Tuesday, June 30, 2009

Overextended Pension Funds?

A follow-up on my last comment where I criticized the Financial Post article, Bonus flap puts Canada Pension's strategy at risk.

While it is true that paying hefty fees to external managers costs large pension funds hundreds of millions, the article makes it seem as if CPPIB is sourcing their own PE deals and they can compete with the top private equity GPs out there.

That is simply not the case. What typically happens is that they co-invest with some of the top PE funds and stick in a big chunk of change. They use their size to write the big cheques and they then ask for reduced fees.

[Note: Pure direct investments are typically money-losing operations at large pension funds.]

It doesn't take that much talent to dangle a big fat cheque in front of some hedge fund or private equity manager and then persuade them to reduce their fees. In fact, it is a lot harder to find lesser known PE players in the mid-market who are performing well.

And the example of CalPERS is terrible because they were known to indiscriminately throw money to every Tom, Dick and Harry PE and hedge fund out there. The best performing PE program among the large insitutional pension funds was at CalSTRS. You can read more about their PE portfolio by clicking here.

I would put the CalSTRS PE portfolio against that of any of the large Canadian pension funds and trust me, nobody at CalTRS is getting compensated the way Mark Wiseman and other SVPs are getting compensated at CPPIB.

Paying fees to external managers is fine as long as you are not paying for beta (which happens a lot in hedge funds) or paying for mediocre PE funds.

Enough of "Bonus Gate". I got nothing against paying out bonuses to those that deserve them and I think Mark Wiseman is a decent guy, but he will have a hard time convincing me that he and his team merit those bonuses, especially after the CPP Fund got clobbered in FY2009.

More importantly, in order to pay someone for alpha, you need to make sure the benchmarks that are being used to evaluate that pension officer accurately reflect the beta, credit risk, leverage and illiquidity of the underlying investments.

I can show you 1,000 ways to scam or fudge your benchmarks. I used to grill hedge fund managers. The more arrogant they were, the harder I grilled them.

I had one guy one time who told me "I come from the George Soros school of risk management". He was acting like a big swinging dick (BSD) and I had enough of his nonsense. I told him "if you are so great, why did George Soros fire you?".

The sad fact was in the heyday of hedge funds, this arrogant BSD had no problems impressing or intimidating some unsuspecting public pension officer in the U.S., but if you took a closer look at his performance, you'd see it was all leveraged beta. I ain't paying any slick hedge fund manager 2 & 20 for leveraged beta!

This brings me to my latest topic. IPE reports that transparency on pension risks is paramount:
NETHERLANDS - Pension funds must make pension risks more transparent to their participants, the Dutch pensions research organisation Netspar believes. Funds should also focus on real guarantees, which should increase with age.

In addition, they should keep on taking investment risk and stick with the principle of solidarity, according to economists Lans Bovenberg and Theo Nijman of Netspar, an academic centre for pensions, retirement and ageing.

The pension sector must also develop instruments against inflation risks and longevity risk, Bovenberg and Nijman indicated during a debate about the effects of the credit crisis.

For the medium term, the economist called for lower indexation, and argued for an economised pension build-up as well as a rise in the age of the state pension AOW by two years to 67.

The large union FNV Bondgenoten is proposing there should be a flexible AOW age of between 63 and 70 as an alternative, according to Peter Gortzak, its vice-chairman.

However, he claimed the existing automatic retirement at 65 must stop and a stable long-term contribution must be introduced.

Benne van Popta, employers’ chairman of the Association of Industry-wide Pension Funds (VB) and the pension fund for the retail sector, questioned whether solidarity is tenable between the generations, as the contributions instrument is insufficient in tems of keeping pension funds’ finances sound.

“The risk is that different generations will opt for their own [pension] scheme,” he suggested.

Guus Boender, an expert on asset-liability management at Ortec Finance, said there was a need for adjustments to the financial assessment framework FTK, to reflect worldwide efforts to bring interest rates down.

Schemes are making wrong decisions about their real funding ratios, Boender argued, because long-term rates are considerably affecting pension funds’ nominal cover ratios.

In the opinion of Bas Werker of Netspar, pension funds should not exclude the prospect of cutting benefits.

“A 2% cut during 1% inflation is less damaging than refraining from indexation while inflation is at 5%,” he stressed.

As I explained in my comment on pensions apartheid, it's only a matter of time before benefits are cut in both private and public pension plans. The pension crisis is a long-term issue and let's be clear on something, it is highly deflationary.

The NYT asks, Has GM overextended its pension plan?:

It had planned — and put money aside — for a steady march of retirees over time. But instead, tens of thousands of blue-collar workers, most in their 40s and 50s, are all becoming eligible for retirement benefits now, as the company rapidly downsizes.

And even as its pension fund faces this giant bulge in payouts, G.M. is not putting any new money in — the company is not required to make any contributions to the fund until 2013.

The longer this goes on, the weaker the fund will be and the more uncertain its long-term viability.

For now, the pension payments to its younger “retirees,” part of a deal G.M. negotiated with the United Automobile Workers union in 2007, allow the company to drastically shrink its work force without having to come up with the cash to pay severance. The payments also relieve some of the burden on social service programs in the countless factory towns and counties around the country with large numbers of G.M.’s newly jobless.

“G.M. basically raided the pension plan, by having a lot of these severance benefits paid through it,” said Douglas J. Elliott, a fellow with the Brookings Institution who specializes in financial institutions and policy.

What G.M. has done is perfectly legal. Nor is this the first time an employer has used a pension fund to pay for pruning its ranks. Well-subsidized early retirements are a time-honored practice in the public sector, where teachers often retire after 30 years and police officers can sometimes claim rich pensions after working as few as 20 years. Many corporations once offered sweetened pensions to people in their 50s and early 60s as well, but they have generally stopped the practice because it locked them into making payments indefinitely.

G.M. never stopped. To the contrary. The question now is whether the plan will run short of money and what effect that might have on the company, its workers and retirees, and the federal government, which insures pensions and is now G.M.’s majority owner.

In the short term, G.M.’s newly minted retirees, those in their 40s and 50s, have the most to lose if the plan is rapidly depleted and fails. But over time, the risk will shift to the government and the dwindling number of active U.A.W. workers still building cars at G.M. For those workers, a secure pension is already becoming an increasingly distant dream.

“They could find that they don’t get their full pensions when they retire, because the plan has had to be terminated because of the payments to current retirees,” Mr. Elliott said. “There are definitely these intergenerational transfer issues with underfunded pensions.”

G.M. declined to discuss the situation, although it has said it intends to keep the plan going when it emerges from bankruptcy.

For decades, G.M.’s blue-collar workers have earned pensions with two components. The first is the “basic benefit,” currently about $1,590 a month, or $19,000 a year, for an auto worker with 30 years’ service. The U.A.W. won this “30-and-out pension” after a strike at G.M. in 1970, and still considers it something close to an inalienable right. In a 30-and-out plan, someone can go to work at 18, work nonstop for 30 years and retire at 48.

The second part is a supplement, worth what each worker’s Social Security benefit will be on the earliest date he or she can start drawing the benefits, currently age 62. (Even then, the workers are joining Social Security three years early, so they qualify for just 80 percent of the full benefits they would get at 65.)

Even in the days when G.M. was healthy, years ago, most of its 30-and-out retirees were too young to qualify for Social Security. The supplements were supposed to make up the difference until the retiree became eligible for Social Security.

The total dollar amounts are not eye-popping. Unlike many pension plans in the public sector, G.M.’s U.A.W. plan cannot be “spiked” by working insane amounts of overtime just before retirement. Nor is it indexed for inflation.

“What we’re getting isn’t enough to live on,” said DeWayne Humphries, a 54-year-old G.M. retiree in Arlington, Tex., who completed his 30 years last year, retired, and is now getting the standard $3,150 a month, or $37,500 a year. Roughly half of the total, $19,000 a year, is the basic benefit. The rest duplicates Social Security.

“It’s tight,” said Mr. Humphries, who was earning $50,000 to $60,000 a year before his retirement. “It takes a different way of living than what you were used to.”

To make ends meet, he helps out with his son’s small business, cleaning swimming pools.

When a G.M. retiree turns 62, he joins Social Security, and the pension fund stops paying him the supplement. So eight years from now, Mr. Humphries will still be getting $37,500 a year, but only about $19,000 will come from the G.M. pension fund. The rest will come from Social Security.

