Taking the Buyout

"I'm gonna do it."
--Robert Gould Shaw (Glory)

I wound up taking the pension buyout. There were strong arguments for keeping the monthly benefit, which I would have begun collecting a few years from now at age 65. In particular, the diversification offered by the fixed pension payment (vs other income streams that are more market dependent) was particularly compelling to me.

There was also the 8-9% annual appreciation until age 65 associated with keeping the pension benefit. I know of few investments with that kind of 'guaranteed' return profile over the next few years.

There is a good chance that if I had a spouse who could collect a residual pension benefit upon my death, then I may have declined the buyout offer for these reasons. 

However, several factors pulled me in the other direction to accept the buyout offer. One was that the offer was better than expected. The low discount rates currently employed in actuarial estimates have driven lump sum valuations higher than they would be under more normalized interest rate conditions. My sense is that interest rates may be headed higher, which would both reduce future lump sum buyout valuations as well as erode the real value of monthly pension payouts. Stated differently, the low interest rate environment that we're currently experiencing makes the buyout option an unusually attractive risk:reward proposition.

Another reason for taking the buyout is that the pension was forecast to comprise a minor percentage of my monthly retirement income. As such, the diversification effect from the fixed monthly payment discussed above would have been muted. If my pension benefit was to be a larger fraction of forecast retirement income, then the buyout choice would have been a more difficult one.

As discussed in a previous post, I also suspect that there is a significant degree of systemic risk building in the financial system stemming from the general state of underfunded pensions. That risk, if realized, ultimately translates into lower real pension payouts--either through plan defaults or through inflationary bailout actions by the federal government. I would rather have a 'bird in the hand' to invest in a manner designed to guard against purchasing power decline wrought by such an event.

Finally, I enjoy markets and investing. The challenge posed by managing the lump sum funds over the next few years offers an intangible benefit that I hope to convert into tangible value over time. At the very least, there should be some residual assets from the original pension benefit available to my heirs should I pass away prematurely.

In any event, my packet has been submitted and is being processed. The lump sum is supposed to be distributed in early-mid December. Once the funds are deposited in my IRA, I will update on what I plan to do with them.

Buying Small, Scaling In

Now
The mist across the windows hides the lines
But nothing hides the colors of the lights that shine
--Joe Jackson

Years ago it hardly made sense to buy stocks in small quantities because of high trading commissions. Because it was not unusual to pay hundreds of dollars to a broker when placing a trade, investors typically bought relatively large blocks of stock at a time to keep transaction costs down. In fact, stock purchases of less than 100 share quantities became known as 'odd lots' because of their unusual nature. 

Now, with Charles Schwab (SCHW) recently eliminating trading commissions and most of the discount brokerage industry following along, purchasing stocks in odd lot quantities makes tons of sense for the everyday investor. Not only have transaction costs disappeared, but spreading buys out over longer periods of time helps manage risk, and often gets you in at a lower average price.

For example, today I began a position in General Mills (GIS) by purchasing a single share at about $53.20. I like the company's story (nice stable of brands and products, attractive 3.7% dividend yield, solid management), but, as you can see from the chart above, the stock has rallied over the past year and now trades at the high end of the 2-3 year range. As such, I suspect that I may be able to buy the stock at a lower price sometime in the near future.

However, by buying a little bit of GIS right here, I have satisfied my desire to own a piece of the company. Now that I own it, I'll be more prone to watch and study it. If the stock price does go down, then I don't have lots of capital at risk. In fact, I'll likely buy more if price declines (as long as the story hasn't materially changed). Perhaps I'll buy several times over the next few months until I acquire the full amount of GIS that I want. Meanwhile, if the stock happens to rocket to Pluto from here, then at least I have some exposure to the name that will allow me to participate in a big price advance.

By spreading my buys over time, I will have done what is called 'scaling into' a position. Scaling in reduces risk because it allows for acquiring shares at lower prices as the position is built in several increments.

