Before there was the One Percent, there was the velvet rope at Studio 54.
Gaining entry to the divine disco, with its adherence to a strict formula, was just as exclusionary. This from Mark Fleischman, the Manhattan haunt’s second owner in a memoir released to mark the 40th anniversary of the club’s opening: “A movie star could bring unlimited guests, a prince or princess could invite five or six guests, counts and countesses four, most other VIPs three, and so on.”
Andy Warhol called it the, “dictatorship at the door.” Brigid Berlin, one of Warhol’s Factory workers and guests, once described to Vanity Fair how she, “loved getting out of a cab and seeing those long lines of people who couldn’t get in.” If beauty alone could sway the dandy doorman, famed for flaunting his fur, a different kind of cordon awaited you once you set foot inside the cavernous strobe-lit mecca, that is a screen hung across the dance floor to separate the chosen from the common. The scrim summarily dropped at midnight, but not a minute before, affording elites ample opportunity to make their escape to the VIP floors above.
The annals of the truly desperate include one reckless raver who rappelled into Studio 54’s courtyard, breaking his neck in the process. But at least he eventually walked away. A less fortunate celebrity seeker perished in one of the club’s air vents. Upon discovering his body, there was no surprise he was in black tie. Studio 54’s velvet rope has long since fallen. Unfortunately, in its place, another has risen.
So inescapable are the headlines pronouncing inequality, we’ve all but grown impervious. But what of the stories of Tomorrowland? What will come to pass in the coming years as demographics and valuations collide?
Last month, Deutsche Bank broke Wall Street’s version of The Ten Commandments, all of them at once, in a comprehensive report titled “The Next Financial Crisis.” In case you’ve been on sabbatical or on the buy side so long you’ve forgotten, the First Commandment is, Markets Always Rise. The nine that follow are a variation on why and how to convey to your clients that the music is still playing, even if you’ve long since sat down.
Though there were many condemning graphs related to the increased frequency of booms and busts, government balance sheets and central bankers gone wild, it was the one you see here that was the most incriminatory in its simplicity.
The chart dates back to 1800 and depicts an equal weighted index of 15 developed markets’ government bond and equity markets. Nominal yields relative to history and share prices relative to nominal GDP are used to gauge historic deviations. The 100 percent reading you see means that in the aggregate, using an equally weighted bond/stock portfolio, bond yields have never been this low and equity prices this high.
You could quibble that stocks are not as richly valued as they were in 2000. But that argument runs counter to the fact that thanks to the bond-sale-proceed/share-buyback feedback mechanism, the symbiotic relationship between stocks and bonds has never been so tight. You could also venture that the central-bank, spoon-fed trend higher in earnings of the past decade will remain intact, that this represents, in the Deutsche analysts’ words, “a new paradigm.” But such declarations do tend to come back to haunt. So why go there?
Instead, marry the inescapable reality of the Deutsche graph to the other fact of life, the $400 trillion shortfall in retirement savings that will pile up over the next 30 years. Perhaps it’s easier to get your arms around the figure if you look at it as a multiple of the global economy. By that metric, underfunding will equate to more than five times global GDP.
The recent World Economic Forum (WEF) report attributed the disaster in the works to longer lifespans and disappointing investment returns. But it’s the what’s to come that is more telling. It’s no secret that employers have been shifting away from traditional pensions to 401(k)s, IRAs and the like over the past several generations. It was somewhat startling, though, to learn that these self-directed plans now comprise more than half of all global retirement assets.
Zeroing in on the United States, we are racking up an additional $3 trillion a year in aggregate retirement underfunding. By 2050, the nation’s retiree assets should be under water by $100 trillion.
It’s safe to say I’ve written reams on the societal ramifications of public pension underfunding in the United States. In far too many cases, it will be mathematically impossible for the funding gaps to be rectified before time closes in and cash flows run blood red. The judiciaries will go toe to toe with the governing authorities who will in turn battle the unions. Around and around the interested parties will go, appearing to man the front lines of the retirement crisis. As is so often the case with appearances, these too will deceive.
While the fiscal unraveling of states and municipalities promises to pack punchy headlines, the World Economic Forum report nevertheless shifts the discussion 180 degrees.
As of the middle of this year, total U.S. retirement assets totaled $26.6 trillion. That’s not all good and well, hence the shortfall cited above. Still, it’s the breakdown of those assets that’s critical. As of the end of June, IRAs held $8.4 trillion followed by $7.5 trillion in defined contribution plans, mostly 401(k)s. Public pensions came in at $5.7 trillion while their dying-breed private pension counterparts rounded out at $3.0 trillion. Annuities complete the picture at $2.1 trillion (who knew?)
Though naïve to do so, remove IRAs from the calculus for the moment given the voluntary nature of these accounts and what that implies, albeit superficially. For the sake of argument, focus solely on 401(k)s and public pensions. Now, envision a typical public pensioner and a typical 401(k)-plan worker. You won’t be alone if similar pictures of hard-working folks came to mind.
