The Really Big Picture

Transcription

1 The Really Big Picture Debt The Economy Demographics Capital Markets Central Bank Policy Retirement Plans

2 Norwood Economics is a fee-only Registered Investment Advisor specializing in low-cost, small business 401(k) and Cash Balance Plans. Our mission is to provide low-cost, unbundled plans that are custom designed to meet the needs of your workforce based on your census. We can: Typically reduce plan costs by 40% to 50% Substantially improve plan design to better accomplish owner goals Provide plan administrators with the support and service they need to ensure the plan remains compliant and participants receive the administrative help they deserve Educate participants to help them better navigate the investment environment, making it more likely they ll achieve a successful retirement

3 Economics Is A Soft Science There is no law of gravity Humans are part of the equation, which means psychology matters An economy is a complex, dynamic system with many feedback loops Complex systems are systems whose behavior is intrinsically difficult to model due to the dependencies, relationships, or interactions between their parts or between a given system and its environment. Cause and effect can change as an economy evolves (As goes GM, so goes the Nation.Not!) Small variations can produce large changes in outcomes

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8 Household Debt Household Debt climbed to approximately $12.58 trillion by the end of 2016 (Federal Reserve Bank, NY) Total Household Debt stood at $12.68 trillion in 2008 (Federal Reserve Bank, NY) Savings rate fell to 2.9% in Nov from 3.7% the prior year (Dr. Lacy Hunt, Hoisington Asset Management, Q4 Newsletter)

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12 Institute For International Finance

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14 A Mountain of Debt U.S. Federal Debt at all time highs Total U.S. Debt at all time highs Worldwide Debt at all time highs Debt still rising sharply throughout the world and in the United States Debt must eventually be repaid, defaulted on, or inflated away

15 Demographics is Destiny The world working age population peaked in 2012 and is now falling. The world is aging rapidly, particularly in developed countries such as Japan, Germany, and the United States. There is a significant correlation between economic growth in the developed world over the last 30 years and immigration patterns. For example: Canada imports around one million new immigrants per year (3% of the population) the growth rate of the Canadian economy is usually around 3%. As countries in the developing world start to exploit the demographic advantage associated with young and growing populations, the developed world will continue to struggle with the economic challenges of an ageing population/workforce. This will cause significant disruption over the next years. (IFLA Trend Report, 2017)

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17 Old-Age Dependency Ratio Over the coming decades, many countries in the developed and developing world alike will significantly age. Old-age dependency ratio - measures the number of those aged above 65 years (currently defined as old age) as a share of those between 15 to 64 years (currently defined as working age). The ratio tells us how many retired people a potential worker has to sustain.

18 Germany, Russia and America Countries like Germany, Russia, and the United States are all experiencing sharp increases Approximately five workers supported one old person in America in the 1990s an old-age dependency ratio of approximately 0.20 America will have an old-age dependency ratio of about 0.37 by workers per old person a big change

19 Source: United Nations World Population Prospects: the 2012 Revision (database)

20 Adult Dependency Ratio Adult dependency ratio: those inactive versus active in the entire adult population, aged 15 and older - gives us a much more positive and less divergent outlook across the three countries examined in this post

21 Source: Bussolo, Koettl, and Sinnott (Forthcoming). Golden Aging. Prospects for Healthy, Active, and Prosperous Aging in Europe and Central Asia. Washington, DC: World Bank.

22 Central Bankers Response To The Great Recession Central banks have expanded their balance sheets, creating trillions in new base money Central banks have implemented Zero Interest Rate Policy (ZIRP) and Negative Interest Rate Policy (NIRP) at the short end of the yield curve Central banks have implemented unconventional monetary policy termed Quantitative Easing large scale asset purchases to lower interest rates and increase the money supply

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29 Liquidity and Capital Markets Central Bankers have practiced unconventional monetary policy since the Great Recession Central Bank balance sheets have ballooned to unprecedented levels The Federal Reserve balance sheet grew from approximately $850 billion to $4.5 trillion Dollars are on the liability side of the Federal Reserve s balance sheet and someone has to hold those dollars

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39 The Economy MV=PY

40 The Equation Of Exchange MV = PY M = money supply V = the velocity of money number of times per year the average dollar is spent P = the general price level Y = real output (quantity of goods and services)