That will greatly lighten the load on the pension fund. But thousands of G.M. workers have taken early retirement in the last few years, and each of those workers’ total benefits come from the fund. So while the benefits may seem inadequate to individual workers like Mr. Humphries, they add up to hundreds of millions of dollars being pulled out of the fund every year.

When a reorganization began to loom at G.M., in 2007, the company faced the choice of offering people cash buyouts or sweetening their pensions, letting them collect their 30-and-out benefits even if they had not yet worked the requisite 30 years.

Mr. Elliott called the decision “a no-brainer,” thanks to the federal rules for funding pensions.

“When you have an increase in benefits in a pension plan, you’re given quite a number of years to fund the increase,” he said. “So by doing it through the pension plan, they could defer paying any cash for this for years.”

How long the fund can sustain this is a mystery. G.M.’s financial reports combine the U.A.W. pension plan with the company’s other big plan, for salaried employees. (It was frozen in 2006 and cannot undergo a sudden increase in benefits.) The U.A.W. plan’s own annual reports, on file with the Labor Department, provide no fresh financial information because they stop at 2006.

At that point, the fund had roughly $67 billion in assets — more than enough to cover the $59 billion in benefits it had promised to pay. The plan was then paying out a little more than $5 billion a year to retirees.

Now the assets are almost sure to be smaller, thanks to the market losses of 2008 and the growing payouts. “My guess is, they can probably go for 20 years before they run out of cash,” Mr. Elliott said. That may sound like a long time, but with so many retirees and spouses still in their 50s, the plan needs resources for at least 50 years.

“If you’re supposed to be paying people for 50 years, it’s actually not that comforting that they have enough cash to pay people for 20,” Mr. Elliott said.

The Pension Benefit Guaranty Corporation declined to comment, but officials there have long worried privately that the collapse of one big automaker pension plan would be the end of the whole federal system of insuring pensions.

Normally, federal law would require G.M. to put fresh money into the pension fund. But G.M. has not had to make any contributions since 2003, when it issued bonds and put the proceeds — $15.2 billion — into the fund. That was more than the required amount, and the pension law allows companies that make bigger-than-required contributions to use the excess to offset the contributions they will owe in subsequent years.

That, and earlier contributions, are allowing G.M. to halt contributions until 2013. By then, the plan may have a significant shortfall. The law gives G.M. seven years to catch up, which could be difficult if the company is not performing well.

Ron Gebhardtsbauer, head of the actuarial science program at Pennsylvania State University, said G.M. and its government stewards could reduce the risk by raising the retirement age in the future.

“They’re a bankrupt company and they shouldn’t be giving overly generous benefits,” he said. “It’s sort of like the banks giving out bonuses when they’re not profitable.”

Or pension funds giving out bonuses after losing billions. It's ridiculous how the financial aristocrats managed to screw over so many hard-working people.

What's even more worrisome is that it's business as usual on Wall Street and at many of the large "sophisticated" pension funds that operate at arms-length and disclose very little information.

Transparency at pension funds is indeed paramount. Too bad we won't see it before catastrophe strikes again, wreaking more havoc on overextended pension funds.

Monday, June 29, 2009

Where is the Fear?

I begin with a message from Diane Urquhart:
You are welcome to put links on your Pension Pulse blog to these letters between Parliamentary Secretary of Finance Ted Menzies and myself. They are about whether preferred status for pension fund deficits and severance would increase the cost and availability of credit. I say it does so on only a nominal basis and so the Federal Government should amend the BIA Act to give preferred status to pension fund deficits and severance.

I have stored the letters to and from Menzies at the following web pages. These links can be added to the LinkedIn Groups' and NRPC's website.



I do not have an active website, but you may be interested in the videos on securities corruption and securities crime policing that I have put up at www.ismymoneysafe.org.

I will then turn your attention to Luc Vallée's latest comment on the tsunami of corporate refinancing:

Did you see this graph in the Wall Street Journal yesterday? It is enough to make you want to read the accompanying article by SerenaNg and Kate Hatwood. I also reproduced it below with all proper credit for those who would have a hard time getting access.

In my blog yesterday (see Chronicles of a Second Wave of Foreclosures based on Ross Mckitrick's "Green Shoots Reality Check"), I commented on another incoming large wave of home foreclosures that could bring a new series of bank failures and renewed financial distress and, as a result, prolong the current economic recession well beyond 2010.Well, it appears that once we are over this second wave, a tsunami of corporate debt refinancing is going to hit us. It maybe hard to see in the distance, hiding behind two large waves of foreclosures: The first one falling on our head right now and the second one due to hit us with full strength in about 18 months.

Starting in 2001, but really getting momentum in 2012 and peaking in 2014, hundreds of billions of dollars of debt are due to be renewed. Already the mountain of debt on the horizon is pushing some desperate firms to attempt debt rescheduling exercise to avoid the crowd in 20013 and 2014. For the lucky ones who have already succeeded or who will succeed in the coming months, this means heavy concession to lenders usually under the form of higher interest payments. It may be good management risk practices but it also means reduced profit outlook for the next few years as interest payments immediately jump. Not very bullish for the Stock market.

Read on.
Reuters Loan Pricing Corp reports that U.S. syndicated loan issuance fell 37 percent in the second quarter from a year earlier, plumbing historic lows in the wake of last year's credit crunch:

Overall issuance fell to $156 billion from $248 billion a year earlier, with investment-grade issuance down by 27 percent to $70 billion and leveraged loan issuance down by 25 percent to $68 billion, according to RLPC.

High-yield bond issuance rose 39 percent in the second quarter to $46 billion.

JPMorgan was lead book-running manager in the second quarter, with $51.6 billion in deals, or 33 percent market share; followed by Bank of America Merrill Lynch, with $30.9 billion, or 20 percent market share; and Citigroup, with $16.7 billion, or 11 percent market share.

Some signs of stability emerged in the second quarter. In the leveraged loan market, prices of the 100 most widely traded loans rose by nearly 15 percentage points to 86 cents on the dollar.

Investors, however, had little opportunity to put cash to work on new deals. Issuance for leveraged buyouts, until recently a key source of new supply, dropped by 95 percent from a year earlier to $590 million in the quarter.

In the investment-grade area, a lack of merger and acquisition financing kept issuance down after the market cleared a number of jumbo deals in the first quarter, such as a $22.5 billion loan for Pfizer Inc.

But things may not be as bad as they seem. The distressed debt ratio is at its lowest point in nine months, dropping to 34% from a high of 85% last December, according to a study released today by Standard & Poor’s.
The amount of affected distressed debt dropped to $177 billion from $232.8 billion in May, according to S&P. The total number of companies with bonds trading at spreads of 1,000 bps ore more is now 268. At the end of May there were 338 such companies.

The speculative-grade corporate bond spread reached 946 bps on June 15, down from 1,136 bps May 15.

The distressed levels in leveraged loans have decreased also. The S&P/LSTA Leveraged Loan Index distressed ratio fell to 47.5% in May from 54.8% in April.

These developments are positive for distressed debt markets and the overall credit markets. In the stock market, growing confidence that the U.S. economy is putting the worst recession in decades behind it has pushed the index known as Wall Street's fear gauge to its lowest level since just before Lehman Brothers collapsed last September:

The CBOE Volatility Index .VIX, known as the VIX, provides investors with portfolio insurance against fluctuations in the S&P 500 index .SPX. It soared to historic highs in the weeks after Lehman's rapid failure pushed financial markets to the brink and left an already crippled economy in tatters.

But amid numerous signs the economy is on the edge of a recovery, coupled with the best quarter for stocks in more than 10 years, the VIX has begun to look like its old self again.

"Investors see a lesser need for protection going forward; it looks like they don't see a revisit to the March lows," said Andrew Wilkinson, senior market analyst at Interactive Brokers Group in Greenwich, Connecticut.

The VIX, which is calculated from Standard & Poor's index options, tracks the market's expectations of volatility over the next 30 days. It often moves inversely to the S&P benchmark and goes up as options premiums are raised.

The S&P 500 .SPX hit a more than 12-year low in early March, down more than 57 percent from the record high it set in October 2007, after the bursting of the housing bubble spiraled into a credit crisis and then into a global recession.

The VIX hit an intraday record high of 89.53 in late October, but on Monday it closed at 25.35, its lowest level since September 11, 2008, before the weekend when Lehman collapsed.

"The path forward appears a less treacherous one according to what the VIX is telling us," Wilkinson added.

