Equity investing

Too much risk, not enough reward

Investors are betting that high returns from equities will pay for decent pensions. They are kidding themselves

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To maintain decent pensions it would be best if all those corporations and governments would repay, in full and with interest, all the funds they withdrew when pension funds were in surplus.

Maybe then, pension funds would not be in trouble now.


This is the beautiful effect of shareholder value mantra.
The beautiful era of deregulation and derivatives added every tool
for the corporate executive to fool investors to keep with the earnings growth dictatorship.
Bad growth(off balance sheets bad apples,offshore accounts,derivatives,leverage,tax evasion,outsourcing in cheaper labor countries) on steroids created abnormal return and so abnormal assumption and every tool to deceive
rather than trying to create genuine growth.


More fundamental economic forces are at work here. The stock market is a leading indicator of future growth. Listen to it and it is shouting at the top of its voice that there is not going to be any meaningful growth - at least in the developed world. The absence of growth means that there is a glut of investable savings - far exceeding the needs of those businesses that can invest for growth.

The fundamentals of savings are that savings can only increase (or indeed maintain) their value if the unspent output of early years creates greater output in later years. It no longer does so and so savings must inevitably decline in true value.

This is what a world that has run into the buffers of growth looks like. Get used to it. Western populations are declining. Resources are running out. We are at the end of the logarithmic growth of the past 300 years. Biologists are familiar with the phenomenon. It is not pretty.

Comte Arnau

My rule of thumb: if you work 40 years and want to live off your savings for 20 years at the same level, you need to save one third of what you earn. Any "equity premium" goes to a) inflation; b) your life-long income increase (you tend to earn more in later years); and c) the last years, which tend to be very expensive.

Saving less is asking for trouble.


It's a lose lose game for honest savers. Head the house win you lose, tail the house win you lose. Everyone knows except the central bankers that because of inflation on almost every essential: education, healthcare dental care, rent, nutrition food, energy, daily living needs, you lose on holding cash you lose on your bank deposit to which they don't pay interest plus may charge you banking fee too. You lose holding low return government bonds. You lose in stock markets because you almost always buy in the high sides. The Marketeers, the financiers and the hedge funders are the ones make all the money. They are not only suck up all the profit in your time, they also suck up all future profit of your children grandchildren's time too, if you have any children that is. And then they spray the ground zero with massive debts to cover up the pot holes.

For the honest savers, it's not about making capital gain anymore. It's about how to lose less money and how to protect what you have. You must not borrow if you are not sure you can pay back. You must consume less and less. You must live within your means. The new American dream is how to be a debt free self so that you can feel you are living in the land of free. ;)

Naughty Bits

Another reason why people must move assets into equities or riskier assets is because the Federal Reserve is systematically devaluing the dollar and depressing interests rates. This means that people are forced to seek higher returns in order to simply beat inflation since real interest rates are actually negative now.

This punishes savers and rewards borrowers. But even the equity market is underperforming investor expectations. Thus, we may be living in one of the most precarious economic conditions ever.


You can hand pick a decade to make equities look any way you want. Centuries however are more likely to be instructive. Most pension plans have a longer horizon than ten years.

WT Economist

"The key measures determining future returns are the current dividend yield and prospective dividend growth."

Right. The executive class has said that they don't have to pay dividends to the same extent, because investors will get capital gains due to inflating stock prices. Inflating in part due to stock buy backs. But do those buybacks really provide returns savers?

"J.P. Morgan CEO Jamie Dimon said the bank would buy back enough shares to offset equity and option grants to employees."


His comment was specific to this buyback at this firm. But I believe that is pretty much what has gone on for all of 15 years. The record profits have gone to increased executive pay (taxed at 15 percent) not investors. And it would take the equivalent of a revolution to change this.

Savers and investors are now no better off than wage earners.


It's surprising and refreshing to see that financial advisers of the first world are rooting for personal savings to stock market investments just as those in third world countries have been doing for ever ! It seems the tables have turned at last ! First world is catching up with the wisdom of the third world ! But are the bankers of the first world bothered ? The rich bankers becoming richer, for ever will remain immature and greedy without any sense of social responsibility or sensibilities. Such morons who are only after money making without considering the immense social cost. They bother only about themselves first and foremost and then their limited shareholders . Neither are in touch with world of the 99%. I am reminded of the epicurean philosophy so succinctly expressed in the following lines from Robert Browning
"Irks care the cropful bird ? Frets doubt the maw crammed beast ?" ( from Rabbi Ben Ezra by Robert browning).
What happens to capitalism, and to the bankers, if people stop spending and start saving without risking in stock market investments ? God save Capitalism!

