Two Giant Pension Funds Just Admitted To Have BIG PROBLEMS

These two huge pensions funds just admitted big problems, and we’re not even in recession or a stock market downturn yet. Here’s the details…

I’ve been talking a lot about the looming pension crisis…

My short thesis is, if you’re depending on a pension for your retirement, it’s time to start looking elsewhere.

Pensions are simply giant funds responsible for paying out retirement benefits to workers.

And today, the nation’s 1,400 corporate pension plans are facing a $553 billion shortfall. And, according to Boston College, about 25% will likely go broke in the next decade.

Think about that… A full one-quarter of US, non-government employees expecting a pension to fund their retirement will likely get zilch.

And it’s even worse for the government…

According to credit-rating agency Moody’s, state, federal and local government pension plans are $7 trillion short in funding.

The reason for this crisis is simple – investment returns are too low.

Pension funds invest in stocks, bonds, real estate, private equity and a host of other assets, hoping to generate a safe return.

But with interest rates near their lowest levels in human history, it’s been difficult for these pensions to generate a suitable return without taking on more and more risk.

And that’s another big problem with pensions – their investment returns are totally unrealistic.

Most pension funds require a minimum annual return of about 8% a year to cover their future liabilities.

But that 8% is really difficult to generate today, especially if you’re buying bonds (which is the largest asset for most pensions). So pensions are allocating more capital to riskier assets like stocks and private equity.

And so far it’s working.

The California State Teachers’ Retirement System (CalSTRS) and California Public Employees’ Retirement System (CalPERS) both earned more than 8% for the second fiscal year in a row. CalPERS is the largest public pension in the US. And, together, the two funds manage $575 billion for 2.8 million public workers and retirees.

Two 8%+ years isn’t the norm. Over the past 10 years ending June 30, CalSTRS returned an annualized 6.3% a year – well below its target. And CalPERS has returned a dismal 5.1% over the same period.

And that’s been with the tailwind of one of the longest equity and fixed-income bull markets in history.

It’s clear these inflated gains can’t last.

And the two California pension giants are even admitting the game is up.

No, no more 8% target return, as we teeter on the edge of what could be the largest market correction of our lifetime.

CalSTRS is making the bold move to drop its future goal to… 7%.

And CalPERS is ratcheting down its return goals in steps to… wait for it, 7% by 2021.

Listen, it’s a nice gesture for these big funds to lower their expected returns and admit things are tough out there.

But 7% is still totally unrealistic. And that’s not even taking into account the tough times I see ahead for markets. Pensions haven’t been able to hit a 7% return in the best of times.

As of June 2017, the 10-year annualized median return for all public pensions tracked by the Wilshire Trust Universal Comparison Service was 5.57%.

That’s nearly 250 basis points below the 8% target.

But there’s another way pensions make money… they collect funds from active workers and taxpayers.

When these funds drop their return expectations, it has real life implications. With a lower, projected return, a pension fund needs more cash to pay out its future liabilities.

For example, CalPERS, which is dropping its expected return to 7% by 2021, said the state and school districts paying into the pension will have to pay at least $15 billion more over the next 20 years once the 7% target kicks in.

So, people depending on a pension not only likely won’t get the money owed to them in the future… but they’ll also get stuck paying more into the system today. It’s a true lose/lose.

Our goal at Sovereign Man is to put our readers in a position of strength.

And if you’re expecting a pension to pay for your retirement, you need a contingency plan today.

Last month, I outlined a series of steps you can take, right now, to improve your financial situation – like improving investment returns and alternative retirement account structures.

Personally, I’ve been selling assets to raise cash. In fact, I’m sitting on more cash than at any other point in my life.

I’m sitting on cash because I’m worried we could see another recession very soon.

And being liquid at a market bottom is one of the best ways to get really rich – you can buy the world’s best assets for pennies on the dollar.

But here’s the best part… I’ve structured my cash holdings so I’m still earning a solid return – better than a lot of these pension funds. But I’m remaining liquid and taking on very little risk.