Stabilization of key economic indicators such as payrolls, home prices, bond yields and consumer confidence, as well as the Obama administration's plan to reactivate the recession-hit economy, have boosted bets on the economy's outlook. Investors are looking forward to this week's key housing and job market data on expectations that it will show further signs that the worst is over.

"I think (the VIX) is down primarily because the expectation is the economy is going to recover and we've started a bull market," said Hugh Johnson, chief investment officer of Johnson Illington Advisors in Albany, New York.

The S&P 500 has risen up to 40 percent from its March lows, and is on path to close its best quarter since the fourth quarter of 1998. But even as some market players expect a correction in the near term, the reading of the VIX suggests that that correction may not happen.

"The bears are beginning to throw in the towel on expecting a substantial stock market decline, so investors are beginning to sell implied volatility," Wilkinson said. "Investors do not perceive there's going to be another big crash."

But although the VIX has returned to levels similar to those seen before financial markets imploded, analysts said that does not mean the economy has recovered from the hit it took last year.

"We've gone through such a change in the economy that has required such drastic steps from both the Federal Reserve and the government that it is going to create a very different landscape going forward," added Wilkinson. "We can't relate (today's) VIX measures to were we've come from."

In the Australian, Charlie Aitken of Southern Cross Equities writes that investors should get ready for the next leg higher:

OUR market was watching the Dow Futures closely here yesterday, which pointed to a 50-point weaker night on Wall Street.

I have no idea why anyone watches the Dow Futures trading on a Sunday night. Similarly, shorters decided some random comments from some Chinese source about commodity prices was a good enough reason to short commodity stocks in the afternoon session here yesterday.

Both ideas look flawed this morning, with the Dow Jones Industrial Average closing a net 140 points higher than the Dow Futures were predicting, and the commodity complex having a good night led by oil and copper.

While rising oil prices (+$US 2.23 a barrel to $US71.47) aren’t a great thing for the US economy, the market point is that Exxon Mobil (+2.2 per cent) is the largest weighting in the S&P 500, while Chevron and Exxon are both Dow components.

Also, for some reason, oil and financials appear to be closely correlated at the moment (risk?) and every time oil rises, so too do the US financials (KBW Bank Index +1.5 per cent). By the end of a summerish volume session (that is, relatively light), the Dow gained 90 points (+1.1 per cent) to 8529 while the S&P 500 gained 8.3 points (+0.9 per cent) to 927.

The markets seemed to like the fact that Bernie Madoff was sentenced to the maximum penalty of 150 years in jail for his ponzi scheme and it was a nice touch to see his own wife stick the boot into him after the sentencing. In good times and bad, hey, Ruth?

More interestingly, the Chicago Board Options Exchange Volatility Index (VIX) continued to fall (25). A close reading of both the VIX and Dow Jones Industrial Average shows to me that the much larger chance is the Dow plays catch-up to the VIX’s collapse and I think that will be the case in the second half of this year. Last time the VIX was 25 points, the Dow was over 11,000. Food for thought.

The truth is that you can create all sorts of nasty scenarios but if the U.S. economy does surprise to the upside, stocks will keep grinding higher and the only fear that will dominate the big fund managers is the fear of underperforming the major averages.

Finally, Karen Mazurkewich of the Financial Post writes that the bonus flap puts Canada Pension's strategy at risk:

When the Canada Pension Plan Investment Board disclosed two weeks ago a $24-billion loss for the previous fiscal year, it sparked a political furor in the House of Commons over hefty executive bonuses.

Now, there may be a higher price to pay from the fallout: the fund's progressive investment strategy could be in jeopardy.

Analysts worry that a parliamentary backlash could put the pension fund's cost-effective strategy at risk if it loses its ability to attract highly talented managers.

Going "cheap" on talent would save a few million in bonuses, but it would also add 10s of millions of costs to the running of the plan because the fund would be forced to rely more on outside fund managers and consultants who charge high fees to handle alternative assets such as private equity and infrastructure funds.

The financial services industry has a bad rap these days, and bonuses "is a strong political plum to bite into," said Keith Ambachtsheer, director of the Rotman International Centre for Pension Management at the University of Toronto and the co-founder of CEM Benchmarking Inc. "In general, we pay our [pension managers] better in Canada, but we do it for the right reasons."

CPPIB and other multi-billion-dollar plans are now boosting performance by direct investing in alternative classes such as private-equity, hedge funds, real estate and infrastructure. Such a strategy requires a high calibre of manager.

"Canadians need to make a choice," mused Mr. Ambachtsheer. "Do they want top of class or go cheap?"

A better barometer for politicians is how well the plan can streamline fees and reduce operational costs.

CEM Benchmarking, a Toronto-based research firm that collects data on 408 pension funds around the world, has calculated that in 2007 CPPIB's operational costs were lower than those of its peers. It cost CPPIB 33.2 basis points (pb) to run its pension fund compared with an average of the 36.9 pb to run similar North American funds in comparable asset classes.

The savings of 3.7 bp translated to $44-million savings - meaning that CPPIB managers negotiated better fees or managed their funds more efficiently in-house.

Those savings are even greater when CPPIB is compared with a pension plan that farms out all its alternative assets to outside fund managers. According to CEM, a North American fund of similar size to CPPIB paid 54 bp in 2007 for the management of their fund. Not only were a large majority of its assets managed externally, but 20% was invested in expensive asset classes: real estate, hedge funds and private equity. That means CPPIB saved 20.8 bp, or $248-million by comparison.

Giving Canadian pension executives hefty incentive packages to run multi-billion funds was a trend that began 19 years ago, when Claude Lamoureux was recruited to run the Ontario Teachers' Pension Plan (OTPP). Mr. Lamoureux, who retired from OTPP in December 2007, remains a defender of that policy:

"When [former executive vice-president investments and chief investment officer] Bob Bertram and I started [at OTPP], we wanted to run money internally because we felt we could do as well as external [managers]. If you look at the economics, it's a fairly compelling case to manage internally."

Mr. Lamoureux said that he faced off with critics who challenged OTPP's salaries, which are some of the highest in their field. In 2006, for example, Mr. Bertram made $6.17-million in compensation - although his total package was shaved to $2.49-million for 2008 after the fund lost $21.1-billion in assets. But his reduced salary in bad times is still many times higher than the average salary for a top manager at California Public Employees' Retirement System (CalPERS), which ranges between US$400,000 and US$600,000.

Mr. Lamoureux argued that when funds reach a certain size, it makes more economic sense to reward top managers internally, while paying less to external funds whose fees in certain asset classes are becoming "prohibitive."

Not only do companies such as Kohlberg Kravis Roberts & Co. (KKR) and The Blackstone Group charge 2% management fees plus 20% of the profits, "they've found new ways to charge fees for practically getting out of bed in the morning," he added. Their real fees are more in the 5% range.

So while CalPERS executives receive less compensation, the real cost of running alternative assets through third-party funds is kept hidden. "In the case of private-equity, these fees never show up in the [operation] expense column of the pension funds because they are deducted from the earnings," said Mr. Lamoureux. He has argued for years that the cost of those fees should be transparent. As a result, "when parliament criticizes the [bonuses] they don't know what the alternatives are," he added.

Mark Wiseman has been in the eye of the political storm. As senior vice-president, private investments, with the CPPIB he was one of a handful of top executives singled out for a compensation package that totalled more than $2.4-million this year. However, Mr. Wiseman argues that his team is saving many more millions that would otherwise be paid out to external fund managers.

Take CPPIB's private-equity arm alone. Over the past three years, CPPIB did $3.5-billion worth of direct investments. If Mr. Wiseman's team had paid 2% in management fees on that sum, it would have cost the fund $70-million annually. That doesn't even include what CPPIB would have to pay their external manager when the investment was realized. If its $3.5-billion investment doubled over time, the pension plan would have to pay $700-million - 20% of its profit - to its outside manager. By contrast, it costs CPPIB about $20-million annually in compensation, office allocation and travel, to run its in-house direct private equity team.

These savings are just a small part of the picture. CPPIB is also beefing up its internal capabilities in all other classes including infrastructure, real estate and private-debt - in hopes of saving hundreds of millions of dollars. By contrast, CalPERS "pays hundreds and hundreds of millions of dollars in fees to external managers," Mr. Wiseman points out.

Success for CPPIB's direct investment teams means earning returns at least as good as those achieved by third-party funds. "And that requires a highly qualified team," said Mr. Wiseman.

That's why the political firestorm over the bonuses has him worried: "I think it would be a shame if these issues forced us to take a different path as an institution, because at the end of the day I think it would be Canadian pensions that would lose."

