With Bernanke's easy money policy slashing rates on fixed income investments to essentially nil on a risk-adjusted basis, those of staring at retirement in a decade or two are hunting for returns anywhere we can find them. Unfortunately, if The Economist's Buttonwod columnist is correct, the prospects are dim:
ONE key reason why I have been pessimistic about the outlook for the US stockmarket is based on the use of the Shiller price-earnings ratio. ... The Shiller version tries to eliminate the effect of the economic cycle on valuations; without it, stock markets look expensive when earnings collapse in recessions and look cheap when earnings are high in booms. So it averages earnings over 10 years, and adjust them for inflation; at the moment, the p/e is 21.5, well above the historical mean.
So what? The noted quant, Cliff Asness, head of fund management group AQR, published a third quarter commentary in which he looked at future equity returns when the Shiller p/e was at current levels. The average 10 year real return was just 0.9%.
In addition to the individuals whose savings are at risk, there is also very bad news for taxpayers in public pension profligate states like Illinois or California:
That is extremely important for pension funds, particularly those in the US which assume a ludicrously high (nominal) return of 8% going forward. As I have pointed out in the past, this is way too high but allows them to stint on their contributions (not to mention this is wrong in theory, as well as practice. Liabilities are a debt, and should be discounted by bond yields).
Some people argue that the 30-year returns pension funds have achieved justify an 8% assumption. But this is fundamentally misguided. Back in 1982, Treasury bonds yielded 10.5% and US equities 6.2%. Investors benefited from the high level of running yield as well as capital gains as valuations improved to current levels. That simply cannot happen again. Treasury bonds now yield 1.7% and the dividend yield is 2.2%. Absent some unexpected surge in profits (which are already vlose to an all-time high as a proportion of GDP), the most likely outcome from here is low real returns. Whether you are an employee in a 401(k) plan or an employer running a final salary scheme, you need to put more money aside to generate a given pension.