If you want to know more about what I’m doing with my own money, and why I’m sitting on so much cash, just click here…

by Simon Black of Sovereign Man

Moody's Warns Of A Junk Bond Default Avalanche As Rates Rise

Having peaked last summer after troughing in early 2016 following the 2015 oil crisis which led to a surge of E&P-linked defaults and prompted the Fed to quietly order banks to suspend marking-to-market their energy exposure, junk bonds have been gently leaking for the past year...

... and while spreads remain compressed - which is understandable in a world where any outsized yield is fiercely bought by managers of "other people's money" regardless of the underlying fundamentals - yields continue to creep higher, tracking the broader rates market, and it is only a matter of time before America's highly indebted, "zombie" corporations most of which are rated somewhere in deep junk territory, hit their tipping point and trigger a mass default avalanche.

That's the warning issued by rating agency Moody's, which writes that "low interest rates and investor appetite for yield has pushed companies into issuing mounds of debt that offer comparatively low levels of protection for investors." Actually that's a major understatement, because as documented previously, the prevalence of covenant-lite debt in circulation has never been greater, which suggests that during the next crisis recoveries on both secured and unsecured debt will be lower than ever before...

... something we first showed during the brief but acute 2016 E&P junk bond crisis.

But besides that technicality, Moody's is - for once -correct, and in a surprisingly dour assessment of the high yield market, Buffett's favorite rating agency warns that while the near-term outlook for credit remains "benign," that won't be the case when economic conditions worsen.

In the report Moody's senior credit officer, Mariarosa Verde, writes that "the prolonged environment of low growth and low interest rates has been a catalyst for striking changes in nonfinancial corporate credit quality," and adds that "the record number of highly leveraged companies has set the stage for a particularly large wave of defaults when the next period of broad economic stress eventually arrives."

She also notes that while the current high yield default rate is just 3%, it has been rising rapidly in recent months as shown in the chart below, and furthermore this artificially low default rates is predicated on favorable conditions that may will not last.

And here is a striking statistic from Moody's: since 2009, the level of global nonfinancial junk-rated companies has soared by 58% representing $3.7 trillion in outstanding debt, the highest ever, with 40%, or $2 trillion, rated B1 or lower. Putting this in contest, since 2009, US corporate debt has increased by 49%, hitting a record total of $8.8 trillion, much of that debt used to fund stock repurchases. Meanwhile, as a percentage of GDP, corporate debt is at a level which on ever prior occasion, a financial crisis has followed.

Furthermore, in the post financial crisis period, there has been a steady deterioration in debt issuance, with the share of investment-grade firms declining while junk-rated debt has increased.

The dynamic here is familiar, and is the basis of every post in which we lament the prevalence of "zombie" companies - those with insurmountable debt loads, kept alive only thanks to artificially lower interest rates:

"Strong investor demand for higher yields continues to allow all but the weakest issuers to avoid default by refinancing maturing debt," Verde wrote. "A number of very weak issuers are living on borrowed time while benign conditions last."

And here is Moody's as close at it will ever go to slamming central banks for being responsible for the next debt crisis. As paraphrased by CNBC's Jeff Cox, it is the easy credit conditions of the past decade that have allowed lower-rated companies to flourish and go to market, as global central banks have kept rates low while flooding the world with trillions in excess liquidity.

To be sure, there is a good side to this artificially extended existence: it has allowed some smaller firms, which otherwise would not have survived , to implement game-changing technologies into multiple industries, particularly energy.

Yet concurrently higher-rated companies have been issuing record amounts of debt, which they used to reward shareholders with buybacks and dividends. As a result, their debt, while still investment grade, has fallen to just a few notches about junk, with the very top of the ladder shrinking from 21 percent pre-crisis to 14 percent currently.

Here Moody's, like Bank of America recently, warned that the trend will result in a surge in "fallen angels," as investment grade companies are downgraded to junk, which incidentally Horseman Global recently said will be his favorite short this year.

Meanwhile, median debt to EBITDA levels have risen 30% for investment-grade companies and slightly less for junk, which means that an even smaller increase in rates will be sufficient to lead to mass defaults.