I can't stand reading this nonsense. What progressive investment strategy? What are the bloody benchmarks for private equity and do they accurately reflect the leverage, liquidity and credit risk of the underlying investments?

And by the way, those "direct investments" in private equity were probably co-investments so don't be so impressed with the headline performance figure. If they are that great, let them start a PE fund of their own (good luck).

The bottom line is CPPIB lost $24 billion and they have the audacity to claim that they deserve bonuses?

As for Mr. Lamoureux, the guy who told me to "shut up" after I testified on Parliament Hill and exposed all these bonus shenanigans based on bogus benchmarks, he is obviously going to defend current compensation practices because he made millions while he was at the helm of Ontario Teachers.

And Mr. Ambachtsheer should come clean and state who pays his salary. Is it the big funds or the pensioners they invest on behalf of?

Should we really fear that the "top talent" will leave Canadian pension funds to join hedge funds and private equity funds?

Give me a break. I say this to all the pension "all-stars" who lost billions in 2008: stay where you are because unlike most pensioners, you obviously have no fear of underperforming these markets. You get all the upside in good years and in terrible years, you can hide behind a four-year rolling return.

These pension fund managers have the best gigs in town and the only fear we should have is that they continue pulling the wool over their stakeholders' eyes and get away with huge bonuses for delivering mediocre performances.

Sunday, June 28, 2009

The New Rising Sun?

In my last comment on the 'Golden Cross', I warned people not to be overly reliant on technical signals. Someone on Naked Capitalism commented that it is better to use the exponential 50 and 200 day moving averages, which lends more weight to more recent data.

While it is true that the 50 and 200 day EMA are not showing a Golden Cross yet (you can verify this for free on Yahoo Finance, for example, on the S&P 500), there is a danger when you just look at technical signals and ignore other things like fundamentals and liquidity.

On his blog, Luc Vallée discusses the chronicles of a second wave of foreclosures and notes the following:
Another incoming large wave of home foreclosures could bring a new series of bank failures and renewed financial distress and, as a result, prolong the current economic recession well beyond 2010. This is because, according to Mckitrick, resets on Option-ARM mortgages, currently averaging $2 billion a month, will rise to $25 billion per month by late 2011; mostly in California and neighboring states. This means we could relive the nightmare of the last two last years when we went through a big wave of resets.
I have already alluded to how Alt-A resets will slam alternative investments and I think it is wise for people to understand the difference between bottoming out and a full fledged recovery.

Importantly, given the economic destruction and spare capacity in the economies of industrialized nations, it increasingly looks like the next recovery will be the weakest recovery in post-war history and expect interest rates to stay low longer than what the market is currently pricing in.

But this does not mean that the world will come to an end. Any student of economics who has studied Schumpeter's creative destruction knows that dynamic changes are constantly occurring in the economy and that innovation will displace older mainstream industries.

Today, I want to focus on one of the new industries in alternative energy, the solar industry. I am personally invested in this industry, both long-term and short-term (trading), and I think it will be the next "new thing".

Greentechmedia notes that the U.S. House of Representatives cleared a big hurdle late Friday by passing a bill that set goals for reducing the United States' greenhouse gas emissions, a first in Congressional history.

The Associated Press reports that the solar industry to see faster than expected growth:
The solar energy industry will grow faster than expected during the next few years as American utilities invest heavily in large-scale solar farms, analysts with Barclays Capital said Tuesday in a research note.

Barclays analyst Vishal Shah noted that demand for utility-scale solar projects could eventually make up half of the U.S. market. Major utilities could install about 5 gigawatts of solar photovoltaic projects during the next three years, the analyst said.

Solar power is still a tiny player on the American electrical grid, however.

The utility-scale projects currently in operation in the U.S. provide 444 megawatts of energy to the grid according to the Solar Energy Industries Association. That's enough to power 2.8 million homes, and it's only a fraction of the power generated by another alternative energy source, the Palo Verde Nuclear Generating Station near Phoenix.

That amount is expected to jump more than 12-fold in the next few years, however, with dozens of new solar plants under development in California, Arizona, Florida and Hawaii.

Shah said SunPower Corporation, First Solar Inc., Suntech Power Holdings Co. and Yingli Green Energy will be the primary players in utility-scale projects in coming years.

Because of the banking meltdown, the expansion depends heavily on the promise of billions of federal stimulus dollars that Congress earmarked for solar in the past year.

Power companies have had trouble raising money for major projects, and they still don't yet know how they can access federal grants and loan guarantees.

SEIA spokeswoman Monique Hanis said the Treasury Department and the Department of Energy are expected provide more information this summer.

"The sooner we can get some guidance, the sooner we can get moving on these projects," Hanis said.

While some are skeptical of government intervention, there is no doubt that the solar industry will need strong government incentive programs to continue expanding. In California, for example, the legislature must act to keep solar glowing.

If the U.S. does not get its act together, it risks losing ground from other countries which are actively promoting the solar industry. Europe's solar power seen competitive in 2010. Japan is relighting its solar PV industry.Beijing's bid to boost the solar energy sector could draw more than $10 billion in private funding for projects and put China on track to become a leading market for solar equipment in the next three years.

Not everyone is convinced solar is the way to go for clean tech. Some feel a more realistic energy option to be invested in for the next 5-20 years is nuclear energy.

But all these naysayers forget that advances in photovoltaics could make solar cost competitive:
Building-integrated photovoltaics (BIPV) is poised to change the face of construction, energy and urban planning in the coming decade.

The Department of Energy has estimated that BIPV technology could potentially generate 50% of the electrical needs of the U.S. and other developed countries, and the DOE’s Solar America Initiative has set the goal of making solar cost-competitive with grid electricity by 2015.
In this continuing effort the Department of Energy just announced the selection of 24 new solar projects to advance photovoltaic technology research, development, and design, ultimately lowering the cost of photovoltaic generation. The competitively-selected projects will be eligible for up to $22 million from the President’s American Recovery and Reinvestment Act and will be matched by more than $50 million in cost shared funding from private partners.
Many of the projects selected focus on improving the effectiveness of the materials used to capture the sun’s rays.
So which stock do I like in the solar industry? My top pick is LDK Solar (LDK), a popular solar stock with pro investors. There are other excellent picks in this sector, like Yingli Green (YGE) who is seeing a pick-up in demand and Trina Solar (TSL) who got $57 million in new credit:

Trina has been helped in recent months by a decline in the cost of polysilicon, the material it uses to turn sunlight into elecricity in its solar cells, but like others in the industry, has suffered from a steep drop in prices for solar panels.

Chinese solar companies have also seen volatile earnings swings because of the sharp moves in the value of the euro versus the U.S. dollar. Europe is the biggest market for solar products.

The new facilities from Standard Chartered Bank (China) Ltd brings its total credit facilities to $520 million.

Credit is important for these companies to continue expanding. Their debt levels are high, but this reflects strong expansion and difficulties keeping up with demand.

I will end by warning all of you, solar stocks are not for the feint of heart. If you cannot stomach crazy volatility, do not bother investing in these stocks. The big hedge funds love manipulating them through naked short selling, an abusive practice that has finally caught the attention of global watchdogs.

I see huge potential in the solar industry and I am a long-term investor in the sector. I also trade them in my short term account because I see the way they move when volume picks up in the sector.

On that note, I am off to enjoy this sunny Sunday afternoon in Montreal.

[Note: Here are the symbols of solar stocks I track: CSIQ, ESLR, FSLR, JASO, LDK, SOL, SOLF, SOLR, SPWRA, STP, TSL, WFR, TIM.TO, TSL and YGE. The symbol for the solar ETF is TAN.]

Saturday, June 27, 2009

From Golden Cross to Golden Goose?

My favorite strategist, Martin Roberge of Dundee Securities, sets the record straight on the Golden Cross in his latest strategy comment:
Much has been said about the positive implications of this week’s Golden Cross (GC) on the S&P 500. However, little emphasis has been put on downside risk analysis. Even though GCs have normally preceded periods of above-average stock market performance, history also reveals that important pockets of market weakness remain. In fact, our analysis suggests that despite this week’s GC, odds of a re-test of March lows should not be taken down to zero. A re-test is not our baseline scenario, but we wanted to set the record straight as far as the GC is concerned.

A GC occurs when an index’s 50-day moving average (MA) rises above its 200-day MA. This event occurred Tuesday on the S&P 500. Since the GC is of a declining 200-day MA, we looked at the implication of such a cross in terms of forward stock market performance. We also screened for episodes when the GC occurred through a recession as identified by the NBER. The forward performance of the S&P 500 appears in Exhibit 2 next page.

