The Fed is concerned that the economy, jobs and the price of housing are not moving fast enough in the upward direction. The Fed is thinking about spending more money to buy longer date Treasury bonds in hopes of driving interest rates down. They already have the short end of the yield curve close to zero and they feel that if they can bring down longer term interest rates they can spur the economy. Part of the logic is that lower interest rates will force people to buy stocks, houses and inspire companies to hire more people and therefore, in turn, make the economy grow. People who need fixed income investments to supplement their social security and pension will find their total income decline. With interest rates low at the short end of the yield curve people were forced to go out further on the duration curve to try and get yield. If the Fed is successful, through its purchases, in driving longer-term interest rates down then people will find their income dropping even further.
As one client pointed out to me recently, the money I have for him in growth mutual funds has gone up and of course has gone down, but in the interim they have not paid a lot in dividends. He said to me “I guess I’m not getting paid enough to take the risk in common stock.” We spent some time talking about what are reasonable expectations for returns going forward.
Before I talk about future expected returns I want to apprise you of two things that could happen in the next 30 days that could have significant impact on future investments. The trustees of the Social Security Trust fund have given indications that there will be no cost of living adjustment for beneficiaries in 2011. That would mean that beneficiaries will have had no adjustment for the last 2 years. Secondly, the Presidential Commission on Tax Policy which is charged with reducing the deficit is due to release it’s report with recommendations to the President by December 1, 2010. The commission has sent up three trial balloons.
In the past I have told clients that I expect, over a 5-year period of time, to earn between 6% and 8% after fees and expenses. Based on what I see at the moment I have to ratchet down the expected returns to 4% to 6% return. Public and private pension funds will have to reduce their expected returns from 8% perhaps to 6% or less. Lower expected returns will strain the balance sheets and I see the only possibilities are reduction of existing benefits and retirees paying a larger share of post retirement healthcare. PIMCO the largest bond manager in the world has created a new phrase called the, “New Normal”. They believe “New Normal” will be lower growth, higher unemployment and low inflation.
I have said many times before in this Blog that I believe we are in for a Japanese type of recovery much like what PIMCO is projecting. If we are correct then return expectations have to come down. The real question is how low is low enough?