Now that trading commissions have disappeared, there is little downside to buying small and scaling in.

position in GIS

Table Manners

And there's a message that I'm sending out
Like a telegraph to your soul
And if I can't bridge this distance
Stop this heartbreak overload
--John Waite

Grateful today for all of God's gifts--life, liberty, and today especially, family.

To those who have gone before us, we will miss you at the table today. We hope and pray for the opportunity to sit with you at the table again.

Bolshevik Politics

"You wanna know what my platform is? Here it is. I'm gonna soak the fat boys and spread it out thin."
--Willie Stark (All the King's Men)

What is Bolshevik politics? It is the narrative that rich people are selfish, corporations are bad, and wealth is too concentrated. All people beside the rich are victims of the system. To correct the injustices of the system, wealth must be confiscated from the few and redistributed to the rest.

The dirty secret of Bolshevik politics, though, is that, whatever you do, don't allow the masses to work hard and be successful. Political power comes from keeping people feeling afraid and downtrodden.

Successful people lose the victim mentality, which is the kiss of death for Bolshevik politics.

Money Spigot

Rain on my face
It hasn't stopped
Raining for days
My world is a flood
Slowly I become
One with the mud
--Jars of Clay

Credit creation is inherently deflationary. Credit money supply increases upon the creation of debt but it contracts when debt is repaid or defaulted on.

In past cycles central banks have countered the deflationary phases with lower interest rates that spark even more credit creation. But each cycle requires lower rates than before, and marginal bang for the credit buck gradually declines.

With lower interest rates waning in their effectiveness and approaching the 'zero bound,' central banks are now turning toward monetization. This involves printing money out of thin air to buy stocks, bonds, and other financial assets to prop up prices in the face of deflationary decline. Why must central banks do this? Well, the system has become so levered up from past credit creation that even small declines in prices threatens to render balance sheets insolvent.

The next logical step involves simply printing money and sending it to people directly. This is the endgame. Flooding the entire economic system--not just the narrow financial system--with freshly minted cash.

This is how all currencies collapse. First excess borrowing and debt. And then opening the money spigot to keep the system solvent, which morphs into a hyper-inflationary endgame.

Chinese Checkers

We got to install microwave ovens
Custom kitchen deliveries
We got to move these refrigerators
We got to move these color TVs
--Dire Straits

Graphical evolution of China's dominant position as a supplier of goods over the past decade. First, 2010:

Now, 2019:

Does this mean that China is getting richer at the expense of others? No. Trade is a two way street. When trade is voluntary, both sides benefit, lest exchange would not occur. Both sides get richer.

If China is creating more value for trading partners than it was ten years ago, then that is good for China...and good for the world.

Fallacy of We

Leo Getz: You hungry? I'll call for anything you want. See this silk robe? Free.
Sgt Roger Murtaugh: It's not free. 
Leo Getz: Yes it is.
Sgt Roger Murtaugh: It's taxpayer's money.
Leo Getz: Same thing.
--Lethal Weapon 2

Article discusses the absurd claim that federal debt is not a problem because it is money that we owe to ourselves. The 'we owe it to ourselves' crowd argues that because government debt can be passed on to future generations, the debt can persist into perpetuity so long as people are willing to lend and government is able to service the debt. Moreover, because federal debt is owned by domestic citizens, the money used to repay debt doesn't leave the economy.

But, as the article points out, about 1/3 of federal debt is in fact owned by outsiders. In other words, we don't owe a substantial portion of federal debt to ourselves. We owe it to others.

A larger problem can be called 'the fallacy of us, we, and our.'  Individuals lend and borrow, not collectives. Individuals who incur federal debt are different from individuals who bear the burden of repaying the debt. The beneficiaries are people today who enjoy the borrowed funds and what they can purchase. However, future taxpayers are hurt, as they must repay the debt borrowed by previous generations.