Key observations are: 1) returns are positively skewed, with a one-year increase of 12.9% on average, 2) when the GC occurs through a recession, the average return jumps to 26.4% vs. only 2.1% for the no-recession scenario, 3) through a recession, the S&P 500 one-year downside risk is -0.6% vs. -18.3% otherwise, 4) intra-year, the downside risk rises to -15.1% under the recession case and -24.0% otherwise, 5) through a recession, the S&P 500 downside risk from the GC level is contained at -4.7% if the 1932 and 1938 experiences are excluded.

However, using daily data, the third panel of Exhibit 1 at right plots the S&P 500 average, minimum and maximum performance path under the recession case. With the index closing at 895 on June 23 (day of the GC), we can see that the 6-month downside risk is located at 783 and then 674 if we follow the path of the 1932 and 1938 GCs.

Bottom line. While the advent of a GC is a positive development for equities, many pundits failed to mention that such a cross does not exclude the possibility of a re-test of March lows. We wanted to set the record straight.

I always tell people to use technical signals as a tool, but never, ever rely solely on technical signals.

Another interesting comment came this week from legendary investor Jim Rogers, who now says he has no short positions:

Investor Jim Rogers said on Thursday that he sees prolonged economic problems and while he did not see much worth buying, he is not shorting any assets either.

He repeated a previous comment that he is selling his U.S. dollars and that commodities were the best investment bet.

“I have no shorts for one of the first times in my life,” Rogers, a co-founder with George Soros of the Quantum Fund, told Reuters TV in Singapore. “On the other hand I don't see much to buy.”

He said huge borrowing by governments, particularly in the United States and Britain, would hurt their currencies and lead to future problems, though he picked the Canadian dollar as one of the “soundest” currencies.

“I've got out of my pounds. I will be getting out of my (U.S.) dollars soon,” he said, repeating his view that commodities were the best place to be, with metals having gained more than stocks this year and long-term potential for soft commodities.

“I'd rather be a farmer than a stockbroker for the next couple of years,” he said. “No-one you went to school with became a farmer... so we have a shortage of farmers.”

Mr. Rogers, who lives in Singapore, co-founded the Quantum Fund in 1970. The fund, since closed, returned 4,200 per cent in the next decade, compared with a 50 per cent gain in the S&P 500 index.

“If you're in London you're in the wrong place at the wrong time... You gotta move east.”

I agree with Mr. Rogers, the "golden era" of financial services is over. We entered a prolonged bear market in that industry.

But he must be blinded or biased, focusing just on commodities when he says there is nothing to buy. Go back to read my comment on the investment labyrinth to see the key long-term themes you should be focusing on:

  • Inflation/ deflation
  • Alternative energy (solar, wind, nuclear)
  • Chindia (China & India)
  • Demographics (healthcare, biotech, etc.)
  • Infrastructure
  • New technologies (nanotech, etc.)

Of these, I think alternative energy and infrastructure are definitely on a long-term secular upswing.

The OECD reports that the world’s main economies are looking to “green growth” as the way forward out of the current crisis, opening up new prospects for climate-change negotiations ahead of the 15th Conference of the Parties of the UN Framework Convention on Climate Change (COP15) in Copenhagen in December.

Tomorrow I will discuss why smart money is going clean tech. As we wait for the U.S. Senate to pass the climate bill, there are tremendous opportunities out there that are worth investing in.

Thursday, June 25, 2009

Feudal Age of Pensions?

More on pensions apartheid. Bill Tufts of Fair Pensions for All sent me this Globe and Mail blog entry, In feudal age of pensions, renaissance must come:

He calls it our “Modern Feudal System.”

A system where a few have a lot and the majority have – or will have – very little indeed.

The difference-maker in our futures, says Bill Tufts, is going to be our pension plans. Public or private. Gold-plated pensions versus pensions that might not even hold a coat of yellow paint.

“Church and King have been replaced by Government and Big Business,” says the Hamilton-based pension specialist with WB Benefit Solutions. “In the feudal age, the church and nobility always wrestled for the purse of those trapped in the caste system. But the poor serf still paid with everything he grew or could make.”

On his blog and in articles and talks, Tufts has been arguing that the average public servant in Canada will end up with a pension valued at close to $1-million – while the average taxpayer is looking at retirement with less than $150,000 in RRSPs or a small company pension.

The world financial meltdown, he says, has created a situation in which private-sector pensions are under siege – some to the point of vanishing – while public plans are not only protected but, in certain cases, will be topped up in the event of a shortfall by taxpayers who will never collect such a pension themselves.

“People are resentful,” he says.

He also says people are becoming increasingly aware of the situation. The North American media have called it “pension envy,” while the British press has warned about a “pension apartheid” in which retirement lifestyle will be decided largely on whether or not the retiree collects a healthy, protected and often indexed public pension or a squeezed and potentially fragile private one.

Tufts’s message is not popular in certain quarters. He calls himself a “libertarian” with a deeply conservative bent, and says he understands perfectly why some government and union workers would lash out at him when he talks about the growing and unfair “gap” between their pension plans and the plans of most Canadians.

“There’s a lot at stake,” Tufts says. “I would be struggling just as hard as them to keep what I had.”

Pension rage

Bill Tufts and others call it “pension envy” – and it is not merely a Canadian phenomenon. It is a simmering topic in Britain, and in the United States it is increasingly becoming an issue.

New York Mayor Michael Bloomberg this week says his own city’s pension system is “out of control.”

Bloomberg, who was elected largely on promises of financial prudence, says in the eight years since he took office the city contributions to the pension plan have risen almost five-fold, from $1.4-billion to $6.3-billion (U.S.).

The pension plan now gobbles up one dollar out of every $10 in the city budget.

Critics say Bloomberg has only himself to blame, having been so generous with pay raises to the city’s 300,000 or so workers. By raising their wages, The New York Times points out, he himself guarantees bigger pensions on retirement. And with pensions typically 50 per cent of salary, the costs are only going to rise even further.

It doesn’t really much matter how public service pensions get so high – politicians voting for their own, unions successfully bargaining – and there would be no complaint to be had if private pensions weren’t stalled or shrinking, at times even vanishing, at the same time.

Bill Tufts likes to compare an Ontario auto worker for GM with an Ontario teacher. The auto worker, he says, is terrified his or her pension – which Tufts estimates averages around $18,000 a year – is threatened. A teacher at the highest end of the teachers’ scale, on the other hand, has retirement security and will collect a pension that Tufts estimates at $50,000 a year. Lucky are those who qualify.

“For you or me to have a pension at that level,” he says, “you’d need about $1-million.”

He argues that public pensions are higher than necessary if you apply a rule-of-thumb that workers generally see a 30 per cent drop in living expenses when they no longer go to work, no longer need to park, buy lunches, have that second car, etc.

He says there is increasing anger over the discrepancy between public and private pension plans, but he’s not predicting a citizens’ revolt or anything close to it.

“We’re a pretty tranquil, docile people,” he says.

Instead, the Saskatchewan native likes to think a Canadian solution will find its way, just as so often has happened in the past with such government initiatives as medicare and equalization.

What Tufts is calling for is a cross-country “crusade” to convince the national government – not provincial governments – to implement a “supplementary pension plan” that would be available to those workers in the private sector who might like more protection and better benefits and are happy to pay for this security with their own money.

“The ideal solution,” he says, “would be some sort of meeting in the middle, more money for private pension plans, public pension plans giving up a bit. It is, unfortunately, a win-lose situation.”

For that reason, he doesn’t see the public sector giving up anything that has been hard fought and won. However, he believes the federal government could and should provide a way – perhaps through a revamped Canadian Pension Plan – in which people could, on a voluntary basis, have more of their retirement savings in a plan as solid and secured as those enjoyed by the public sector.

One headline writer at the C.D. Howe Institute has called it “A Pension in Every Pot” – a play on Herbert Hoover's famous election promise of “a chicken in every pot.”

Bill Tufts doesn’t have all the answers but he does have one question that is increasingly being asked about the growing difference between public and private retirement plans:

“How,” he wonders, “are people going to get over that gap?”

On Thursday morning, CBC radio had a discussion on this topic:

There are public sector picket lines up in a various parts of the country this morning. In Vancouver, ambulance paramedics have been on a picket line for 3 months - 5 percent of them anyway because the rest are designated as essential workers and only 5 percent are allowed to picket at one time.