"For many speculative-grade issuers, debt capacity may have reached its limit but structural protections continue to weaken," Verde said. "Many of these highly leveraged borrowers have more latitude than at any other time in the past to engage in potentially credit-eroding activities such as asset sales or debt-accretive transactions without needing to get lender consent."

The moody's analyst also noted that it is only thanks to central bank intervention that lower-rated companies have managed to keep their defaults below the historical average even though their credit metrics are "deeply stretched."

"This extended period of benign credit conditions has helped many weak, highly leveraged companies to avoid default. These companies are poised to default when credit conditions eventually become more difficult."

Which incidentally, is precisely what the IMF warned one year ago, when it predicted that 20% of all US corporations are at risk of default once rates rise, as they have been for the past year. In fact, as the IMF chart below shows, some $3.9 trillion in corporate debt is at risk of defaulting when rates rise enough.

The only question is what is "enough?"

Fonte: qui

"There Is A Sense Of Panic In The Air": Italian Bond Carnage Returns

Update: The speculation of "will he, won't he" is over as Italy's president Mattarella gives Conte the green light to form a populist government, one which will blow out the Italian budget, and set the country on collision course with Brussels and Berlin: 

• ITALY PRESIDENT TO ASK CONTE TO TRY TO FORM GOVT: REPUBBLICA

* * *

The blow out in Italian yields has returned after taking a brief one day hiatus, with the 10Y BTP yield hitting a fresh 2018 high of 2.46%, the highest going back to 2014...

... as the carnage in the short end resumes, send the 2Y to 0.28%...

... while the Bund-BTP spread has blown out again to 194 bps on Wednesday.

Today's selling was prompted by a report that Italian President Mattarella has not yet decided whether to give the PM role to PM appointee, law professor Giuseppe Conte, with Repubblica reporting that Mattarella is to take time on the Premier candidate over concerns that his cabient may be far too anti-establishment.

As the FT notes, the anti-establishment Five Star Movement and the far-right League have become locked in a stand-off with Sergio Mattarella after pushing for a staunchly Eurosceptic economist, Paolo Savona, to be finance minister. As Repubblica adds, Mattarella is taking extra time before his decision on premiership as he is highly critical of Finance Minister candidate Savona.

Meanwhile, the public debt contagion has started to spread, as Monte dei Paschi’s bonds are also selling off with the yield on its €750m Tier 2 bond climbing to a record high of 8.2%: Monte dei Paschi raised the debt, which counts towards its capital ratios, at 5.375% in January and had planned to sell a further €700m of such paper before the year-end to strengthen its balance sheet.

Concerns have emerged about Italian banks’ non-performing loans; the two populist parties have said they will repeal laws allowing banks to forcibly recover debts from Italian citizens without judicial approval. The share prices of bad debt collection specialists such as Cerved and DoBank have fallen heavily this past week.

Quoted by the FT, Fidelity portfolio manager David Simner said there had been “a sense of panic in the air” in recent days as "investors have scrambled to reduce risk as the spending implications of the new government has naturally caused concerns over the future dynamics of the debt load of a country which is already very heavily laden." He concluded that many investors remain in a wait and see mode "if [the market] has found a new lower clearing level that may provide some consolidation."

However, the best summary of Italy's troubles came from Bloomberg's Mark Cudmore overnight with the following damning summary:

In Italy, the president has no good options as far as markets are concerned. If he blocks the coalition, it’ll leave the country in limbo and stir up popular resentment before new elections. But if he approves the coalition, then it’s even more worrying because of the government’s fiscally irresponsible proposals.

Of course, the real catalyst for the ongoing selling in Italy is the market's much delayed reaction to the electoral victory of the anti-establishment parties which now threaten to blow out the Italian budget, at a time when the ECB is not only the only buyer of Italian bonds...

... and worse, coming just as the ECB is tapering its BTP purchases.

What happens next? Well, as most sellside desks predict, the Bund-BTP spread is virtually assured of hitting 200 bps, and until there is some further clarity on how the current political power moves play out, it will be impossible to call a bottom to the Italian rout, which meanwhile is starting to "contage" across Europe as that old Europe bogeyman, redenomination risk...