California Voice

Sorry, but I'm making good profits in the market by employing common sense, fundamentals and watching it every day. No leverage, no margin, no tricks. There is ample information available to make good decisions. You just have to keep up. This is American optimism speaking. If we can just dump Obama, things will really look up.


Useful article. However, I think it needs to be noted that we had two recent bubbles so that one could only expect comparable returns in future if we had another bubble or two. One could say that Japan's problem is that they were not able to inflate a second bubble. Gloom & doom is warranted in terms of retirement expectations. Save 20 to 30% of your income, work to 75... OR, live in a place where you can have a vegetable garden & some chickens. Reduce your reliance on the financial markets to secure your retirement. I think enough people will reach this conclusion so that it will have a significant impact on the economy. In that their resources won't be deployed entirely in the financial markets.


"...the circumstances of the times, rather than the immutable laws of finance, may have been responsible for the size of the premium."

The immutable laws of finance specify that the size of the premium IS a result of the circumstances of the times. So if you want to draw sweeping conclusions from long time series of historical data, you should rely not of laws of finance, but laws of economics. I won't attempt to argue any particular theory of economic growth here because I'm not going to add anything new to the conversation. But suffice it to say that if you (the author) are seeking to make an argument with any sort of causal/explanatory/predictive validity, you're barking up the wrong tree.

WT Economist in reply to Charel

With regard to "governments" where would they get the money? Do they have their own private wealth, the King's estate for example?

No, what occured was a transfer to the generations in charge from future generations. And subsequent cuts in old age benefits, at least here in the United States, are always for younger generations.

Not only that but at least with regard to U.S. public employee pensions, a big part of the hole -- most of it -- was for retroactive pension enhancements handed out as a part of political deals.

In NYC, teacher who were hired with a promise of a pension at 62 after 30 years or work with an employee contribution at 3 percent got their contributions suspended after 10 years of work and then got to retire at 55. No money had been set aside for this increase in benefits. Those long retired even got a retroactive pension increase in 2000.

During the stock market bubble, executive pay and public employee pensions were inflated. Neither have come down since the bubble was revealed. After all, they've got irrevocable contracts with themselves.


This of course assumes no intergenerational wealth transfer. In practice there is some wealth that passes from parent to sibling (or grandchild). This is real. Any analysis worth its salt should account for this. Back to you, Economist.

WT Economist in reply to Lunatic Fringe

"In a piece* by Robert Arnott for the CFA institute, he finds that net equity issuance has averaged 2% a year over history. So even if one assumes that the modern buy-back ratio is as much as 2%, all of that is cancelled out by issuance."

There it is, my impression confirmed by numbers. Thanks for the heads up.

You can't say that consumers should be paying more while workers should be earning less, because in the U.S. consumers have been selling themselves into debt slavery to bridge that gap. So that leaves two possibilities with regard to dividends.

Executives should be paid less so that dividends could be higher. Or dividends are at the right level, but stock prices are far too high compared with them, and are headed for yet another big fall (perhaps when inflation or interest rates rise).

FreedomUSA in reply to Naughty Bits

I think you are exactly right, the FED is effectively orchestrating one of the largest wealth transfers in history from savers to debtors (primarily the Federal and local governments and the financial industry). They are able to continue this ponzi scheme for a long time because if the reserve currency status of the dollar. These actions of little help to individuals because they don't really have access to cheap debt like the banks do. The banks use this money to buy treasuries for guaranteed rates of return and distribute most of the profits as compensation. In my opinion, this is going to spell disaster for most Americans in the long term because a) low savings will lead to low investment in the future, leading to high unemployment and low innovation, b) impoverish most because we are consumer society and a lot of what we consume is imported and c) most people's retirement savings are disappearing. At some point, foreign holders of $'s will start dumping them and we Americans are going to get stuck holding them.


Dividend yields may be historically low, but the payout ratio most probably is not. The reason is that many companies now prefer stock buybacks to dividends (due to tax reasons mainly) and that stock buybacks are a relatively new instrument. Apart from tax considerations, dividends and stock buybacks have the exact same effect (Modigliani Miller).

The US is not Japan. A tremendous stock market rally has already begun and it will be a pretty wild ride. Brace yourselves for one heck of a recovery. Or invest in emerging markets, where you will most certainly get an ERP.

Equity investments also act as a shield against inflation, because equity investors are holding real assets. Equity is as American as apple pie. There might not be an ERP in Japan, but Japan is a fixed income culture. The US is high-risk, high equity, high-winning!

4horseman in reply to WT Economist

Good point. But one would think pension funds, which own a boatload of shares, would elect a board that increased dividends (instead of buybacks). Studies also show the buybacks are often poorly timed & destroy shareholder value. Also, I think that companies should not be able to suspend the match to 401k plans at will (after having shifted employees from a pension to a 401K). This wouldn't take a revolution, just a law passed by Congress.


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