Windsor's city workers in Ontario are in week eleven of a strike. And Toronto is moving into a fourth day with no garbage collection because of a city-wide strike of about 24-thousand municipal workers. And as the temperature climbs toward 30 degrees, the city's residents aren't happy. The Current's Natasha Dos Santos was at a transfer station yesterday, where people were lining up to cross a picket line to dump their garbage.

The main issues in the labour dispute are health benefits and the right to bank sick days. And, as you heard, many people think the worst economic downturn in decades is the wrong time for unions to be going to the wall on those issues.

But Paul Moist begs to differ. He is the National President of the Canadian Union of Public Employees. CUPE has 600,000 members across Canada, including the striking Toronto workers. Paul Moist was in our Ottawa studio.

Labour Concessions - Panel

But according to a poll conducted on Monday and Tuesday -- the first two days of the Toronto strike -- more than three quarters of residents are opposed to the job action. And 81 per cent would like to see the Ontario Government legislate the municipal workers back to work. Catherine Swift is no fan of the strike but thinks unions should be making concessions during recession. She's the President and CEO of the Canadian Federation of Independent Business and she was at her home just outside Toronto. And Jim Stanford is an economist with the Canadian Auto Workers Union. He was in our Toronto studio.

You can listen to this interesting discussion by clicking here and then going to part 3. Jim Stanford made an excellent point when he said that the financial crisis was caused on Wall Street and now it's Main Street and the unions that have to give concessions.

But Catherine Swift was right to blast those generous public plans and to question the health of city pension plans. There is no transparency on city pension plans, many of which operate in the shadows of city treasurers. When is the last time you saw a detailed report on Toronto or Montreal's public pension plans? This is another scandal that will hit taxpayers hard.

Finally, the FT reports that in the U.K., Ministers last night abandoned plans to increase the taxpayer contribution to the pension scheme for MPs ahead of a potentially embarrassing vote.

The government backed down hours after the Liberal Democrats and Conservatives said they would vote to stop a 7 per cent rise in the public contribution to MPs' retirement benefits.

The plan was designed to address the growing liabilities of the scheme. A proposal will still go forward to increase MPs' contributions into their pensions by £60 a month. But it was unclear whether MPs would increase this amount to make up for "freezing" the official taxpayer contribution.

Talk about adding salt to the wounds of pensioners. In the feudal age of pensions, voting to increase taxpayer contribution to the pension scheme for MPs is just another example of stupidity and arrogance. The only thing worse than that is collecting millions in bonuses after losing billions of dollars.

Wednesday, June 24, 2009

Pensions Apartheid?

Let me begin by wishing all Quebecers "une bonne Fête nationale". I hope you enjoyed St-Jean Baptiste celebrations on this glorious sunny day in Quebec.

In my last post, I discussed the global pension crisis and how it might lead to a long social crisis. Today I read that final salary pensions "unsustainable" claim 96% of firms:

A poll of 157 UK firms – including 33 FTSE 100 companies – by PricewaterhouseCoopers (PwC) finds as well as closing final salary, or defined benefit, pensions to new employees as many have done 72 per cent were considering closing schemes to existing employees.

Earlier this month both BP and Barclays both shook up their final salary pension schemes.

While five years ago 40 per cent of companies offered final salary schemes – promising a pension income based on the level of the final salary – now just four FTSE 100 firms - Shell, Tesco, Cadbury and Diageo – offer workers such pensions.
Only 17 per cent of the firms surveyed had defined benefit schemes and only a quarter of these were planning to leave schemes unchanged.

Of all firms five per cent expect to have a final salary pension open for new employees in five years time and only 22 per cent are committed to maintaining future benefit accrual for existing scheme members.

Marc Hommel, PwC partner and UK pensions leader, said: "Future generations will have to do far more for themselves relative to those people who have been lucky enough to belong to a fast-disappearing, defined benefit scheme."

The PwC poll revealed firms were aiming to reduce their pension provision due to the risks of running a final salary pension, the costs and measures on the Budget.

In fact, 77 per cent of firms polled said the Budget’s pensions tax proposals have further reduced their motivation to provide workplace pensions – both as final salary schemes and defined contribution schemes.

Just four per cent of employers are not planning changes to the defined benefit or defined contribution pensions they provide.

The introduction of auto-enrollment of pensions in 2012 is hoped to encouraged more people to save for their pensions, but many firms will drop contributions to the minimum.

“Pensions apartheid is upon us, with a growing gap between the relative generosity of the public sector and the intention of more than a third of private sector employers to provide the bare minimum under the 2012 auto-enrolment pension requirements," Mr Hommel said.

Forty-one per cent of smaller companies said they planned to offer just the bare minimum pensions provision required by law under auto-enrolment, compared with 25 per cent of larger firms.

Mr Hommel said: “We will see increasing divergence in the pension provision offered by smaller and larger companies."
Is pensions apartheid here? No doubt about it, and in the next decade, you will see increasing pressure on governments to curb public pension benefits.

For private companies, many will scrap defined-benefit plans but the smarter ones will work to bolster their plans, ensuring that they remain viable for as long as the company exists.

I believe that pensions are already a major concern for many employees so firms looking to attract the best and the brightest to their companies better bolster their pension plans and their pension packages, committing the necessary resources in good times and in bad times.

For those of you working in the public sector, do not take your pensions for granted. Make sure you save on the side and invest that money wisely or else you too risk a rude awakening in your golden years.

In the new era of pensions apartheid, nothing is sacred, including your public pension plan.

Tuesday, June 23, 2009

Decades of Social Crisis?

The FT reports that the OECD warns on pension crisis:

Strains in pensions systems, in both private and public provision, threaten to turn the financial crisis of the past two years into a social crisis lasting for decades, the Organisation for Economic Co-operation and Development warned on Tuesday.

In its annual analysis of the health of pensions systems globally, the Paris-based organisation found private pension plans lost 23 per cent of their value last year, while higher unemployment “leaves little room for more generous public pensions.

Angel Gurría, the OECD secretary-general said: “Reforming pension systems now to make them both affordable and strong enough to provide protection against market swings will save governments a lot of financial and political pain in the future”.

Pensioners hit hardest include those heavily dependent on defined contributions, where people save to build up a personal fund, those near retirement and those heavily invested in equities. This applies to many US citizens who have large pension pots, known as 401(k) retirement plans.

For these individuals and for the recently retired who have not bought an annuity, losses will be greatest, the OECD said, exacerbating the sense of a looming pensions crisis worldwide. Those with defined-benefit private pensions are not immune from potential losses, as companies are increasingly restricting the amounts paid.

By contrast, younger workers have time to repair the damage to their pensions. Their losses are also smaller compared with their annual contributions than for those near retirement who have already built up a big pension pot.

Losses in private pension schemes were highest – at over 25 per cent – in countries such as Ireland, Australia and the US, where the greatest proportion was invested in equities. Losses in Germany, Mexico and the Czech Republic, however, were under 10 per cent as private pensions there were heavily invested in bonds. Future incomes from public pensions are not immune from the financial crisis, the OECD warned, because stretched public finances will prevent countries augmenting public provision and might lead to cuts.

Canada, Germany and Sweden, for example, already adjust public pensions in payment according to their schemes’ performance.

The OECD said this form of adjustment “needs a rethink” to prevent cuts in pensions exacerbating the recession. But it does not suggest reversing the proposed cuts, suggesting they are merely postponed until economies recover.

Some countries provide extremely low incomes for poor pensioners with a history of low-income employment.

The OECD singles out Germany, Japan and the US as countries where deficiencies in “old-age safety nets are a concern”.

For private pensions, the recommendation is that governments should ensure most members of defined-contribution pensions gradually reduce the proportion of equities and other risky investments in their portfolios as retirement nears.

Ageing strategy

Planned increases in pensionable age, restricting the generosity of early retirement schemes, less generous public pensions, even cuts in pay for Irish public officials. These are all examples of strategies advanced countries are using to reduce the financial burden of pensions as their population ages.

The financial crisis will focus policymakers’ attention on the short term, warns the Organisation for Economic Co-operation and Development, threatening to postpone long-term strategic planning. Officials in the Paris-based organisation are most concerned about a repetition of the mistakes of the 1980s, encouraging early retirement, which improves unemployment figures today at the cost of fewer workers and a greater pensions burden tomorrow.

The OECD describes these changes over the past five years as “one of evolution rather than revolution in pension systems”.

Over the next 40 years it still expects population ageing, which will create a demographic transformation and increase the burden of pensions on the public purse.