However, the most fundamental problem is one not directly addressed in the article. Government debt constitutes borrowing by force. Sovereign debt is a contract between governments and private lenders with the promise that bond principal and interest will be repaid by citizens under threat of force. Confiscating economic resources by force distorts how those resources would have been allocated by individuals engaging freely in production and trade.

Moreover, when government knows that it can take resources at gunpoint, it will surely 'borrow' more, which leads to lower saving and, ultimately, to capital consumption over time.

The result is fewer resources available for investment and productivity improvement down the road. Prosperity, consequently, is restrained.

Decline in Job Quality

Hey, I'm not complaining
'Cause I really need the work
Hitting up my buddy's 
Got me feeling like a jerk
--Huey Lewis & The News

Article indicates that, while unemployment is near record lows, quality of work has been declining. The Job Quality Index, a product of Cornell Law School, factors in hourly wage growth, hours worked (higher deemed better), labor force participation rate, and rates of core economic growth to reflect to find a ratio of 'high quality' to 'low quality' jobs. A number less than 100 indicates more low quality jobs.

Notice that the index has been trending down since its inception in 1991. Why might this be? The best jobs come from capital investment. But real capital investment has been dwindling as savings have declined. We are now engaging in capital consumption. High quality jobs are unlikely when there is little real capital to create them.

Until we borrow less and save more, job quality should continue to deteriorate.

Community

There is no greater value of community than during times of grief.

Shared sympathy. Hands, hugs, love.

The best of who we are.

Living the Deep State

"Listen, people, everyone knows where this is going. If this was a legit op, and I can't imagine how it could be, then so be it. But if this was someone's unilateral wet dream, then that someone is going to prison."
--Admiral Shaffer (Enemy of the State)

Meadows is correct. The chorus of bureaucrats testifying at the impeachment circus demonstrate the officials in various federal agencies are behaving as if they set foreign policy. This, of course, is not their job.

Unelected bureaucrats in Washington, D.C. work for the President.

Not the other way around. https://t.co/f840sN9CH6

— Oversight Committee Republicans (@GOPoversight) November 21, 2019

Their job is to execute foreign policy set by the president.

When unelected agency bureaucrats go off the reservation and act unilaterally on policy matters, they are living the Deep State.

False Alarm

You run, run, run away
It's your heart that you betray
--Scandal

Nice example of a head and shoulders pattern that turned out to be a 'false alarm.'

After wallowing around the H&S neckline, PAAS reversed higher and is now challenging previous highs.

position in PAAS

Since QE4

You see the signs
But you can't read
Your heart's running 
At a different speed
--Robert Palmer

Piggybacking on previous post, below chart shows performance of SPX since the Fed began 'QE4.'

As noted previously, there is little else you need to know about the causes of new market highs.

Monetized Markets

'Cause she's so high
High above me
She's so lovely
--Tal Bachman

Global 'liquidity' proxy is a sum of money that central banks worldwide have created out of thin air and poured into the system worldwide in various forms of 'quantitative easing,'--understood more simply as monetization.

This is really all you have to know about what is propelling stocks to all time highs.

Ulitimate Victory

When we pray to Our Lady of Victory, the victory that we sometimes hope and pray for is an earthly one. But Mary intercedes for our ultimate victory--victory over death.

Because victory over death means everlasting life, it is the only one that matters.

Historical Budget Deficit

"We have a crisis situation."
--Viper (Top Gun)

Historical budget surplus/deficit as % of GDP. This year it is 4.6%.

Save for wars, this level of deficit has typically been reserved for economic 'crisis situations.'

No Fed, No Debt

Isn't it ironic
Don't you think?
--Alanis Morissett

Earlier this week Fed chair Jerome Powell testified in front of Congress that he is worried about the federal budget deficit and called the level of federal debt 'unsustainable.'

Pot, meet kettle.

The Federal Reserve, through its low interest rate policies, is the enabler of big federal deficits and debt.

As noted here, this is the drug dealer lecturing to junkies about their habit.

Without the Federal Reserve (and other central banks), there would be no deficit or debt problems.