41 Slow Economic Growth Velocity is currently low, standing at 1.43, its lowest level since 1949 Money growth has slowed to 5% as of Q The Federal Reserve continues to raise the Federal Funds Rate and also continues to shrink its balance sheet, putting additional downward pressure on money growth If money (M2) continues to decelerate, and V stabilizes (although it has declined at a 2.4% rate over the past eight years), then nominal GDP will record a lower growth rate in 2018 than the estimated 2017 pace of 4.0% Even nominal GDP growth of 4.0% equates to approximately a 2% real growth rate expect worse (Dr. Lacy Hunt and Van Hoisington, Hoisington Asset Management Q4 2017)

42 Debt And The Economy This Time Is Different: Eight Centuries of Financial Folly (Dr. Carmen Reinhart and Dr. Kenneth Rogoff) Countries with high debt levels rarely grow out of them Instead they: default, restructure, or allow inflation to reduce the real debt burden Countries with debt in excess of approximately 90% see reduced growth rates? A recent IMF study disputes that finding

43 Demographics and Growth Real GDP growth is the sum of labor force growth and productivity increases Currently the U.S. labor force is expected to grow at a 0.5% annual rate over the next 10 years (Bureau of Labor Statistics) During the current business cycle, which started in the fourth quarter of 2007, labor productivity has grown at an annualized rate of 1.1 percent (Bureau of Labor Statistics)

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45 Debt Service Debt can t grow faster than the economy forever Low interest rates have allowed the Federal Government to sharply increase borrowing without raising the cost of servicing the debt Rising rates will sharply increase the cost of servicing the U.S. debt (Under current law, the Congressional Budget Office (CBO) projects interest payments to nearly triple in nominal dollars and double as a percent of GDP from $241 billion and 1.3 percent of GDP in Fiscal Year (FY) 2016 to $712 billion and 2.6 percent of GDP by FY 2026)

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47 Retirement Plans Slower economic growth due to high debt levels, lower labor force growth rates, and lower productivity gains Lower capital market returns due to elevated asset levels and slower economic growth Continued low savings rates among baby boomers Rising inflation as the U.S. government struggles to meet rising debt servicing costs?

48 Public Pension Plan Funding As of June 30, 2017, the aggregate funded ratio is estimated to be 70.7% as assets experienced healthy growth One-third of the plans reduced the interest rate assumptions they use for determining contribution amounts The difference between the median sponsor reported discount rate (7.50%) and our independently determined assumption (6.71%) continues to widen, indicating that further reductions in interest rate assumptions are likely The Milliman Public Pension Funding Study 2017 the study annually explores the funded status of the 100 largest U.S. public pension plans.

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50 Range of Funding Among States Across the country, funded ratios for plans reviewed by The Pew Charitable Trusts ranged from 37% in New Jersey to 104% in South Dakota Indiana is 86% funded as of 2 Dec according to the State of Indiana

51 Baby Boomers One in four 65-year-olds today will live past age 90, while one in 10 will live past age 95 One out of every three Americans has no retirement savings whatsoever Over 40% of single seniors 65 and over get at least 90% of their income from Social Security

52 Baby Boomers A recent study by Fidelity Investments estimates that the average 65-year-old couple retiring this year will need $275,000 to pay for medical expenses during retirement. (Kiplinger, Sept. 2017) The number of bankruptcy filers age 65 and older more than tripled from 2.1% of seniors in 1991 to 7% in 2007, according to a recent study. (U.S. News & World, 2010)

53 Baby Boomers Only 54% of Boomers have retirement savings, the lowest recorded in the seven years of the Boomer report Only 23% of Boomers believe they will have enough money to last throughout retirement, and that they have done a good job preparing for retirement 82% of Boomers underestimate the percentage of their income that may be required to pay for health care At current savings levels, most Boomers with savings face a potential annual retirement income gap of between $3,864 and $12,072 Boomer Expectations For Retirement 2017, Insured Retirement Institute

54 Impact of Low Returns Public pension plans and individual households routinely use 7% to 8% return assumptions Likely expected returns of 0% over the coming 12 years, and perhaps 4% to 5% over the coming 20 years will exacerbate the savings deficit in the United States A retirement crisis is highly likely

55 Retirement Plan Specialists What can those of us in the retirement plans space do to help? Find ways to help plan participants increase savings: Auto-Enrollment, Auto-Escalation, HSA, Cash Balance Help people do a better job investing: Simplified investment choices such as pre-built, diversified portfolios lead to higher accumulation rates Reduce costs 1% saved is 1% earned Plan designs that encourage enrollment: Loan option, hardship distributions, shorter eligibility periods, more frequent start and change options)