Pension Deficit Overreaction?

Bruised and battered at the start of 2009, Wall Street looks ahead to the inauguration of Barack Obama as president with hopes the new administration can tackle the global economic crisis:
The markets, which open trade on inauguration day after the Martin Luther King holiday on Monday, will see a light week for economic data but potentially market-moving earnings.

The earnings reports will be the latest to show the horrific impact of the economic slump on the health of the corporate sector, but the change at the White House will be the focal point, say analysts.

"The economic data will take a rare back seat early next week, as eyes turn to the political sea change stateside," said Peter Buchanan, economist at CIBC World Markets.

"Obama's inauguration comes at a time of renewed conviction that governments must incur sizeable fiscal deficits for the time being, to get the world's troubled economies moving again."

Some say the mere fact of change at the White House will be positive.

"No matter how one feels about President (George W) Bush, most Americans are pleased to see him go and Obama to arrive," said Al Goldman, chief market strategist at Wachovia Securities. "This could provide an emotional uplift."

The market will be eager for any news to help lift it out of its funk, following a rocky week.

Stocks were roiled by news of dismal retail sales, more heavy losses in the banking sector and price declines that suggest a potentially dangerous period of deflation.

In the week to Friday, the Dow Jones Industrial Average slid 8.34 per cent to end at 8,281.22.

The technology-heavy Nasdaq shed 2.69 per cent to 1,529.33 over the week and the broad-market Standard & Poor's 500 dropped 4.52 per cent to 850.12.

While Obama's inauguration as 44th president may lift spirits, some analysts argue that it will do little in the near-term to help the market or the economy.

"The inauguration is coming up soon and it can't come soon enough for those who believe that once we change administrations, pump in a few dollars through a stimulus package, poof, all our problems will go away," said Kevin Giddis, analyst at Morgan Keegan.

"Wake up, Alice. Wonderland is the other direction."

But Joel Naroff at Naroff Economic Advisers said the nation's economic woes were at least in part because of depressed sentiment among both consumers and businesses, which could get a lift from a change at the White House.

"I believe confidence is a critical factor in turning the panic and depression around," said Naroff.

In the upcoming week, the Obama inauguration will be the key as markets will look to how the new president addresses the economic challenges.

"This historic inauguration will launch a major new direction in the conduct of executive policy on both domestic and international issues," said Nigel Gault and Brian Bethune, economists at IHS Global Insight, in a research note.

"Given the gravity of the domestic economic crisis - and the global recession - the inaugural takes on a symbolic importance on aspirations for the future not seen since the inauguration of Ronald Reagan in 1981."

Also on tap will be earnings reports from key firms including Microsoft, Google and General Electric, which should highlight the challenges facing key companies.

"Investors are still selling the stocks of companies that dramatically miss analysts' estimates but are tolerating those that deliver earnings that are in line with estimates reflecting dramatically lowered guidance from the company," said Fred Dickson at DA Davidson & Co.

"The real test will be how the market reacts to disturbing guidance relative to current quarter revenues and earnings."

The bond market gained on the rush away from equities. The yield on the 10-year Treasury bond fell to 2.304 per cent from 2.407 per cent a week earlier, while the that on the 30-year Treasury dropped to 2.894 per cent against 3.055 per cent.

Bond yields and prices move in opposite directions.

So will there be an Obama rally? Some believe that optimism about Barack Obama's first 100 days as president is running high, but Wall Street's post-inaugural celebration may well be short-lived:

"I think there's going to be something of an Obama honeymoon for a few weeks," said Terry L. Morris, senior equity manager at National Penn Investor Trust. "But I think there's still a lot of pessimism out there about the economy."

Since 1932, stocks, as measured by the S&P 500, have gained an average of 1.6% in the first 100 days of a new president's term regardless of the party. The S&P 500 has gained 0.9% on average under a Republican president and 2.2% under a Democrat like Obama, according to research by Standard & Poor's chief investment strategist Sam Stovall.

While a gain is a gain, a 2.2% rise following a year in which the S&P 500 lost 38% - and saw its worst year since the 1930s - does not suggest the rallying cry of a new bull market.

In fact, Wall Street could very well see the same market reaction that briefly followed both the November election and the start to 2009, said Joe Arnold, wealth manager at Dawson Wealth Management.