Kangaroo Court

But I know the neighborhood
And talk is cheap when the story is good
And the tales grow taller on down the line
--REO Speedwagon

Previously we've noted the Left's increasing preference for hearsay, particularly as a tool for running Donald Trump out of office (here, here, here). Leftist use of hearsay and supposition reached crescendo levels this week during the House Democrat's sham impeachment hearings this week.

The progression of witnesses producing nothing but second, third, fouth-hand testimony, often led on by Democrat facilitators became so absurd that GOP onlookers ridiculed the proceedings by evoking 1980s REO Speedwagon lyrics.

“I heard it from a friend, who heard it from a friend, who heard it from another…” https://t.co/mCdCPC4Uh5

— Rep. Jeff Duncan (@RepJeffDuncan) November 13, 2019

Were this a real courtroom, any disinterested judge would have run the Democrats out the door by their ears. But this is not a real courtroom, of course. It is the Democrat's kangaroo court.

In Sight, In Mind

Confusion that never stops
The closing walls
And ticking clocks
--Coldplay

Federal debt has now marked north of $23 trillion. Congressman Chip Roy proposes that debt clocks be posted various rooms in the Capitol building to keep the numbers in front of policymakers.

Last week we surpassed $23 trillion in debt. Neither party in DC seems bothered enough to stop it - so I introduced the “Know Debt Resolution,” which would place debt clocks in the main meeting rooms of the House Budget & House Appropriations Committees. #KnowDebt #HRes868

— Chip Roy (@chiproytx) November 12, 2019

The opposite of 'out of sight, out of mind' is 'in sight, in mind.'

Flashpoint Approaching

Patrick O'Malley: You know, I only made one real mistake.
Eve Tozier: What was that?
Patrick O'Malley: I should have sold you when I had the chance.
--High Road to China

If you're not keeping an eye on the escalating tensions in Hong Kong, then you're ignoring due diligence. Flashpoint seems near. Chinese hardliners are undoubtedly anxious to take control of the situation with an iron hand.

CPC heads may feel that they have to intervene. After all, if they cut slack to Hong Kong protesters, then Mainland citizens will demand similar treatment.

Liberty is not part of the central plan.

Offending Freedom

Miyagi: Karate for defense only.
Daniel LaRusso: That's not what these guys are taught.
Miyagi: Hai...can see.
--The Karate Kid

A free state does not lift its military on a pedestal. It views military action as a last resort--as a failure to establish voluntary cooperation with others. Past wars should be seen as tragedies, not as glories.

Force is valid only when used as defense against aggression. Preemptive force is not defensive. It is offensive. When troops are stationed in other lands to 'keep the peace,' this is not self-defense. It is aggression.

When a country raises resources for military action thru acts of force (e.g., taxes, conscription), then it is not 'defending freedom.'

It is offending freedom.

Stupid Compromise

The middle of the road
Is trying to find me
I'm standing in the middle of life
With my plans behind me
--Pretenders

Well done by Scott Adams.

Compromise is usually stupid.

Negative Productivity Trends

Gonna pack my lunch in the morning
And go to work each day
And when the evening rolls around
I'll go home and lay my body down
And when the morning light comes streaming in
I'll get up and do it again
--Jackson Browne

These pages have observed downtrends in productivity growth--particularly over the past ten years. After the Q3 number printed at -0.3% earlier this week, people are once again wondering what is going on.

Let's look at the productivity series. Below we see the annual percentage change in productivity (i.e., output per hour worked) in 'non-farm business' (i.e., manufacturing and service sectors excluding agriculture).

Ignoring measurement challenges (e.g., how to accurately capture all hours worked?), it is clear that productivity has been declining over time--with perhaps some pushback inspired by the productivity-boosting info tech movement in the late 20th century. Although I don't have statistical capability right this moment, I would bet that a linear regression model fitted to these data would find a negative and significant slope.

What is grabbing people's attention is that the variation that accompanies the data points in this downtrend is beginning to touch, or cross zero with increasing regularity.

