Fidelity: 401(k) and IRA Balances Hit Record Highs

Earlier today, CNBC posted a report with the above title on their website.  The article referenced a new report of Fidelity Investments that claimed that 401(k) and IRA balances hit record highs in the first quarter of 2015, with the average balance now standing at $91,800.  Now, the article doesn't exactly identify what constitutes the "average", whether this is intended to be the median balance of accounts at Fidelity or just the simple arithmetic mean.  Either way, it doesn't quite square with other research, including data of the Federal Reserve.

Tracking just how much individuals have saved in IRA and 401k accounts is tricky business, due to the various measures used to report the data.  Many sources, including brokerage firms and mutual fund companies report their data as a simple arithmetic mean: they add up the total balances in all IRA and 401k accounts they manage and divide by the number of people holding those accounts.  Thus, the estimated $102 million that Mitt Romney is believed to hold in his IRA is averaged in with the $15,000 of the average middle class household.  It’s just not a meaningful number.

No slight to Mr. Romney’s contribution to America’s retirement savings, but for the data to be reported in a way that is of any value in understanding the current retirement crisis, the “average” balance needs to be calculated on the basis of the median.  To do this, of course, you simply line up all the account balances at a place like Fidelity from smallest to largest, and find the account in the precise middle by value, with exactly fifty percent of accounts holding greater balances and fifty percent holding lesser.  This would only tell you, of course, what the average balance is of investors who hold accounts at Fidelity (and, therefore, not representative of the average American) but it’s certainly more realistic than reporting an arithmetic mean.

While the median value of retirement assets has risen in recent years, according to recent data of the Federal Reserve Bank the portion of respondents who even owned a retirement account of any sort fell to less than half, continuing a downward trend that began in 2007.  For those who are fortunate enough to have a 401k account, even with recent record gains in stock prices, the median balance of 401k/IRA accounts was just $59,000 at the end of 2013.  At a four percent recommended annual spending rate in retirement, an account of this size would produce (pre-tax) retirement income of less than $200 per month, or less than the average American family spends on groceries each week. 

UST Negative Yields

Sounds crazy, doesn't it? The idea that the US Treasury, or any government could be paid to borrow money is contrary to everything we've learned about finance and the time value of money. Yet, strange as it sounds, there are now 17 countries whose sovereign debt trade at negative yields, including Austria, Belgium, Denmark, Finland, France...well, you get the idea. Even 2-year sovereign debt of the Czech republic traded in negative yields this week.

As of this writing, the German 2-year bond is yielding -0.27%, while the 5-year was at - 0.11%. This means that an investor will accept -0.27% less of his principal investment back each year for the next two years, for the privilege of keeping money parked with the German government . When Swiss yields dropped below zero, everyone rolled their eyes, but reconciled the silliness with the idea that this was Switzerland where wealthy foreign investors, for reasons of safety, have stashed large sums of cash  for generations. Swiss government bond yields are now negative out to ten years.

But yesterday's crossing of Japanese bond yields into negative space, has us really scratching our heads. After all, there as many highly informed, highly educated investors who believe that Japan's fiscal woes are unsolvable, as not. If repayment is in question, then how are investors being compensated for risk?

The question is, what's happened to credit spreads; the idea that each borrower's debt yield "spreads" to some "risk free" rate of interest, based upon credit-worthiness? With US credit ratings previously in question, the risk free rate has more recently shifted to Germany. And with the ECB now buying bonds of european central governments, many of these nations' debts are showing negative yields.

Bill Gross, the legendary bond king came out last week and argued that the German 10-year, currently at 0.16% is the short of a lifetime. Meaning, those investors betting that German yields will rise (and therefore the price will decline) stand to be handsomely rewarded. Far be it for us to disagree with any bond royalty, but in this case maybe not so fast.

What's far more interesting is the credit spread of the 10- UST to German bond, with UST now yielding 1.80% over the Bund (http://www.investing.com/rates-bonds/government-bond-spreads). By the way, if you're looking for something more juicy, take a look at the Brazillian 10-year, now yielding 12.60%. Wasn't it just a few years ago that all the talk was about the BRICs? Now, the Russian 10-year is at 11.20%, India at 7.66% and what did the "C" stand for again?

Getting back to the point. While German 10-year yields may be unsustainable at this level, shorting the Bund is a dangerous proposition. Remember John Maynard Keynes adage, "markets can stay irrational longer than you can stay solvent". The more interesting trade is the US 10-year, now yielding a 25-year high relative to the Bund (ideally, you'd want to short the Bund and go long UST to play this trade, but a simple long position might be worth considering). 

It's also interesting to consider what could cause this credit spread to widen. Negative economic news in the US? While theoretically, bad economic news should widen a spread to the risk free rate, such news would also cause interest rates more generally to decline (due to lower inflation risk) thereby improving the long trade. And good news? This might cause rates to rise, but in a compressed fashion by a tighter spread to the Bund. Thus, the ECB is effectively anchoring the yield of most developed world debt. This all suggests that the most likely scenario is that credit spreads narrow over time, lowering UST yields and boosting prices. Safer to be long the UST 10-year, than short the Bund.

