There was not too much excitement happening with our stock picks today.
Not surprisingly we continue to get mixed signals. Bad news from Spain. But Caterpillar earnings way up.
A lot is riding on the slow recovery in the U.S. housing market. With higher house starts comes lower unemployment. And higher house prices help the banks as well. Rumors of the-end-of-the-financial-world-as-we-know-it continue to be greatly exaggerated.
10 year bond yields in the U.S. are at 1.41%, so let’s see that’s a 70 year payback at that rate. Count me out. Anyone who can’t find a better expected return than that is not trying very hard.
A comment on Pensions…
These low bond yields could be the final nail in the coffins of many defined benefit pension plans. Hopefully this is the darkest hour before the dawn of higher rates. Even government plans are going to have think about closing the plans to new employees. And giving people the right to walk away with commuted values based on these low rates is becoming just too generous.
The Alberta government employee pension plan has seen its contribution rates more than double since 2001. In 2001 it was 4.675% of wages up to the Canada pension maximum (then $39,100 per year ) and 6.55% above that. It has risen sharply since then and in 2013 is set to go to 11.7% up to the Canada pension maximum (now $50,100 per year) and 16.72% above that. So quite a bit more than doubled.
The Alberta government matches these “employee” contributions. (And really the government pays both sides since it pays the employee’s wages). These are staggeringly large pension contributions. It’s driven by an assumption interest rates will stay low. The Alberta government plan uses a discount rate of 6.35% which was as of December 31, 2011. If they did it today the rate would be a good bit lower and increase the pension deficit even further. The current deficit is estimated at 23% on a going concern basis. A large chunk of the current contributions are to make up for a belated realization that past contributions were too low.
Non-government pension plans have to use discount rates that are even lower, they must use government bonds wile government plans are allowed to use corporate bond yields. Canadian National Railways for example used a discount rate of 4.84%.
If pension plans were allowed to discount the liability at the expected return on assets rate their “deficits” in many cases would turn into surplus. This would not be as conservative, but to my mind would be more accurate. Why should C.N. calculate it’s pension deficit on the basis that it would invest ALL the funds in bonds at 4.84% when in fact it expects to make 7.5% on assets? Now you can argue that 7.5% is too optimistic but to me the deficit should be calculated on some best estimate of the expected return on assets not some nonsense about investing ALL the money in bonds.
If rates are as low or lower at the end of 2012 as they are now, then pension deficits calculated on bond yields are going to be even more eye-popping. And contribution rates will have to rise once again.
This hit to government finances never seems to make the news. At some point it will. And while Alberta can handle this, what about Ontario, other provinces and the Federal government? It’s truly becoming unsustainable.
The whole notion of pensions starts to break down if have a model of working 35 years and being retired for 30 years. If pension returns are so low that one-third of wages needs to be set aside (Alberta is close to that) then something has to give. Either pension returns have to be higher or the retirement age has to increase a lot. Freedom 75 anyone?
Those in retirement now or close to it should be thankful that they can get their pensions before the retirement age rises.
And it may not be implausible that the government could simply make an arbitrary change to some of its pension plans. If features like unreduced pensions at age 55 were taken away, or phased out, the public would support that. Government workers would howl.