...is slowly but surely rising. 

Fonte: qui

Subprime Chaos: The Auto Bubble's Bursting And The Data Is Worse Than 2008

Last week, used car prices had their biggest drop since 2009 – directly after the financial market meltdown of 2008.

Right now, the auto market is showing signs of incredible worry.

Delinquent subprime auto-loans are higher than they were in the last recession.

Look for yourself...

What’s interesting – and worrisome – is that consumers are defaulting on subprime auto loans when the economy is reportedly doing ‘very well’.

Like I wrote last week – there are cracks under the economy’s foundation. And it’s like a bucket of cold water in the face of the mainstream financial media that’s pushing the ‘growth’ story.

We must ask ourselves – “if things are going so well, why are subprime loan delinquencies at a 22-year high?”

I can’t help but feel a bit nostalgic. This was the same situation that led up to the 2008 housing crisis. . .

First, there was massive growth in mortgage-backed securities and mortgage debt. Then, the Federal Reserve – led by Alan Greenspan – began aggressively raising rates after years of low rates. Soon after, subprime loans started blowing up – which trickled into the prime loans. And eventually, everything was in chaos.

Using the often-ignored Austrian Business Cycle Theory (ABCT) – coined by the little-known but brilliant economist Ludwig Von Mises – I am blaming the Fed for all this.

Thanks to the Fed, a near decade of zero-interest rate policies (ZIRP) and three rounds of Quantitative Easing (which totaled over $3.8 trillion in printed money) – the consumers became hooked on cheap auto loans. . .

Their policies made the entire system fragile by getting consumers addicted to cheap debt through their easy money.

They then began tightening credit – crippling the borrowers.

Think of it this way – imagine you’re addicted to alcohol. And your bartender keeps giving you cheap drinks each night for months. Eventually, from drinking way more than you should’ve been able to afford, you now have a very high tolerance.

But suddenly – the bartender becomes strict and starts giving you less booze. He tells you, “sorry but no more free alcohol for you.” Problem is, you wouldn’t have drank so much if you had to pay full price for it.

Now you’re left with awful withdrawals – scrounging together all the extra money you can just to pay for a drink. But the only way you can really afford to feel better is if he starts giving out free drinks again or you painfully detox.

Just look at the collapse in auto-loan growth since 2015 – when the Fed began tightening with their end of QE and talk of rate hikes...

Clearly the higher rates had an impact on new auto loans.

But a bigger – and more pressing – problem is that the Fed’s short-term interest rate hikes are making these current subprime auto loans unserviceable. The borrowers are having a harder time paying more interest for an asset that depreciates 15% the moment they take it off the lot.

Clearly, affordability is becoming a problem. . .

As I learned from Ludwig Von Mises and the other brilliant Austrian economists – the Fed created a bubble in auto-loans by keeping rates low and printing trillions. And now they’re going to blow the whole thing up with their rate hikes.

Just like taking the free drinks away. . .

I expect delinquent subprime loans to keep hitting new highs. And I expect the ‘growth’ story the pundits keep pushing down our throats will fade.

Because even if the auto-loan industry and general economy hasn’t rolled over yet, each new Fed rate hike pushes us one step closer to the edge.

0.25% at a time. . .

So, with our Macro-Fragility Index (MFI) alarmingly high in the auto sector – I’m going to spend time looking for opportunities here.

History shows us that when things start their descent into collapse – the subprime market is the first to get hit.

Food for thought. . .

Authored by Adem Tumerkan via Palisade Research

"What Is The Magic Number?": Wall Street Answers The Most Important Question For Investors Today

In its latest Fund Manager Survey, Bank of America asked what may be the most important questions for investors today: "What level of US 10y Treasury yields would cause you to rotate from equities into bonds?"

That level, which Bank of America's Michael Hartnett has repeatedly dubbed the "magic number", rose from 3.5% last month to 3.6% in the May survey, and represents that weighted mid-point of the responses by the 223 survey participants, who manage a total of $643BN .