"Both times, the optimism had an emotional effect on the stock market for a few days or weeks," said Dawson. "But then the happiness wore off and people returned to the reality that we are still in this crisis and we don't know when it's going to end."

History favors the Democrats: Similar to the first 100 days, stocks tend to perform better for the rest of the year when the Democrats are in power, according to S&P. In the subsequent eight months, stocks on average lose 7.7% under Republicans and gain 4.8% under Democrats going back to 1932.

"Election year history favors a Democratic president, but nothing is certain in this world except death, taxes and volatility - of share prices and emotion," wrote Sam Stovall, S&P's chief investment strategist in a recent note.

He noted that investors tend to approach the periods surrounding a new president's term with optimism, despite a lack of convincing evidence to justify those rose-colored glasses. Although the first 100 days and the full year are positive on average, there have been plenty of exceptions.

In the 19 election years since 1932, stocks only posted full-year gains 60% of the time under Democrats and 55% of the time under Republicans.

Will Obama buck the trend?

The hope surrounding Obama's election has been compared to the hope felt after John F. Kennedy's election in 1960.

For Wall Street, that optimism correlated with higher stock prices. During the first 100 days of JFK's administration, the S&P 500 gained 8.9%. It gained another 9.6% in the rest of the year, according to S&P.

But the stock reaction is likely to be different this time as President-elect Obama faces what many describe as the worst financial crisis since the Great Depression.

Even with an $825 billion stimulus plan being debated in Congress and the likelihood of further capital infusions from the Federal Reserve, the recession isn't expected to be over until late this year or early next.

Also, investors may have already shown their enthusiasm for a new administration and the eventual end to the recession in the recent rallies. As a result, there may not be much of a follow-through this year.

Between the bear market lows of Nov. 20 and Jan. 6 of this year, the S&P 500 gained 24%. Since Jan. 6, the S&P 500 has lost 6%.

Stocks are perhaps due for a bigger bear market rally in the first half, but the outlook is so cloudy it's hard to see what could cause it, said Drew Kanaly, chairman and CEO at Kanaly Trust Company.

"I think a lot of investors are waiting for the new administration to come in," he said. "They want to see what they are going to do first before they start participating more fully in the market."

The pressure on for Obama to head off an even deeper downturn, but one thing is for sure, regardless of what happens in the stock market, pension woes will persist in 2009 and 2010.

Importantly, while the financial meltdown happened on President Bush's watch, the pension meltdown will happen on President Obama's watch.

But hold on a minute. Some are now warning against pension deficit 'over-reaction':

Government, investors and trustees are in danger of over-reacting to growing pensions deficits caused by the economic downturn, the UK's largest employers group warns today.

The CBI says falling share prices have plunged defined benefit final-salary pension schemes £194 billion into the red, less than a year after they were £53bn in surplus.

It adds that the huge deficits are starting to play on investors' minds and that pension trustees could ask for more money up front from firms trying to weather the recession.

The result would be a reduction in business investment, forcing shares even lower.

Firms would than have less money to help survive the downturn, sparking a "vicious circle" of falling shares and growing pension liabilities, the CBI warns.

John Cridland, deputy director general of the CBI, said: "An over-reaction to deficits could be a factor in sending some firms under, and leave the rest struggling for capital at a time when they need it most.

"We urge investors and trustees not to feed the fire. Instead they should step back from these spot valuations, and recognize that the deficits are a snapshot indication that does not reflect the full picture."

Of course trade unions in Britain are having none of that as they and employer groups clash over calls for the government to push pension scheme fund managers to be more responsible with investment.

A statement signed by the TUC, MPs and some members of the pension industry demands clauses be written into investment principles to prevent further damage to the economy.

Brendan Barber, general secretary of the TUC, criticised large pension providers for their contribution to the financial crisis.

"We have seen damage done to the financial system by the unchecked use of complicated products and practices like derivatives and short-selling," said Barber.

"There has been a huge human cost, too, with job losses and millions of people seeing the value of their pension funds plummet."

Terry Rooney, chair of the House of Commons Work and Pensions Select Committee, said the cost was borne by the everyday employee.

"Hard-working people saving for their retirement want to know that their pension funds are being invested responsibly and for the long term," he said.

"People are worried about their jobs and pensions, but their savings can actually have a huge influence. The steps set out in this statement can work in the interest of savers, workers and companies themselves."