Consider this, the world's 65-and-older population will triple by mid-century to 1 in 6 people, leaving the U.S. and other nations struggling to support the elderly.

IPE reports that the OECD fears pensions backtrack in economic pressure:

The Organisation for Economic Cooperation and Development (OECD) has warned governments should not to try and deal with short-term challenges in economic conditions by postponing pension reforms as the longer-term impact could be more damaging further down the road.

Authors of a biennial report published today, entitled Pensions At A Glance 2009, said a review of OECD countries and their retirement regimes noted planned pension reforms in some countries have either stalled or been postponed, while other nations, such as the Slovak Republic, have attempted to undo earlier reforms – a move which the OECD fears could happen elsewhere should finance ministries feel too much pressure.

The 280-page report warned “the financial and economic crisis means that governments’ attention is focused, more than ever, on the short term” and said the concern is, based on the actions of countries such as Italy – which has now postponed planned reforms to the retirement age and benefits paid – that “governments may be tempted by short-term expediency to backtrack on earlier reforms by…relaxing rules for early retirement as labour-market conditions worsen”.

At the same time, authors warned long-term, strategic planning, which is vital to retirement income policy, is being “set aside”.

“The short-term political pressures on governments to respond are huge. But it is important to resist expedient reactions that threaten the long-term stability and sustainability of retirement income provision.”

It continued: “The crisis may lead to further changes that are not consistent with the long-term strategy needed for a sustainable pension policy.”

The OECD also argued that governments should consider a diversified approach to delivering pensions benefits overall, as it believes this would better protect people.

“The best approach to pension provision is to use a mixture of sources of retirement income, including both public and private, as well as the two main forms of financing (pay-as-you-go and funded pensions). Relying solely or largely on one source in the face of different kinds of risk is imprudent,” suggested the report.

The document provides a complete review of OECD countries’ pension regimes, the reforms and updates on poverty levels among pensioners, the likely impact poverty and earning brackets have on retirement benefits as well as comments about the potential costs to government coffers.

It noted, for example, that Germany's pension system has been less affected by the recent crisis so far than many other OECD countries, though the replacement rate of pensions income to earnings is also one of the lowest at 43% - the average net income of people aged over 65 within OECD countries being 82% by the mid-2000s.

Interestingly, however, the OECD noted the speed of pension reform slowed considerably between 2004 and 2008, compared with earlier years – in only five countries there was little or no change - and the process was described as being “one of evolution rather revolution”.

We are evolving towards a pension revolution - and not the good kind of revolution. It's only a matter of time before we hit a major brick wall, placing enormous pressure on already stretched public finances.

What amazes me is how incredibly silent politicians are when it comes to the pension crisis. It's as if they are hoping that a new super bull market, and inflation, will magically cure the pension pandemic and ease global pension tension.

While some pension experts advise governments to do nothing on pensions, I advise them to have a global pension summit as soon as possible and figure out ways to bolster retirement plans all over the world before it's too late.


The Independent reports that a group of pensioners has been accused of kidnapping and torturing a financial adviser who lost over €2m of their savings:

The pensioners, nicknamed the "Geritol Gang" by police after an arthritis drug, face up to 15 years in jail if found guilty of subjecting German-American James Amburn to the alleged four-day ordeal.

Two of them are said to have hit him with a Zimmer frame outside his home in Speyer, western Germany, before he was driven 300 miles to a home on the shores of a lake in Bavaria.

Mr Amburn (56) says he was burned with cigarettes, beaten, had ribs broken, was hit with a chair leg and chained up "like an animal".

The incident began on Tuesday last week after Mr Amburn, the head of an investment firm called Digitalglobalnet, was allegedly attacked by two men aged 74 and 60.

Another couple, retired doctors aged 63 and 66, later arrived to join in the alleged torture.

"I was struck. Again and again they threatened to kill me. The fear of death was indescribable," he said.

He told them he could pay them back if he sold some securities in Switzerland and they agreed to let him send a fax to a bank there.

He scribbled a plea for help on the fax. Armed commandos stormed the house on Saturday.

Is this an omen of what lies ahead? Let's hope not.

Monday, June 22, 2009

The Summer Pullback?

A surprisingly bleak forecast for the world economy pushed stocks to their biggest loss in two months.

Major stock indexes tumbled by more than 2 percent Monday, sending the Dow Jones industrial average down 201 points, after the World Bank estimated the global economy will shrink 2.9 percent in 2009. It previously predicted a 1.7 percent contraction.

The grim assessment was the latest unwelcome surprise for the market since last month and further eroded hopes that the economy was starting to emerge from recession. Investors began driving stocks sharply higher in early March, encouraged by modest improvements in housing, manufacturing and even unemployment.

The dampened economic outlook from the World Bank, a global lender based in Washington, also weighed on the prices of oil, metals, and other commodities. Those price drops in turn sent energy and metal producers' shares falling.

Hugh Johnson, chief investment officer of Johnson Illington Advisors, said the downbeat economic prediction confirmed fears that have been building in the market for two weeks.

"The forecast by the World Bank just dramatized that the market may have overstated what's coming for the economy," he said.

The stock market is coming off its first weekly loss in more than a month after mixed economic readings last week.

Investors have gone from enjoying a string of better-than-expected economic data to trying to manage a list of worries about the economy. Stocks have lost ground several times in the last month on fears that rising interest rates and inflation would upend an economic recovery.

Many analysts also say the relief that erupted in early March about the economy then led to outsize expectations for how quickly a recovery could occur. Other economic news has hit stocks since May. A disappointing government report last month on retail sales suggested the economy remained fragile, and the Federal Reserve reined in its expectations for how the economy will fare this year.

There were no major economic reports Monday, but traders will get data this week on new and existing home sales, durable goods orders, gross domestic product and personal incomes and spending.

The Federal Reserve also will be in the spotlight after its two-day meeting on monetary policy ends Wednesday. The central bank is widely expected to hold its key funds rate steady near zero, but investors want to know whether policymakers will say the economy is recovering or still in need of aid.

The Dow fell 200.72, or 2.4 percent, to 8,339.01, its lowest finish since May 27. It was the biggest drop for the blue chips since losing 290 points, or 3.6 percent, on April 20 as investors worried about the soundness of bank balance sheets.

The Dow has fallen for five of the last six days and remains down for June.

The Standard & Poor's 500 index fell 28.19, or 3.1 percent, to 893.04, also leaving the index with its biggest slide since April 20 and erasing its advance for the year. The Nasdaq composite index fell 61.28, or 3.4 percent, to 1,766.19.

After Monday's drop and a 3 percent slide last week, the Dow is down 5 percent for the year. The Nasdaq, however, remains up by 12 percent in 2009.

The market is selling off on the uncertainty of what lies ahead, said David Kotok, chairman and chief investment officer of Cumberland Advisors.

"The picture's not clear. You've got a market that's acting just that way," Kotok said.

Bond prices jumped Monday, pushing yields down, as the drop in stocks drove demand for the safety of government debt. The yield on the benchmark 10-year Treasury note sank to 3.69 percent from 3.78 percent late Friday.

So what was the big deal about the World Bank forecast? After all, Yves Smith notes that the forecast was cut in mid-June so why did markets take notice now?

One of my buddies sent me an article, Insiders exit shares at fastest pace in 2 years as market rises:

Executives at US companies are taking advantage of the biggest stock-market rally in 71 years to sell their shares at the fastest pace since credit markets started to seize up two years ago.

Insiders of Standard & Poor's 500 Index companies were net sellers for 14 straight weeks as the gauge rose 36 per cent, data compiled by InsiderScore.com show. Amgen Inc. Chairman and Chief Executive Officer Kevin Sharer and five other officials sold $US8.2 million of stock. Christopher Donahue, the CEO of Federated Investors Inc., and his brother, Chief Financial Officer Thomas Donahue, offered the most in three years.

Sales by CEOs, directors and senior officers have accelerated to the highest level since June 2007, two months before credit markets froze, as the S&P 500 rebounded from its 12-year low in March. The increase is making investors more skittish because executives presumably have the best information about their companies' prospects.

"If insiders are selling into the rally, that shows they don't expect their business to be able to support current stock- price levels," said Joseph Keating, the chief investment officer of Raleigh, North Carolina-based RBC Bank, the unit of Royal Bank of Canada that oversees $US33 billion in client assets. "They're taking advantage of this bounce and selling into it."

I always track insider selling activity but the truth is that very few insiders are good market timers. Most are horrible market timers and often sell at the worst possible time, so I wouldn't read too much into this.

