Hot Off the Web- August 17, 2008

A sign of the times is the growing amount of discussion about pensions. Jennifer Hughes of the financial Times writes that UK “Pension trustees set to seek more cash” . A combination of rising longevity, falling markets and “regulatory pressure to act prudently” will make trusties demand additional cash. However some accountants warn companies against buckling to the pressure (when they in fact are allowed up to 10 years to make up shortfall), because in the coming credit crunch they may need funds for short term requirement, while survival of pension plans is dependent on the long-term health of the company”. (Then of course some pension plans with deep funding shortfalls may in fact fall into bankruptcy and leave pensioners with a serious problem. Read my in-depth blog this week on Under-funded pension plans).

BusinessWeek’s Mat Goldstein in “Now Wall Street wants your pension, too” warns readers that the people who created the current mess in the financial markets are clamouring to be allowed to take over “frozen Pension plans”, i.e. don’t accept new members (and perhaps no additional benefits/liabilities can be accrued?) Wall Street likes it (fees), the sponsoring companies love it, especially as new accounting regulations may not only require pension shortfalls to be shown on balance sheet, but fluctuation may also become visible in earnings. Time will tell if legislators will be able to resist the pressure and if the pensioners will be better off (which should be the ultimate test). I suspect it will take a few years for many firms to rebuild their credibility with the public from the devastation that they delivered with structured investment products.

The Financial Times’ John Authers discusses how the fall of commodity prices shifted the worry from the fear of resurgent inflation to a growing “Risk of deflation” . He also suggests that with lower inflation expectations “it is justifiable to pay more for stocks. If inflation will eat less of the earnings stream paid by the companies, then multiple of earnings can go up.”

Mark Hulbert in NYT’s “Illusions about inflation”  he points out that the inflation is bad for stocks argument makes sense to investorsand thus they tend to drive down stock prices, yet in fact research indicates that during inflationary periods companies have been able to pass on (some of) their cost increases more effectively than anticipated by investors. Thus investors historically drove prices lower than justified. So increasing inflation is bearish in the short-term, but the pessimism leads to  P/E price compression that in turn leads to long-term buying opportunity, when inflation starts to decellerate and P/E ratios expand again. (I updated this paragraph as the earlier version included some my tongue-in-cheek comments that may leave some readers with the impression that rising inflation is good for equities may be misunderstod as an endorsement of rising inflation, which I did not intend. Thanks to KH for pointing this out to me.)

And finally the NYT’s Bob Tedeschi reports on a new product that helps “Finding cash in a home”. Unlike reverse mortgages with high charges, this new innovative product gives you up-front cash in exchange for a future participation in the appreciation of your home. For homes over half million dollars in value owners between ages 65-85 who are life insurable may receive up to 15% of the home’s value in exchange for a 50% share in value appreciation after 10 years. “Those who move out within 10 years must pay back the entire amount — and 5 percent more if they move within the first five years….If the homeowner dies within 10 years of signing the deal, the heirs owe nothing (life insurance is paid to investors.).” (Certainly worth having a further look at the fine print which comes with this new concept. For the investors, if going forward real estate appreciation is equal to historical long-term appreciation of about 4.5% -inflation plus about 1.5%- then over 10 years that’s about 55% appreciation in the home value. Thus investors’ share is 27.5% on the original 15% or about 6% per year over 10 years. However if the appreciation, following the current severe downturn in prices will average 6% over the next 10 years, then investors’ return may be as high as 10%! So it sounds like there may be enough benefits to go all around.)


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