reason for the illusions – which is essentially to boost economic growth – isn't working at all (see #1 above).
Mice In A Maze
To better understand the extraordinary disconnect between what the public is encouraged to believe and what is actually happening, using an analogy of laboratory mice in a maze may be helpful.
Changing investor behavior in order to achieve desirable outcomes is core to both macroeconomics theory and central banking policy. The theory is that by changing incentives, investor behavior can be changed in such a manner that supports stability and growth, thereby serving the greater societal good. These incentives can be positive or negative, and currently we've been seeing a lot of both.
In other words, the mice need to be made to move to a different place in the maze than they are right now. And if too many "mice" are in the low risk location of keeping their money in cash at the bank or in money market funds, which is not generating economic growth – then they need to be given the motivation to leave.
That's where the "electric shock" comes in. The scientists / central bankers pull down on the lever in order to get all of us mice jumping up in the air and moving around as we try to avoid the discomfort.
The electric shock is of course zero interest rate policies accompanied by somewhat higher rates of inflation, which means we steadily lose purchasing power. In other words, the officially stated policies of central banks around the world right now.
These very low interest rates actually serve multiple purposes for governments, four of which are in direct conflict with the interests of most investors – as explained in this article. Now they do also directly facilitate a rise in stock prices in multiple ways, including lower cost capital for investment (which leaves money for equity owners), lower cost margin loans for investors buying stocks, and providing very cheap funding for the massive stock buyback programs (where corporations borrow money to buy their own stock).
But inflicting discomfort on investors is also a key objective. Because the theory is that too many people keeping their money in safe assets has a negative effect on economic growth, so the government and central banks aim to provide the strongest motivation possible to get people to move their money and to take the risks that are theorized to spur growth, and therefore investors seeking safe income are punished with negative returns (once the effects of inflation are accounted for).
So, the continuous administration of electric shocks thus force some of the mice out of their comfort zone, and they take risks which they would not otherwise take. And these millions of "mice" seeking out risky investments impacts the supply and demand for risky investments such as stocks and high yield bonds. Which predictably increases the prices of stocks, thereby producing profits for stock investors. And so it is that we have the appearance of big juicy profits in what is an otherwise yield-starved environment (as a matter of maze design).
In other words, the first cheese cube just materialized, and in exactly the place in the maze where the scientists want the mice to move.
Other mice that are getting tired of scurrying around trying to avoid the unrelenting electric shocks, notice that some cheese just appeared, and in a place where nobody is being shocked. So they run through the maze and buy some stocks, so they can enjoy their cheese too.
Their purchasing stocks further increases stock prices. Which produces more cheese. Which attracts still more mice. Until there is a great big pile of cheese in exactly the place where the scientists want the mice to be. Which in theory is supposed to create a veritable mouse stampede, as the mice flee the shock zone for the cheese.
What's another name for those piles of cheese? That would be the "wealth effect" that Dr. El-Erian referred to in his interview.
Now, one of the truly twisted things about economics, which can be very confusing for non-economists, is the relationship between perceptions and reality. That is, people base their behavior on what they perceive to be true. And it is the collective behavior of people within a society that creates the economy, and determines whether it grows or shrinks, as well as what wages and unemployment are.
So the theory is that by quite deliberately manipulating perceptions (aka fooling the public), the behavior of the population can be changed. Because economic reality is nothing more than behavior, this means that what started as a false perception can actually become the desired reality.
The "mice" perceiving that their investments are doing wonderfully (the "cheese") is supposed to lead them to spend more money, which produces jobs while increasing the wealth of society. Even while from the other direction, they're forced into taking risks (the "electric shock"), which creates an increased supply of money on cheap terms, which is supposed to enable businesses to make more investments in new plants and technologies, which produces jobs while creating wealth. Increasing supply reinforces increasing demand, and a virtuous cycle is thereby created, as a stagnant economy wrestling with high unemployment is replaced by a thriving and growing economy that creates ever more jobs.
That's the theory, anyway.
In practice, however, the most important part and the reason behind the whole exercise – which is that perception becomes economic reality – isn't working at all.
Oh, the electrical shocks are still working just fine in terms of investor pain from very low interest rates, and are indeed increasing in strength in Europe. The cheese production and the creation of the illusion of wealth is working exceptionally well, as shown so clearly in the latest Retirement Confidence Survey.