What is driving the decline? While many theories are being advanced, it seems to me that the central cause is this: dwindling savings.

To improve productivity, humans need tools that they can combine with labor to produce more output per hour. In order for some people to produce those tools, however, they must forego producing food, clothing, and other vital resources necessary for their own survival. The toolmakers live off of resources that others have set aside (i.e., savings).

Savings that fund tool production are often referred to as capital. When people save less and consume more, there is less capital. Less capital means less tool production. Less tool production means lower propensity for productivity improvement.

When people consume everything they make and dip into past savings to fund their immediate lifestyles, then they are engaging in capital consumption. When government debt is factored into the mix, savings rates in the US have been increasingly negative for some time.

Negative savings rates are driving productivity decline--a decline which will surely compromise standard of living if it continues to persist.

Yield Signs

"My husband could get you a 10% mortgage. I'd do it myself but I'm into four other deals."
--Delores the Realtor (Wall Street)

Ten year yields have risen 20% in a month and now stand at about 1.9%. Because interest rates sometimes rise on prospects of economic strength, some view this as bullish. On the other hand, higher rates can be a wind in the face of growth.

Any any rate, the technical downtrend in place since last year's highs above 3% has clearly been neutralized by the recent strength.

Liz Sonders also observes that the recent increase in the long end of the curve coupled with a decline in the short end (primarily due to the Fed's new monetization program)--has 'uninverted' the yield curve.

Treasury curve now positively sloped across all maturities (kink is gone) @SoberLook pic.twitter.com/nVgE3C5JGs

— Liz Ann Sonders (@LizAnnSonders) November 8, 2019

Just because the yield curve has straightened out does not absolve the warning signal, however. Inverted yield curves commonly return to normal prior to recessions.

Underfunded Pensions and Systemic Risk

Here comes the rain again
Raining on my head like a tragedy
Tearing me apart like a new emotion
--Eurythmics

Managing a pension fund is similar to saving for retirement. Just like each of us needs to determine how much money to set aside for when we're no longer working, pension fund managers must determine how much to set aside for all of those payments to retirees down the road.

Naturally, when you put money into a retirement account, you're unlikely to let it sit there idle. You'll try to grow those funds through investment vehicles like stocks, bonds, etc. It follows, then, that determining how much to contribute to your retirement account is influenced by the return that you expect on your investments in the account.

The basic rule is this: The higher the expected return on investment, the less you have to set aside in order to achieve your retirement goals. A simple example helps demonstrate. Suppose that you'd like to have a million dollars available to fund your retirement beginning 40 years from now. If you expected no return on your savings, then you would need to set aside $25,000 for each of the next forty years to obtain $1 million. However, if you're able to realize annual growth of 7% on retirement fund investments, then you would only need to contribute about $5,000 annually to meet the $1 million goal in forty years.

Pension managers go through a similar process. When many pension funds were created in the 20th century, returns on investment portfolios consistently averaged 8-12% annually. Pension managers began to bake those return assumptions into their decision-making processes for determining how much new money to put into the pot. Because they assumed 8-12% returns in the future, pension managers contributed less new funds than they would have added in anticipation of lower return scenarios.

Then the unexpected happened. Realized returns on pension fund investments began dropping. Interest rates on long term government bonds fell into a secular decline. Because pension funds traditionally over-weighted their asset allocations toward fixed income instruments, as bond yields fell, so did portfolio yields and annual returns.

In an effort to win back some of the returns lost in fixed income, pension fund managers shifted asset allocations toward more stock exposure. Stocks, of course, are generally riskier, and, under normal conditions, throw off less income, than bonds. Moreover, because every time stock markets take a dive, funds with large equity exposure lose a big chunk of value, funds carrying significant stock exposure are more subject to capital loss.

The last 30 years have seen a steady decline in pension fund investment returns. Today's returns are far lower than the assumptions used by pension managers years ago when they were determining how much new cash to sink into theirs funds to cover future payouts to pensioners.

