William John Market Report 23-12-21
US pension funds look to de-risk as they pour hundreds of billions into fixed income. William John assesses.
WilliamJohn, PensionFunds, AssetManagement, Markets, Bonds, FixedIncome
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William John Market Report 23-12-21

William John Market Report 23-12-21

Category: Reports

In 2021, US pension funds have invested hundreds of billions of dollars into bonds avoiding the expensive and riskier equity markets in the process. Large cap equities in major Western markets are all trading at record highs or close to record highs in aggregate, judging from the record performances of the indexes that measure them including the S&P 500, FTSE 100 and STOXX 600.

Consequently, equities have become relatively expensive in contrast to other traditional asset classes such as Fixed-Income and Real Estate for example. Looking at the cyclically adjusted price earnings (CAPE) of large cap US stocks indexed in the S&P 500 from 1920 to 2021:

Source: William John Analytics, Robert Shiller, Yale University

The CAPE uses real (inflation-adjusted) earnings per share adjusted over a 10-year (cyclical) period to smooth out fluctuations in corporate profits. It relates large cap stock prices to their underlying earnings and as such is a broad measure of how valuable US equities are, i.e., how under or overvalued they are; with a higher CAPE ratio indicating that equities are more overvalued relative to preceding periods. 

Currently, the CAPE for the S&P 500 stands at 38.3x earnings. This is substantially higher than the Wall Street crash of 1929 aka “Black Tuesday” as well as higher than prior to the Financial Crisis in 2007. It is approaching its highest level on record prior to the dotcom bubble bursting in late 2000. This measure alone demonstrates how overvalued equities are and provides robust evidence as to why US pension funds are seeking alternative asset classes to invest their billions. 

According to pension advisory firm Milliman, since the start of 2020 the average funded ratio, that is, the average value of a fund’s assets divided by the value of its promised lifetime income benefits, of the 100 largest corporate plans in the US has jumped from 88% to 98% – almost all these pension plans are fully funded. Furthermore, the firm estimates that the average funded ratio of these pension plans is on track to pass 100% for the first time since the Financial Crisis. 

The observed “de-risking” of pension fund portfolios since the outbreak of the COVID-19 pandemic and subsequent massive investment in investment grade bonds, which is estimated to represent 10% of the $3 trillion-dollar corporate pension fund industry according to the Financial Times, is likely to push down bond yields even further and sent their prices skyrocketing. 

The industry wide trend is viewed by analysts as a pairing of liabilities – long term maturity assets to the long-term income needs of their clients. Whether or not portfolio de-risking is the right opportunity in the current moment, fixed income has emerged as the asset class of choice for pension funds and given they are on track to become fully funded for the first time since the Financial Crisis, it represents a major milestone for both the industry as a whole and for the employees enrolled in their plans. 

Any opinions expressed in these documents are those of William John and are provided for information only. E&OE.