But the goal has never been to create either hardship or dangerous illusions for their own sake, but rather to accept those (intended to be) temporary costs as the (supposedly) necessary price of boosting the economy and creating real wealth. Which takes us back to #1 of our Surreal Triangle, and all these years of subpar to no growth.
The danger is that if the "mice" fall in love with their new cheese supply, but they don't actually change their spending behavior and therefore the theorized wealth effect never kicks in – then the whole experiment backfires for the nation and possibly much of the world, in a potentially spectacular fashion.
That is, millions of people are lured into sinking their retirement savings into stocks at artificially high prices, which aren't being supported by the real economy. Then the bubble pops. And surging optimism is crushed by financial catastrophe – and potentially when there may not be enough years remaining before retirement to do anything about it.
So, another way to understand what El-Erian – our Oxford economics PhD "mouse" – is doing with his own money is that he is opting to stay in the shock zone, with no interest income, and take steady losses on the value of his ample cash to inflation. Though of course unlike most of us, he can afford to take the losses without it changing his future standard of living. And he endures those losses because he knows what those piles of cheese are all about, and he would much rather endure years of continuous mildly painful shocks than go anywhere near that cheese.
And as for the general public? Oh, they love that cheese and always have.
They love the increase in prices. They have renewed hope for higher income in retirement and greater financial security. All because of this extraordinary turnaround in the markets and this growth in wealth.
This goes back much further than modern financial history, but I think one statement that can be made that has proven true again and again over the centuries and across the nations is that the general public LOVES a good financial bubble.
The general public absolutely loved the tech stock bubble. They also loved the real estate bubble. That is because each one of those created great wealth on paper, as well as enhanced feelings of positive emotions and personal security for millions of people – right up until the time they didn't, and the hopes and dreams were dashed.
Levers & Dials
I hope that my comparing us all to laboratory mice did not offend, that was not my intention. It was instead meant to serve as an eye opener.
The point is to make clear something which relatively few people understand, yet is crucial to understand, which is that from the perspective of those at the very top of our monetary system, looking down, savings and investments aren't actually about you and me, or whether we find personal wealth or financial security.
Savings are considered a vital societal good, and can be used to stimulate economic growth. If the collective savings for the nation as a whole are not at what is considered a good level, then – effectively – levers are pulled, dials are turned, and the maze is reconstructed a bit. We are then prodded to move away from the newly reshaped "shocks", and in the direction of the somewhat modified rewards, and in the process – in theory – the national savings rate moves to a more desirable level.
Now, as for the individual savers themselves personally achieving the genuine financial security that they thought was the idea behind their saving? Well that would of course be nice, and if things work out that way then all the better. But from that clinical governmental / central banking / macroeconomics perspective looking down on us in our teeming multitudes – that is actually not the primary reason that savings are encouraged.
And the sharp contrast between the purported collective needs of society and the very real needs for financial security by individual savers comes into particularly sharp focus during times of prolonged economic stagnation, with financial crisis mixed in as well. As it's been in recent years.
This is of course the exact environment in which people need their savings and the financial security that comes with them. But because "excess" savings are theorized to slow economic growth and prolong economic stagnation, the naturally "selfish" behavior of people trying to hold onto their own security instead of seeking out risks to take for the common good, becomes a major obstacle for central banking economists.
From the perspective of the "scientists" looking down on the "maze", too many individuals acting in their own self-interests and trying to make their own savings work for themselves – can become a major obstacle to be dealt with, and fast. So it's time to crank up the electrical power dial, pull down on the saver punishment lever and make those mice jump straight up in the air. Until they scurry off and do what they are supposed to do.
The Conflict That Threatens Retirement Security
The 2nd part of this article explores the disconnect between what conventional retirement investors are told is true about their future financial security, and the almost entirely different reality of how government and central bank actions are threatening the very foundations underlying that security. Those who are unaware of the "levers and dials" lack defenses against this conflict, but for those who are aware, there are not just defenses but a range of new opportunities that can become available.
Continue Reading The Article
Daniel R. Amerman, CFA
This article contains the ideas and opinions of the author. It is a conceptual exploration of financial and general economic principles. As with any financial discussion of the future, there cannot be any absolute certainty. What this article does not contain is specific investment, legal, tax or any other form of professional advice. If specific advice is needed, it should be sought from an appropriate professional. Any liability, responsibility or warranty for the results of the application of principles contained in the article, website, readings, videos, DVDs, books and related materials, either directly or indirectly, are expressly disclaimed by the author.
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-- Published: Monday, 4 May 2015 | E-Mail | Print | Source: GoldSeek.com