Update for July 9, 2014 - Newsletter (Who Owns Your Equities? -5)
No, there has to be another reason for all of this heretofore unprecedented activity on the global equities markets. If we were looking at a hypothetical activity of the Fed in buying up US equities, we would (in all probability) see screams of “backdoor nationalisation” and the like. In such emotionally charged articles, we would NOT see the rationale behind such an action. No, we can look at overseas central banks and their activities in this area and come to the conclusion that it is something which we have been examining for sometime now: pensions. Japan is one of the three major players in the pension market and they have been so for sometime now. When they started doing this, they restricted themselves to overseas bond markets. This made good sense because their pension returns needed to be 8% or higher and Japanese Yen securities were simply not paying their way. They purchased US Treasuries in the main which, at the time, yielded well in excess of this benchmark. Today they are the number two holder of US Treasuries (look at the URL I have provided above) with well over $ 1 trillion. So, if the Japanese are becoming skittish about US Treasuries and are looking at equities overseas, there is definitely a message here (some $ 2.6 trillion of messages actually!).
I have been ranting and raving about the crack up of pension funds generally for sometime now and the math has been obvious. Anybody can see this and likewise see that a few years down the road when the baby-boomers start to retire in droves, the money will not be there. How can it with bond yields at 1-2% when 8% compounded is required? You might say that when interest rates go back up that all will be well, and you would be quite wrong. The main gimmick to make pensions work is the element of COMPOUND interest, and if that is taken away for even a brief period (much less the years and years of near zero returns we have seen recently) then the making of the “Defined Benefit”payouts becomes increasingly difficult.
No, treasuries and highly rated bonds are not going to suffice. Pensions have been attracted, in desperation, to an old nemisis: “junk bonds”, and the primary obligations of countries such as Mexico and Rwanda (!) which have been paying over 6%. Yes, this is not 8% (much less 8% compounded), but at least it is better than 3-4%! So, apart from real estate and the various derivatives which led to the demise of nearly everything back in 2007-08, equities are about the only game in town. What do you want to have your money invested in anyhow? Some sort of sub-prime bonds or mortgages, or a “AAA” rated equity such as Boeing, General Electric, Nestle, Toyota, or something like that? You are caught, and short of some sort of miracle, your fund is going to be destroyed when the serious demands for pension payments start coming in. As a fund manager, you will really be hung out to dry (and probably sued to personal bankruptcy in the US in the fullness of time) if it turns out that you have placed a larger then normal allocation of your funds into some “CCC” rated bond issued by somebody in Dogsbreath, Appalachia just because it was paying 9%. The fact that other pensions did exactly the same thing in a desperate fight for yield will not help you one iota.