It is my professional opinion that today’s stock market and bond market are both generally overpriced. If I am correct, future returns for passive investors will be lower than hoped-for and the implications will be quite large.
The US is facing a substantial pile of age-related liabilities. I am not talking about the tens of trillions in federal government debt. I am also not talking about the many trillions more in mortgage, auto, student loan and credit card debts either.
Instead, I am talking about the very real funding shortfalls in government, corporate pension plans and the critically thin level of household retirement savings we see across the nation.
According to one study by the Economic Policy Institute and another by the Government Accountability Office, retirement readiness for most pre-retiree households in the US is downright alarming.
For the cohort of people age 55-64, the average retirement savings is about $100,000. However, this doesn’t paint the whole picture. To provide further perspective on a widening wealth gap, about 10% of this age group have retirement savings of at least $500,000, while nearly half have zero saved for retirement. The situation is clearly about the few haves and the many have-nots.
Further, at the corporate pension plan level, a glance at these plans’ funding status shows a shortfall totaling hundreds of billions of dollars.
In addition, layering on the officially estimated shortfalls in both state and local government pension plans, their funding deficits alone add up to yet another $1.5 trillion.
Everywhere you look, our increasingly aging population appears poised to expose what has been decades of looming financial issues.
What do these trillions of dollars have to do with the stock and bond market? Plenty.
Using the longer term measure of the stock market’s price level today relative to companies capacity to earn profits – measured by the Shiller Price-to-Earnings ratio, among multiple other reputable, value yardsticks – today’s stock market ranks in history as one of the most expensive ever.
The same can be said about most forms of bonds as well. Interest rates around the globe are hovering at rock bottom low levels. This means bond prices are likewise hovering near all-time highs.
A truism of investing is the higher price you pay today, the lower your returns will be over time. Price acts like gravity; silently pulling down future returns.
Given this, it’s nerve-racking to realize that the trillions of funding deficits across government, corporate and private households widely use the assumption of future investment returns in the range of 7% to 8% per year. Let me non-eloquently say, fat chance!
In contrast, it’s much safer to assume that passive stock market investors will earn, at best, low single digit annual returns over the next decade. Of course, with currently very low interest rates and some irrefutable math, bonds are slated to do no better.
As a result, the longer-term implications are big and our retirement system’s dependency on high returns grows ever larger. We certainly do live in interesting times!
Jason P. Tank, CFA is the owner of Front Street Wealth Management, a fee-only wealth advisory firm located in Traverse City. He encourages questions and comments about future columns. Contact him at (231) 947-3775, by email at Jason@FrontStreet.com and at www.FrontStreet.com