What that means is that many pension funds today are chronically underfunded. Investment returns are lower than expected, and not enough new cash has been injected into pension funds to make up for the shortfall. This is similar to individuals who did not contribute enough to their retirement nest eggs over the years because they assumed that the returns on their investment positions would be higher than they turned out to be.

How to deal with underfunded pension situations? Ideally, pension fund sponsors would simply raise a bunch of cash and dump it into the fund the plan adequately. But think about it. If you as an individual have not saved enough for retirement over the course of many years, then how realistic is it for you to make up the difference when you are older? Many organizations with pension obligations face a similar problem. They simply don't have the resources to allow them to make up ground lost from years of chronic underfunding.

To reduce some future liabilities, some pension plans are offering lump sum buyouts to prospective pensioners. By dangling one time cash payments in front of some participants in exchange for them agreeing to exit the plan, pension managers hope that many of these people, using 'a bird in the hand is worth two in the bush' line of thinking, take the money and run. The managers' hope is that, by buying some participants out of the plan, the monetary resources remaining will be more capable of fulfilling monthly payment obligations to pensioners still in the plan. At best, however, buyouts more likely offer a way to reduce the degree of underfunding rather than to eliminate it.

Another option is for pension plans to default on their future obligations. Cease payments to pensioners. Or pay only a fraction of what was initially promised. Some of this is already occurring in chronically underfunded pension plans in the public sector involving teachers and government workers.

In the private sector, most corporate pensions are insured by the Pension Benefit Guaranty Company. The PBGC is a federally chartered corporation designed to take over private sector pension plans that go bust and cover monthly payouts to pensioners up to a certain amount. Unfortunately, the PBGC itself is thinly capitalized, meaning that it would not take many pensions defaulting at the same time to bankrupt the insurer.

It is here, I think, where serious risk lurks. A pension insurer that is essentially an agency of the federal government carries an implicit promise that the government will make pensioners whole--even in the event of a systemic crack-up that drains the PBGC's capital reserves. With so many pensions so chronically underfunded, the chances of such a systemic event cannot be ignored.

Where would the federal government get the resources to make pensioners whole? Taxing and/or borrowing are possibilities but politically unpopular. Federal tax rates are near the upper bound of political expedience, and federal debt levels are at $23 trillion and growing by the minute.

More likely is that the federal government would opt to monetize (i.e., print money) to pay pensioners. Send pensioners monthly checks for monetary sums created at the click of a mouse. Such a policy would create a form of 'helicopter money' infamously suggested by former Fed chair Ben Bernanke.

The inflationary implications of such a bail out policy are obvious. Specifically for pensioners, these people would be getting the nominal monthly paychecks originally promised them, but each dollar paid would be worth less due to the increasing supply of dollars in the system. The effect, from a purchasing power standpoint, would be as if the original pension plan defaulted on a fraction of the original promised payments. The systemic consequences could be far worse. As history indicates, once inflation toothpaste is out of the tube, it is difficult to put back in.

The bottom line is this. If you believe that pensions are chronically underfunded, then there is a significant likelihood that pensioners will not receive anything close to their promised monthly payments in real purchasing power terms. Inflationary bailouts designed to make pensioners whole are likely to do anything but.

Where to Comfortably Retire

Billy Chapel: Are you saying I should retire?
Gary Wheeler: Why not? It wouldn't hurt the negotiations. And it would serve those sons of bitches right.
Billy Chapel: I don't know...I don't know what to say.
Gary Wheeler: Well, you know...you can't tell me you haven't thought about it. And you've been smart with money, right?
--For Love of the Game

Study maps how much it costs to retire comfortably in the various states. The analysis factors in life expectancy, average living expenses for age 65+ (including a 20% fudge factor), cost of living for each state, and the average retirement age for each state (retiring younger requires more savings).

