Today’s Wall Street Journal opinion page features an article by Michael Thompson, chairman of S&P Investment Advisory Services, titled “How the Fed Has Warped the 401(k).” While Mr. Thompson makes his case well, his column is full of the same myths regarding the Fed and the stock market that, – for whatever reason, – have perpetuated despite all evidence to the contrary.
First and foremost, Mr. Thompson claims that, “[s]even years of near-zero interest rates has created a serious problem for retirees and those nearing retirement…In place of the Treasurys and investment-grade corporate bonds that had been the hallmark of retirement investment strategy for decades, current retirees, and those soon to retire, have resorted to investing in equities and high-yield corporate bonds to generate the returns they need to avoid outliving their nest eggs.”
While it is true that more 401(k) participants held stock in their accounts than at the prior market peak in 2007, the numbers are not that much greater, and probably are mostly the result of growth in the stock market since then. For example, the Employee Benefit Research Institute (EBRI), in its December 2014 issue, noted that while at the end of 2013 (the last year for which complete data are available) 44% of plan participants held more than 80% of their 401(k) in equities, that number is up only slightly from the 43% it hit at the end of 2007. While Mr. Thompson is concerned that “[a] recent report from Fidelity Investments found that 11% of its 401(k) account holders aged 50-54 had a staggering 100% of their retirement assets invested in stocks,” in its report, EBRI noted that “22 percent of 401(k) plan participants in their 60s had more than 80 percent of their account balances invested in equities at year-end 2013, compared with 30% of 401(k) plan participants in their 60s at year-end 2007[.]” To be fair, I haven’t had the luxury of reviewing myself the Fidelity report to which Mr. Thompson alludes. However, I very much doubt that even if the data it presents are more recent than EBRI’s, investor allocations cannot have changed so much so quickly. What is more, the fact that those closest to retirement (those in their 60s) had more invested in stocks in 2007, – when the 10 year treasury yielded 4.7%, versus 2.3% now, – gives lie to the claim that low interest rates have pushed older workers into equities.
401(k) data aside, two other pieces of evidence support this view. First of all, as Business Insider pointed out in July (referenced by us earlier here), “barely any new money has come into the market” since the bear market bottom in 2009:
Furthermore, as Blackrock’s Russ Koesterich, CFA, noted, the level stock market ownership among the general public remains well below prior cyclical peaks in 2000 and 2007.
Well, we have shown that there is little evidence to Mr. Thompson’s claim that the Fed’s easy money policies have coerced investors into equities. What is there to be said about this claim that the Fed actually has the power to manipulate longer-term interest rates? To an extent, we addressed this issue in September, when we wrote that “long-term inflation expectations have a much greater impact on bond yields than Fed policy.” However, NYU professor Aswath Damodaran, – whose blog is highly recommended, – puts it better when he writes:
“If expected inflation is low and real growth is anemic, as has been the case since 2008, interest rates will be as low as well and they would have been low, with or without central bank intervention.”
To illustrate the relationship among interest rates, inflation expectations, and real growth, Professor Damodaran provides a great graphic:
One final argument Mr. Thompson makes is that stocks are overvalued as a result of retiree assets being misallocated into equities:
“The investment committee at my firm estimates that roughly $1.3 trillion in retiree assets are currently misallocated into equities based on the the historic 16-year average price-to-earnings ratio for the S&P 500. This has resulted in stock price inflation that has kept equity valuations aloft even as quarterly corporate earnings results have begun to show signs of weakness.”
However, as Michael Batnick, CFA, posted last week, the price-to-earnings (P/E) ratio for the S&P 500 is well below prior peaks seen in the last 25 years, so it’s difficult to claim, – as Mr. Thompson does, – that current valuations are purely attributable to an insatiable appetite for equities induced by Fed policy.
In sum, there is no way to tell what has been driving investor allocation decisions in their 401(k)s or otherwise, and it seems to me that those in Mr. Thompson’s camp, – who attribute every market move one way or another to the Fed, – make the mistake Charles Dickens described in Great Expectations when they seek to fit the evidence to their theory instead of building a theory based on the evidence.