Why pension losses are likely to be worse than we think after a terrifying year in global markets

Even before the market fire broke out last week, the scene looked ugly.

While it may come as a shock to many, pension balances — which swelled last year during the worst recession in more than a century — actually tumbled into the red late last month as the fiscal year drew to a close.

After pulling off the oomph last week of rising interest rates, turmoil in global stock markets has turned this grim prospect into a grim reality.

It’s best now to mentally prepare for a big drop in retirement savings when the June 30th statement hits your inbox.

Even those who erred on the side of caution — with a more conservative retirement option — are likely to see a significant decline. The only people who will be saved are those who have the foresight – or good fortune – to turn to cash at the start of the year.

Until last week, it somehow appeared that global monetary authorities had engineered a major downturn in financial markets – without that usually accompanied by panic and desperation.

Image of Australian dollar coins stacked on top of the note coin
Australia’s ability to avoid heavy losses on Wall Street appears to be over.(AAP: Joel Carrett )

no more. Financial markets are in a state of despair and – unlike previous downturns – there seems to be nowhere to hide. Everything has been falling off lately. This has made life very difficult for investors, both home and professional alike.

It is likely to continue. After more than 30 years of low interest rates and minimal inflation, the world appears poised to enter a new era – or perhaps a return to an old one – of slow growth, spiraling costs and more expensive capital.

It is a world that many investors have not experienced before.

Australia has been off the world stage this year. While Wall Street has been dropping since January, soaring commodity prices — thanks to Vladimir Putin’s war on Ukraine — have kept financial market news off the front pages here.

Until now.

Why were we in the red before this?

After Australians bathed en masse in the waters of the global financial crisis, our large pension funds have reviewed their investment strategies.

Most of them discovered that they had a lot of investment in Australian stocks, and that their portfolios were closely related to the local stock market.

Therefore, they have diversified into offshore stocks, property, infrastructure, bonds and other alternative assets in an effort to reduce the volatility of your fund’s performance.

The idea was that if the bottom came from one asset class, it should be offset by another well-performing class.

Two hands holding a piggy bank filled with coins.
The re-emergence of inflation meant that wages did not have the same purchasing power.(Unsplash: Rawpixel)

Even after this reorganization, a regular balanced fund will occupy about 20 percent of your savings invested in the local market. Fortunately, this bias was working well until April because our stock market was shrugging off global problems.

However, most other assets have performed rather poorly, and unusually, all at once. The sudden appearance of inflation – and the surge in interest rates by central bankers to tame it – temporarily negated the theory about diversification. And now, local stocks have joined the plunge.

International stocks, which make up about 30 percent of most pension portfolios, have been on the decline since Christmas.

If you were surprised by the sudden drop in our market last week – which helped bring down 15 per cent from the peak in April – consider this one.

Wall Street has fallen 23 percent since January. The high-tech Nasdaq, which has led the stellar performance on Wall Street for more than a decade, is down 32 percent.

As for cryptocurrencies, well, don’t go there. At last glance, the entire market was in disarray, with total losses now at more than 70 percent from their peak.

Bonds be more of Alan than James

This may come as a shock, but the driving force behind all investments is not the stock market.

It’s the bond markets.

Basically, bonds are IOUs. Both governments and companies issue it when they raise debt, usually with a promise of a fixed interest or coupon rate for a certain period of time, say 10 years. Once released, they are traded on open markets dwarfing stock markets.

A trader looks at financial information on computer screens in the IG Index on the London trading floor
US bonds have fallen by an unprecedented 12 per cent in the past year.(Reuters: Simon Dawson)

Colossal trillions of dollars are invested in it, and the sheer weight of that money makes it the foundation, the solid foundation that dictates performance in everything, from interest rates to property, stocks, and currencies.

In fact, Bill Clinton’s adviser, James Carville – the man who famously coined the phrase “It’s the economy, stupid” – is famous for this line: “I used to think, if there had been reincarnation, I’d want to come back as president or pope. But now I want to be a bond market Because you can scare everyone.”

Last year was really scary. It was the worst year ever for US government bonds, with losses of 12 percent. To put that in context, 1984 was the second worst year, when they lost 2.9 percent.

Since governments rarely default, bonds are considered risk-free. That is why they attract so much money and so much attention.

Over the past 40 years, as interest rates have fallen, it has made huge gains. However, being risk free does not mean that you cannot lose money on it as many top professional fund managers have suddenly discovered.

There is an inverse relationship between interest rates and bond prices. If gamblers think rates will go down, they raise bond prices. And this has been a one-way bet for more than 40 years.

But suddenly, everything turned backwards.

Once in a half-century storm for US bonds

Chart showing the rise in US bonds from 1978 to 2020

So what should we do with you?

You have US bonds in your retirement fund portfolio. In any balanced fund, about 10 percent of your savings are in what are known as fixed-interest investments.

Because they are – or at least considered – relatively safe, there are fewer of them in higher-risk options such as growth funds.

But, if you choose safer alternatives like a fixed or conservative option, about a quarter of your investment is in bonds…that have been shaken and moved.

So, where to now?

Ask five different economists and you will get 10 different answers. On the one hand …

However, it is difficult to see any rapid recovery in the market any time soon. The surge in stock prices that followed the February 2020 crash came because central banks, led by the US Federal Reserve, not only cut interest rates to zero, but also printed money as if there was no tomorrow.

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