Good to see Ohio in one of the lighter shades. Per this study, a retiree requires a nest egg of $777K to comfortably stop working in the Buckeye State at the average age of 63.

Most expensive state: Hawaii. Predictably, Cali and New York also fall into the high cost bracket.

Cheapest area is the south. Mississippi and Alabama are both estimated to require less than $700K to retire comfortably. Plus, you get the warm weather as a bonus!

Inflation and Purchasing Power

Hundred dollar car note
Two hundred rent
I get a check on Friday
But it's already spent
--Huey Lewis & the News

While inflation carries many meanings, a popular contemporary definition is loss of monetary purchasing power. Stated differently, as inflation goes up, the value of the dollars in your wallet goes down.

The same is true with streams of dollars coming your way in the form of income. Picking up on our previous pension example, suppose that you are 65 and begin drawing a pension income of $1,000 per month (amounting to $12,000/yr). Let's also assume that inflation amounts to 2% annually. That's the Federal Reserve's current inflation 'target,' btw. (Think about that for a second. The Fed is saying that it wants to destroy your purchasing power by 2% each year.)

What happens to your fixed income pension over time in this environment? A 2% decline in purchasing power after one year may not seem like much, but the losses compound annually. After 10 years, that $12,000 in annual income spends like it was only $9,800 in today's dollars (an 18% decrease). At the ripe old age of 85, the purchasing power of your pension would have deteriorated to about $8,000--a 33% decline.

If inflation goes higher, then your pension's purchasing power declines more rapidly. A 4% annual inflation rate turns $12,000 into $5,300 after 20 yrs. At 6% inflation, your annual pension would be worth about $3,500 twenty years later--that's a 70% decrease.

Don't think higher inflation rates can happen? In the 1970's the US saw prolonged inflation rates well above 5%. Other countries (recent example Venezuela) have experienced 'hyperinflation' where inflation rates increase by over 100% annually.

This pension example may seem arcane, but lessons here readily transfer to a mainstream asset class: fixed income. Like pensions, most bonds and CDs pay a preset level of income to their owners on a routine schedule. Inflation erodes the value of these income streams just as it does to pension payouts.

The message should be clear. Inflation, even at 'low' rates, can whittle away at the purchasing power of an income stream. How can individuals protect against the wealth-destroying forces of inflation? If you're still working, you can endeavor to be more productive so that you earn more and outpace the eroding effects of inflation on your paycheck. Retirees, of course, can't employ this approach because by definition they are no longer working.

Another way to hedge against inflation is to invest in asset classes that generate returns deemed to keep up with inflation. Asset allocations that favor stocks and some alternative assets such as gold have historically been decent inflation hedges. Retirees or prospective retirees who have built sizable investment portfolios can offset risk that inflation poses to fixed income pension benefits.

A third way to manage inflation risk presented to some prospective retirees is the lump sum pension buyout. If a decent lump sum offer is made by the pension plan, then it might make sense to take the offer and then invest the proceeds in a manner that hedges against inflation.

Personally, I suspect that inflation rates are likely to increase in the years ahead--perhaps substantially. As I consider the pros and cons of accepting the lump sum buyout recently offered by my former employer's pension plan, my inflation outlook constitutes a 'pro.'

position in gold

Climbing Upstairs

There's a lady who's sure
All that glitters is gold
And she's buying the stairway to heaven
--Led Zeppelin

Both the S&P 500 and NASDAQ closed the week by eclipsing their all time highs previously marked last July.

The Dow closed just shy of its record.

Bulls are thinking all systems go. Futes up pre-open this am...

Stability Motive and Institutional Resistance

"These wall are funny. First you hate 'em. Then you get used to 'em. Enough time passes, you get so you depend on them. That's institutionalized."
--Ellis Boyd 'Red' Redding (The Shawshank Redemption)

People are generally driven by the stability motive. They act to reduce uncertainty and gain predictability.

Effort to change the status quo will be met with resistance for the same reason. Change makers are seen as de-stabilizing the environment. The greater the force for change, the greater the pushback.