As to the Fed and raising rates, we think the Fed is in a box for quite some time, the subject of a future post.

California Pension Crisis 5.0

We found this news story from a couple of weeks back quite startling.  Organized and supported by public employee labor unions, protestors picked up signs and marched out front the Sterling Hotel in Sacramento, while chanting anti-Wall Street themes.  This activity was all part of an effort to express their opposition to a forum being held inside the hotel by the Reason Foundation to explore possible solutions to the public employee pension crisis in California http://www.sacbee.com/news/politics-government/the-state-worker/article18192998.html. Now, we support first amendment rights in all instances, including this one, but the themes of the protest are quite curious.  

It has us thinking about a much broader issue that has crept its way into American politics and business, as well, for that matter.  I like to refer to it as "a thumb on the scale".  The ideom refers to the practice of unethical butchers in days (hopefully) long gone, of slipping a thumb onto a scale used to weigh a customer's purchase to inflate the price.  Scales for weighing meat and other products are now more commonly in plain view, and we'd like to believe used by a new breed for whom such open customer display is not even necessary.

But the practice has more general application to those in the worlds of business and politics who, in an all consuming desire to succeed, might be willing to cheat ever so slightly to out-maneuver an unsuspecting customer, opponent or audience.  We're not implying anything outrageous, illegal or even overtly unethical, after all, influencing outcomes is in part what political campaigns and marketing efforts are designed to do.

The practice of "spinning" news for political gain crept into the common vernacular in the 1990s. The idea was to reinterpret the news for the viewer to bias the viewer's perception.  Before long newscasters on the nightly news were referring to political aids as "spin doctors" (not to be confused with the highly talented musical act of the same name).  In short span, America had managed to legitimize an activity of highly suspect intent.

So what does all of this have to do with a union organized protest in Sacramento?  Perhaps this photo is a good place to start.  These protestors are voicing their opposition to efforts under discussion in California that could, in their estimation, limit pension benefits to which they are entitled by virtue of their employment by public agencies.

But it's the sign being held up that caught our attention.  The sign reads "Good for Wall Street...Bad for the Rest of Us" and in so doing characterizes efforts to limit public employee benefits as being initiated by or inuring to the betterment of Wall Street.  On the face of it, you might be wondering what in the heck Wall Street has to do with any efforts to limit public employee pension benefits. And in this instance at least, closer inspection will not cause the argument to make any more sense.

The argument, awkwardly put forward by the labor unions - and to which this poor soul holding up the sign may actually be convinced - is that Californians are somehow faced with a choice.  Either favor the interests of hard working school teachers, police officers and firefighters, or do something that would benefit those evil, greedy demons on Wall Street.  But now the reasonable person might ask, how are these two unlikely groups even remotely connected?

If I'm following their argument correctly, and I admit it's a bit of twisted logic, I'm guessing it has to do with the bankruptcy case of the City of Stockton.  You see the city, faced with insurmountable debts to the CalPERS pension system, bondholders and other creditors, was forced to file for bankruptcy in 2012.  Despite the Judge in the case opining that the obligations to all creditors, including CalPERS could be amended by the bankruptcy process, the city, in its reorganization plan chose not to do so.  That is, the city chose to fulfill its obligations to its pension system in full, but renege on its promises to repay bondholders who had lent the city money for a variety of public purposes.  Now call me old fashioned if you like, but my Dad taught me that if someone lends you money, you have an obligation to repay it.  In full.

One of the purposes for which the city borrowed money, was for building a new fire station.  One of the investors in those bonds was Franklin Advisors, who purchased $35 million of the city's bonds back in 2009, long before any talk of bankruptcy.  It deposited those bonds into two of its municipal bond funds.  Per the bankruptcy plan, now approved by the courts, however, Franklin will be paid 12 cents on the dollar that it invested, leaving its fund with a $30 million loss on its investment.

Now, I guess this is where Wall Street must come in.  Apparently, Franklin and other investors who lent the city money for vital public projects must be considered by the unions "Wall Street" firms, even though Franklin is located in San Mateo, California and runs mutual funds that invest in municipal bonds, and whose shareholders are retirees and other ordinary citizens.  But, then again, public sentiment is decidedly against Wall Street.  

Now here's where the thumb gets slipped on the scale.  The union organizers or public sector employees who printed this sign must clearly know that.  To not, would be ignorant.  Let's assume, as is likely the case, that it's the former.  So, knowing quite well that private individuals like you and me might be investors in these Franklin funds, and would suffer losses from Stockton's failure to repay its promised obligations, why in the world would the unions represent otherwise?  Could it be that if the interests of public pensioners were pitted against those of ordinary citizens, it might be more of a fair and reasonable fight?  And who wants that anymore.  I mean, when it's just so tempting to tip the scales.