Allison's Ode to the Second Moment


Welcome to the 59th issue of Allison’s Ode to the Second Moment, a newsletter that is feeling a little contrarian this week.

The Economy and the Market

In the past two weeks, the S&P fell about 6%, rose almost 4%, and fell 0.6%. Welcome back, market volatility! We always knew you were there, even if you did not always show it.

Perhaps we should take some comfort. It started to feel like the lack of risk was the big risk. Now that it’s back, the markets are feeling a little healthier.

I’ve heard a fair amount of chatter about what the Fed should do about it. It comes from market commentators and even the president. They all think rates should stay low or even be cut. All this chatter is strange to economists because it is not in the Fed mandate to produce a stable, ever-rising stock market. That might be nice, but it is not possible.

But there is actually something the Fed can do to reduce market turmoil. It involves predictable policies and maintaining the credibility it will make hard choices. The Fed does not have much power over structural elements of the economy, but it can reduce uncertainty by being one less unpredictable variable.

I think this point is lost in lots of market commentaries. All you ever seem to hear is low rates are good for the economy and higher rates are bad for the economy. But it does not really work this way for three reasons:

  1. Low rates have costs and benefits.

  2. Low rates don’t solve economic problems like low productivity or structural unemployment.

  3. Low rates all the time may be predictable, but they undermine the Fed’s credibility.

Some of the volatility is from unpredictable fiscal policy—particularly trade. If the Fed wants to do right by markets and reduce volatility, it will follow through on its guidance.

The new jobs report has unemployment at its lowest level in 50 years. Wages are starting to rise, so if we don’t increase rates now—when is a good time?

Bonds Are Where the Action Is

So says the FT. Since the financial crisis, fewer companies borrow money from banks, they are selling bonds in the market themselves. This may make banks safer, but it means the financial system and monetary policy work differently than before. We don’t know what risks it may create. Heck, we still don’t even know if Fed policy has a meaningful impact on long-term rates.

If you are an investor, bonds may be a better investment than stocks, even if you are investing for 30 years. Now I don’t predict markets or know how to time anything. But I think it’s not crazy to think bond prices won’t repeat the past 25 years.

How much lower can yields go? If Treasuries fall to -5%, won’t people stop buying debt at some point? Bonds aren’t like stocks in that you can expect some mean reversion over the long run. So, if rates are still near-record lows, I personally would not bet on a bull bond market for the next 30 years—that’s just me.

Retirement Danish Style

Mercer has released its annual report ranking retirement programs around the world. Once again, Denmark and the Netherlands have the top slots. Their experience holds many lessons for other countries, and their success is somewhat surprising given how much we fetishize large Northern European welfare states.

Compared to other countries, including the U.S., both countries rely more on the private sector for retirement benefits. The state pensions in both countries are fairly small, so most Danes and Dutch depend on fully funded retirement benefits from work. I think their experience shows that retirement security need not come from the government. Actually, depending on the government, unfunded benefits may introduce more risk and insecurity (Argentina ranks lowest).

Another interesting aspect of their success is that Denmark has defined contribution plans and the Netherlands has defined benefit. This shows either kind of pension can work. It just depends on how the DC or DB plans are structured.

Now each system has its challenges. There is more risk than meets the eye with the Dutch defined benefit plans. But they are better than anyone else. Maybe expanding Social Security is not the answer.

Make Annuities Great Again

One issue many countries with defined contribution plans need to solve is how people should spend in retirement. Denmark encourages its citizens to take an annuity. However, The Wall Street Journal does not think annuities are a good idea. It reported on a rise in annuity sales after the Department of Labor stopped threatening to impose the fiduciary standard on all kinds of advisors.

It is true that the incentives to sell annuities steer consumers to expensive products with features they don’t need. But annuities can be an important part of any retirement. They provide stable income in these turbulent markets and protection against outliving one’s assets.

Maybe the uptick in annuity sales is due to more people retiring or rising interest rates that make annuities cheap (you see, there are some benefits to higher rates). I am not convinced that a fiduciary standard will actually fix retirement advice. It may make advisors fearful of selling all kinds of annuities because The Wall Street Journal does not like them. But there are good and bad annuities, just look at Denmark. I think rather than demanding advisors follow vague terms of suitability, let’s just align the incentives better.

Oh, and you should definitely take the annuity if you win the lottery. Even if you win $1.5 billion, bad financial management can ruin any fortune.

Time to End Time Changes

I hope you are responding well to the time change. It could be one of our last. The EU is considering ditching the practice. But true to EU form, they have not decided whether to go with permanent winter or summer time. Member countries must agree on one. Good luck with that. As if Northern and Southern Europe aren’t already divided over things like spending and debt, now they throw time into the mix.

Until next time, Pension Geeks!