There are no shortage of bears out there. Charles Nenner of the Charles Nenner Research Center uses some unorthodox methods to predict the markets. The former market-timing consultant at Goldman Sachs has made some stellar calls, including:

  • Forecasting a Dow peak of 14,500 in the summer of 2006.
  • Calling the market top in October 2007.
  • Forecasting in late 2007 a “deflation scare” would occur in 2008, something he says isn’t over yet.
  • In February 2009, predicted a major rally would start “in a few weeks” and could take the S&P as high as 1000.

So what is he saying now? After some short-term gains to coincide with month-end window dressing, Nenner predicts the stock market will turn south, possibly sharply.

“I’m still worried we could test the lows,” he says, suggesting a break of S&P 850 would make that grim outcome a near certainty.

Check the accompanying video for more on Nenner’s analysis, including some insights on how he uses the past to predict the future.

I exchanged some thoughts with Martin Roberge, Portfolio Strategist and Quantitative Analyst at Dundee Capital Markets to get his views on the pullback. Martin told me that he was not too concerned about today's selloff but the volatility is keeping investors on the sidelines longer. He was disappointed with the poor performance of Canadian stocks on Monday.

He added that he expects stocks to rebound from here but he warned me "stocks are driven by technicians and this is bad because technicians are bearish".

In a recent research report, Martin notes the following:

In our recent monthly strategy wires, we argued that equity markets were behaving no differently than following other bad years for equities, in which there is a clear pattern for the stock market to bottom in the first quarter and stage powerful bear-market rallies in Q2-Q3. Exhibit 1 provides an update as to how we are tracking this pattern so far. Needless to say, the ongoing consolidation is not unusual at this stage in the rally. Importantly, this post-equity crash pattern reveals that there could be important performance-chasing activities over the next few weeks, especially if the S&P 500 manages to stay above 900, the high-water-mark for the year.

That said, while Exhibit 1 (click on chart above) suggests that equity bears could be fooled again by end-of-quarter buying forces, it also shows that the equity market advance since March lows could hit a brick wall in July-August. This perspective is among factors that have led us to reduce our overweight equity exposure last month. Also, our next monthly strategy update will shed more light as to why the 4-month market recovery may not represent the beginning of a new bull market. The crux of our argument revolves around the competitive return offered by real corporate bond yields above 5%.

Bottom line. The post equity-crash pattern suggests that fears of a market breakdown are premature. Equities should be re-energized by end-of-quarter buying forces and performance-chasing activities. History suggests that the back half of Q3/09 is likely to be more challenging.

While I agree that the second half of the year will be tougher than the first half of the year, I still feel that there is a lot of performance anxiety among the bigger funds and these dips will be bought. I am watching the 50-day and 200-day moving averages on the major indexes and how we will close this week.

You should also note that the U.S. Securities and Exchange Commission may force investors to disclose derivative stakes in companies, a step that would make it difficult for hedge funds to accumulate equity-swap positions without tipping off targets. This rule will make it harder for hedgies to short this market.

Can we retest the March lows? Sure, why not? But there is a fundamental difference now compared to March or November of last year.

Importantly, all financial stress indicators are nowhere near where they were back then. This does not mean that I don't have concerns going forward.

Jean-René Guilbault, a former colleague of mine at PSP Investments who worked in real estate, sent me an article on where U.S. housing will be in 2012. He added these observations:

Key Points: US House prices might drop by 16% this year... with recovery in 2012... Surpassing Bank's stress test worse case.

Opinion: There is a saying: "When Real Estate (RE) construction goes well the whole economy goes well." But the RE construction cannot go well if there is tons of residential properties on the market without any buyers and a high unemployment rate that brings in low consumption. This makes me rephrase the previous words of wisdom to the following: "When the US residential market will do well the whole US economy will be on the recovery."... with this observation and based on the article in reference, we could believe that nothing will be on the up side in the US economy until mid-2010...

[Leo's note to traders: If you want to play the short side of real estate, trade the Ultrashort Real Estate Proshares (SRS). If you think financials are going to get clobbered, then trade the Ultrashort Financials Proshares (SKF).]

Another former colleague of mine at the Caisse, Luc Vallée, wrote this comment on green shoots in his blog a couple of days ago:

People are seeing green shoots everywhere these days. In the economy and now in Iran; it is spring after all. Yet I believe that all these green shoots still remain only wishful thinking. I am not counting on them to reach anything remotely close to full bloom anytime soon but, as a market observer, I am definitively keeping an eye on both buds to manage my risks. I can’t deny that they have long term potential to flourish and that they may evolve in unexpected ways in the short term.

What is most relevant for now is that the risks of these events are not similarly accounted for in the markets today. The “risk” of a quick economic recovery is probably more than fully priced in the U.S. stock market. Given that it is still a low probability event for 2009, the current rally could thus be short-lived.

On the other hand, the risk of another Iranian revolution that would, for instance, topple the clerics and replace the regime by moderates (admittedly a lower probability event and a much more difficult one to play) has not had any discernable or significant impact on the markets yet. Part of the difficulty for market participants resides in evaluating the probability of such an event and judging whether such a revolution would bring more stability or more unrest to the region.

The potential for more instability in the short-term is real if current demonstrations can gather steam. The most likely scenario for now is the status quo. I expect Moussavi’s supporters to gradually go home quietly within the next few weeks. Yet the potential for a significant market event is still very much a reality and represents a risk that has not been priced by the markets. In other words, markets are still treating the recent demonstrations as non-significant.

This could be because market participants are not falling for the media hype about the events in Iran. The “media hype” scenario has some merit. By this I mean that it is possible that many of us are making a big deal out of the events in Iran just because of the Western media’s reaction to them. Here are my thoughts on the issue. One the things that struck me during the last couple of days is that the US media is still very much in a pre-emptive strike mood. They see it as an american responsibility to support the opposition in Iran.

In other words, they are not only wishing for democracy and freedom in Iran, they are also wishing for action on the part of the U.S. government. Read Charles Krauthammer in the Washington Post to see what I mean. Although not everyone is as radical as Krauthammer in calling for Obama’s support of Moussavi, the wishes of many journalists are that Obama should “do something”. Even the Democrats are at it. Bill Maher is starting to take jabs at the President for not acting with more audacity and Thomas Friedman, in subtle ways, is wishing that "our social networks" are going to do the job of toppling the Mullahs.

Haven't we learned that unexpected consequences are the lights that we perceive at the end of the fog of war tunnel? Mirages do not exist in the desert. They exist in our mind. They are the product of tricks played by nature on our mind. They can also be the result of tricks ideological constructs play on our values: We hope and foresee democracy and freedom in the Middle East but we get war and death once we reach destination.

Hubris and hopes are not so distant from one another. The making of one or the other is often determined by the wisdom (and luck) of those who lead us. This is the dilemma we are in right now. I thus understand President Obama's reluctance to get involve in Iranian affairs, in yet another crisis or to provoke or accelerate its occurrence. It’s not that he has already so much on his plate right now but what would be the consequences of his intervention? This is, without a doubt, a question that weights heavily on his temptation to get involved. But isn't this why we elected him? To change the world? Isn't he the one with the wisdom? the good ideas?

George Bush had no wisdom, no good ideas and was not intellectually curious according to his detractors. He was hubris; even if to his supporters, he was just plainly unlucky. If he could only have found these WMD, if only Katrina had struck under Obama, if only the financial crisis could have waited just a few more years to unfold, etc.

But Obama? He is hope. He has the audacity of hope, not the arrogance of hubris. Yet, assuming Obama has the wisdom, he would still need to be lucky to pull this one off. And maybe he has enough wisdom to know that. I don’t know. All I know is that it is possible that our hopes (or hubris for that matter) for democracy and freedom in Iran are not in line with the reality on the ground in that country. And that the most likely scenario I alluded to above is the only scenario ... at least for now!

This could explain why the markets haven’t budged. Sometimes markets know better; but sometimes not. The risks appear to be real. Have a look at videos 8, 9 and 10. It’s definitively a story to follow.

Geopolitical tensions in Iran can easily degenerate from here. But a terrible situation does not have to degenerate further. Fareed Zakaria sat down with former National Security advisor Zbigniew Brzezinski to discuss the Iran election crisis. I urge you to carefully listen to his comments.

Where will the markets head in the months ahead? I am watching to see if the dips will be bought and I remain cautiously optimistic that despite all the bad news, equities will continue to grind higher.