Institutions die hard. But in their quest for stability, they will eventually die.

Discount Rates

Balian of Ibelin: How much is Jerusalem worth?
Saladin: Nothing...  Everything!
--Kingdom of Heaven

As previously noted, I'm currently pondering a lump sum buyout offer from a previous employer's pension plan. There are many factors to take into account when deciding whether to take a lump sum or stick with the monthly payout. Some of these factors include life expectancy, size of the pension compared to other prospective retirement income streams, desire to manage retirement funds, financial health of pension plan, and number of years remaining before monthly payments would kick in.

Another factor that is vital to consider is known as the discount rate. The discount rate is the interest rate used to calculate the present value of future annuity payments. It is usually based on an estimate of yields that can be obtained from so-called 'risk free' investments. Theoretically, if you can get, say, a 4% annual return on a particular investment instrument with little or no potential for loss, then that return provides a good benchmark for evaluating the attractiveness of other investment alternatives.

For better or worse, many people regard the 10 Year US Treasury Note as such a risk free investment. This is because people tend to believe that, no matter what, the US government will make good on its bond payments. As such, the risk free discount rate commonly employed in determining how much a future stream of monthly pension payments is worth today is the yield on 10 Year Treasury bonds. A long term graph of 10 Year yields appears below.

Here is the issue: what yield to choose for the discounting operation? The most recent one? An average of the last 20 years? An extrapolation of the current trend? It turns out that in present value calculations, the lower the discount rate, the larger the present value of a future annuity stream. As you can see from the graph, 10 Year T-Note yields are near historic lows. Using current 10 Year yields as the discount rate will cause the present value of a pension to look unusually large.

Let's consider an example. Suppose that you've just turned 65 years old, and you can begin drawing a pension of $1000/month. You expect to live till age 85. How much is that income stream worth today in a lump sum? Using the current 10 Year Treasury yield of ~ 1.7%, the present value of that twenty year monthly income stream is about $206,800. What happens if we use a higher discount rate? Well if we use a 3% rate--a level that 10 Year yields were at just one year ago--then the present value of the pension declines to $185,700--about 10% lower than the initial estimate above.

Here are some historical average 10 Year yields (source here):

Last 10 yrs: 2.43%
Last 20 yrs: 3.47%
Last 30 yrs: 4.54%
Since June, 1984 peak: 5.26%

If we were to use the avg 10 Year yield for the last 30 yrs in our example situation, then present value of twenty year monthly pension falls to about $164,700--20% lower than the value estimated using current 10 Year yields.

Hopefully you get the message: choice of discount rate matters. Higher discount rates result in more conservative estimates. In my personal pension analysis, I want to err to the conservative side.

Another thing that we need to discuss related to this matter: inflation. Coming soon...

Outlook Gap

Stand up in a clear blue morning
Until you see what can be
Alone in a cold day dawning
Are you still free?
Can you be?
--Steve Winwood

Interesting observation by Liz Ann Sonders. The 'outlook gap,' defined as the difference between CEO and consumer expectations about the economy (as measured by survey), finds executive views at record levels of 'depression' (pun not intended).

As of Q3, “Outlook Gap” from @DiMartinoBooth is widest on record...never have CEOs’ views on future been as depressed as they are relative to employees they lead (suggesting reversal in unemployment rate typically seen at cyclical inflection could be more violent) pic.twitter.com/X1L5HQGNFB

— Liz Ann Sonders (@LizAnnSonders) November 1, 2019

Note that the outlook gap is typically lowest prior to recessions. As such it can be a 'leading indicator' of sorts. It portends managerial activity to address their doubts about the future.

On the other hand, note that unemployment is often lowest just prior to a recession. Unemployment is a classic 'lagging indicator' w.r.t. economic activity. It reflects what has been rather than what will be.

The combination of the two, suggests Sonders, is cause for pause--particularly on the back of this morning's strong job report that continues to suggest unemployment near record lows.