The question is, how do their fates differ in Tomorrowland, after markets have begun to revert to the mean? (A full reversion to the mean is more than most can stomach, hence the softer suggestion.)
The fact is 401(k) holders suffer double damages vs. public pensioners, at least initially. While both individual investors’ and pensions’ portfolios take a beating, the pensioner won’t feel it due to their income being guaranteed by law. Heck, the pension fund manager won’t lose too much sleep knowing where there’s a loss, there’s a way…to raise taxes, that is.
That’s where 401(k) investors’ second helping of lumps enters the picture in the form of higher state or municipal taxes. Some lucky residents might see everything save their federal taxes rise if they’re fortunate enough to live in windswept areas where spineless politicians were corrupted by even more corrupt interested parties who negotiated pensions that could never be repaid. If push comes to shove and the increased taxes still don’t cover the pension bill, public services can be slashed.
Of course, public pensioners will also feel the brunt of cost of living increases, if they’ve not relocated to a town with faster EMS response times and more frequent trash pickups. But then, in the public sector many are able to retire at young enough ages to secure second careers and with them, supplemental sources of income.
Recall, though, that the retirement assets of the protected pensioners ($5.7T) are a pittance of those of the unprotected, especially if you factor back in those IRA assets to say nothing of at-risk private pensioners, whose benefits are severely cut in the event of bankruptcy ($18.9T).
It’s hard to conceive a blanket acceptance of working men and women bailing out working men and women. But that’s what we’re supposed to believe to be the solution to what is and will continue to ail public pensions, from, by the way, a starting point of record highs in asset prices.
Now might be a good time to add another snippet from that Deutsche Bank report. “Prior to the last decade, the only comparable rise in populism started in the 1920s and culminated in World War II. So although populism has proved unpredictable in recent years, the rise surely increases the risks to the current world order and could set off a financial crisis at some point soon.”
Substitute out ‘populism’ for ‘anger factor’ as it better captures the sensation shared by so many today who believe they’ve been dealt an unfair hand by a dealer on the take. Most who remain among our middle-income earners understand the terms ‘elite’ and ‘establishment.’ As much pride as they still have, they will find a way to revolt at the first whiff of being asked to bank a bailout on their pittance of a living.
The majority of workers may not have the statistics at the ready – that their paltry and at-risk retirement assets are but a third of the country’s financial assets, that the balance sits in the hands of the wealthy. But they do know what it’s like to be frozen out on the other side of society’s velvet rope and they won’t sit back and take it.
In other words, there’s simply no denying that some pensions, especially those of some acutely fiscally enfeebled states, will require federal bailouts in the coming years. As for how that is funded? More taxes yet, of the federal sort, of course. That is the only fathomable answer, which adds a dollop of insult to injury for those whose other taxes had already been rising for years.
Stepping back, you may be asking, why sound the alarm if the worst of the underfunding won’t crest for another three decades? The shortest answer is the sooner pension underfunding is addressed, the lower the probability a financial matter morphs into one that engulfs our society and provides one more reason yet to add parental controls to the evening news.
In the event your capacity for combining nobility, vision and politics is limited, you might deduce that some can-kicking takes place long before any preemptive pension reform is conceived. If you’d like to capitalize on that assurance and at the same time profit from the few states that have put their finances in order, you might want to put in a call to your municipal bond manager (I have several suggestions if you’d prefer).
The directive is simple enough. First, identify the most vulnerable states with the least-funded pensions and the lowest per capita income. The bottom three are Kentucky, Kansas and Mississippi. Next, locate the mirror image, the states with the most funded pensions and the highest per capita income, as in South Dakota, Wisconsin and Washington State. Now, short the weakest and buy the strongest and then sit back and wait for politicians to do their jobs.
As for the here and now, you can toss out any superstitious notions about October being a spooky month for the markets. September is traditionally the nastiest of the year’s bunch and it was a flat-out party in the house. Market history suggests the year will end with a bang.
But it’s much more than pure pattern that should sustain your risk appetite. The past two years, Federal Reserve policymakers have committed to hike in September and delivered in December. What’s followed have been Happy New Years, one after the other. It’s a safe bet most investors will remain in textbook Pavlovian momentum mode and go long into the mid-December Fed meeting.
Besides, fourth-quarter, hurricane-influenced economic data promise to do one thing and only one thing — produce more noise than the punk backlash that followed disco fever. Fundamentals will thus be fuzzy at best.
And finally, corporate bond issuance in the year through September was yet another for the record books, which says something about lenders looking the other way, or better yet, tuning out altogether. Those sales proceeds do tend to find a home and it doesn’t tend to be a bear cave.
So do the hustle, and fight that rational urge to short these irrational markets. Keep on dancing, dancing, dancing in Wall Street circa 2017’s answer to Studio 54 lest you find yourself rejected and subjugated to boogying down at the Crisco Disco.