As a reminder, last week Hartnett explained why he agrees with the FMS response, saying "it should not be a surprise if reallocation starts before yields get to 3.5%. Indeed, as we breached 3% the following asset classes all suggested that the 3-3.5% range would become “painful” if not accompanied by much stronger economic data."  As the BofA CIO further added, banks, homebuilding stocks, US dollar, EM, yield curve all suggested 3% on the 10-year Treasury yield was the "magic number."

• Lower US bank stocks: rise in rates was shifting from a “good” rise to a “bad” rise (financials underperformed utilities by 1250bps since mid-March)
• Lower US homebuilding stocks: a good lead indicator of interest rates, homebuilding stocks are saying the Fed is making a “policy mistake”

Then, yesterday, as 10Y yields broke out to fresh post-Taper Tantrum highs, rising above 3.05% and as high as 3.09%, a level not seen since 2011, Bill Gross tweeted that "the Economy can't support yields higher than 3.25% for 30s and 10s, nor 3% for 5s. Continuing hibernating bond bear market is best forecast."

And, as we also showed yesterday, demonstrating the recent sharp drop in loan demand across the board as a result of higher rates despite far easier lending conditions, and affecting everything from C&I loans...

... to residential mortgages...

... to consumer loans...

... Gross is right, only the Fed hasn't quite realized yet that US interest rates are now at a level that leads to not only lack of loan growth, but outright deleveraging, loan destruction and thus, deflation.

To underscore his point, Gross also noted the technicals and said that "30yr Tsy long-term downward yield trendline for the past 3 decades now at  3.22%, only ~4bps higher than today's yield." Asking rhetorically, "will 3.22% be broken to upside?" his answer was no.

Then, overnight, another bond titan - and Gross' former employer - Pimco also agreed with the "magic number" consensus, when its co-head of Asia-Pacific, Robert Mead, said that 10Y yields will move in a 3% to 3.5% range for the rest of the year as the Federal Reserve continues raising interest rates.

Addressing the second longest US economic expansion, and second oldest business cycle in US history...

... Mead stated the obvious to the Bloomberg Invest summit in Sydney: "we do think this hiking cycle is quite well advanced." adding that while "the backdrop of the U.S. economy has been pretty strong and going for a long time. At some point we will find these high yields will become an impediment for growth.”

As the charts showing negative loan demand above suggest, that point is now.

Mead then said that the higher rates rise, the more the record short overhang will, or at least should, be unwound: “Nothing is pound-the-table cheap,” but rising yields mean investors can gradually reduce their underweight bond positions, Mead told the Bloomberg conference.

Confirming this observations, Mark Delaney - the chief investment officer of AustralianSuper Pty, the nation’s largest pension fund - said he was thinking about buying bonds again after selling almost all holdings last year.

"We sold almost all our bonds in 2017, but now they’re a percent higher - a percent plus, a bit higher - we’re starting to think about whether or not we should start closing those short positions," Delaney told the Australian summit.

It's not just positioning however, and the inevitable short squeeze: according to Jeffrey Johnson, head of Asia-Pacific fixed income at Vanguard Australia, inflation will remain anchored due to the global secular deflationary tailwinds: 

Powerful forces such as demographics, globalization and technology should keep a cap on yields, Johnson told the summit.

Putting that in numbers, Johnson said that the fair value for U.S. 10-year yields would be 3% to 3.25%. And as evidence, he added that Vanguard has seen evidence of investors getting back into fixed income to take advantage of the higher yields.

Ultimately, it will be up to the pension funds of the world, most of whom are significantly underinvested in fixed income having rushed into equities in recent years, to be the marginal buyer that pushes rates decidedly lower, especially if the Fed indeed plans to hike at least another 3 more times this year, in which case if Wall Street is right, it would be the Fed itself that inverts the yield curve.

But there's time before that happens. For immediate next steps, just keep an eye on the value of the US Dollar: should the recent torrid rally finally fizzle, that will be the time to go long bonds. Fonte: qui