Zero (rate) intolerance syndrome
Investors always looking for sources of new income
We have been tracking a “global income crisis” for well over two decades. New confirming symptoms are appearing. Therefore, it is essential that its impact should be understood by all retirees present and future.
Originally, we recognized that ever-lengthening longevity and plunging birth rates would lead to the onset of what we called “Zero Intolerance.” Interest rates would plunge to the zero bound and “zero” intolerant investors would therefore begin to look for escapes and alternatives. The consequent frenzied dash to accumulate future income played a facilitating and reinforcing role in driving down interest rates and channelling enormous inflation into asset markets.
There are additional causes of slumping interest rates to be sure. However, without the aforementioned demographic shifts, Zero Intolerance would not have occurred. And so, declining interest rates around the global began to reduce the income yield of retirement portfolios. More and more capital would therefore need to be saved in order to maintain a level retirement lifestyle. For example, it takes more capital at an average of 1% yield than a 2% yield …in fact, twice as much. We have pointed to this rising cost of future financial income as the greatest inflation of our era. The yield inflation in the example above is equivalent to 100%.
Therefore, actuaries and their employers (pensions and insurance companies mostly) have been pummelled by the unexpected this past half century. Populations began to age rapidly and households began to shrink. Time after time, experts underestimated these trends. Actuarial forecasts of future longevity were plain wrong…repeatedly; and the social shifts to lower population growth were not well understood.
The result? Interest rates have plummeted these past five decades. In fact, many government bond yields have fallen to levels of 0%…and below. The face value of negative-yielding debt has soared to $17 trillion worldwide (representing 70% of world sovereign bonds outstanding).
Predictably, financial income is now so low that other sources of future cash flow must be found.
Consider the plight of the financial planner today. Perhaps only a decade ago, many households could plan their retirement expecting to solely live off the income proceeds of their retirement portfolios. For many, that is no longer possible.
Consider that the “post-WWII baby boom cohort” is now going through a 180-degree about-turn.
Where once this retiring generation was the legendary conspicuous consumer, driving economic growth and personal expenditures (PCE) as a share of GDP, today they are needing to become consumers of capital instead. Out of necessity, they must start to run down their capital in order to generate cash for their retirement expenditures. A serious turn of mind has therefore unfolded.
While the world today likes to disapprove of the use of nonrenewable energy, at the same time it finds itself backed into the situation where it must depend on “nonrenewable capital.”
Income-yielding investments (i.e., a high-yielding equity) produce renewable income and capital. That counts as renewable capital. Also, dividend payments recurrently provide renewable income and cash flow. But given plummeting interest rate levels (this generally also applying to dividend yields to an extent), renewable income is becoming a dying species…and expensive.
Therefore, with declining renewable income, investors must increasingly rely upon non-renewable capital. Portfolio holdings are therefore being liquidated to generate sufficient cash to pay for retirement costs. This is a perspective not well explained to the public.
Geologists may talk of “peak oil” (this notionally meaning the point at which oil demand has terminally outstripped supply). In a way, a similar phenomenon is occurring with financial income. Peak income has been reached. This implies that demand for income (renewable income) now exceeds supply. Therefore, non-renewable capital must be sourced to make up for the insufficiency in renewable income. Non-renewable flows of capital must be accessed to generate cash sale of an asset in order to fund the cost of one’s lifestyle.
Past the point of no return
To make matters more challenging, lately, monetary policymakers, too, have forced markets down the road of lessening renewable income (lower interest rates). It is one thing to have no income returns, quite another that policymakers can no longer reverse their interventionist polices.
It presents a double whammy. As already discussed, there is declining “renewable return” (i.e., lower interest rates). And now, monetary and fiscal policies find themselves are past the point of “no return.” Given the increase in debt levels globally ($15 trillion alone in the first three quarters of 2020), policymakers must now manage capital market valuations, too.
No matter that nominal income yields are near record lows, one must nevertheless continue to search the world for positive real interest rates. Admittedly, these are rapidly disappearing. Yet, they are still available. Go global. Consider that China’s real 10-year rates are positive. It is one reason why we think that Chinese (and other Asian) government bonds will be a source of above-average income yield…and also act as anti-fragile assets.
Equities that pay good dividends are the clear-winner asset. That said, investing globally or in stocks may seem risky to investors who have been conditioned to rely upon fixed-income investments for their retirement. However, as long as one focuses upon stocks that have earnings yields that are two or more percentage points in excess of a sovereign 10-year yield, this recommended strategy has a high probability of boosting overall income and returns.
Finally, it is likely that some investors will consider themselves unsuited to pursue the strategy of buying equities because they are wary of volatility. That is a tradeoff that must be considered in order to generate sufficient returns.
Wilfred Hahn is the founder, Global Strategist, and Chief Compliance Officer of Forstrong Global Asset Management Inc. He brings unique global macroeconomic perspectives to Forstrong, spanning four decades of research and strategy experience. This article first appeared in Forstrong’s Global Thinking blog. Used with permission. Follow Forstrong global thinking on Twitter @ForstrongGlobal.
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