\n"}I read an interesting interview with Robert Shiller here:
\n\nWhat is interesting is this: (1) Shiller finally acknowledges that valuations of all financial assets are related; and (2) Shiller\u2019s supposed cause for the overvaluation is that\u00a0\u201cpeople are not confident in their future.\u201d
\nHe also makes the comment that this will end badly.
\nI have a different take.
\n\n
I will try to illustrate through a simple example.
\n-Assume you are nearing retirement and trying to calculate how much you need to save for your golden years. \u00a0
\n-Assume also that due to advances in medical technology, you really have no idea what your lifespan will be. \u00a0It could be 5, 10, or 50 years.
\n-Assume you need $50,000 year for living expenses and that there is no inflation (just to make things simple).
\n\n
How much will you need?
\nThis equation tells you what you will need:\u00a0
\nPresent Value = Cash Flow / Rate of Interest (lets make Rate of Interest = r)
\nSo, you will need $50,000/r. \u00a0
\n\n
OK, what the hell is r? \u00a0(I\u2019m simplifying here, bear with me\u2026)
\n-In 1980, r was around 20%\u2026for both stocks and bonds.
\n-In 2000, r was around 5%\u2026for both stocks and bonds.
\n-in 2015, r is 2%\u2026.for both stocks and bonds.
\n\n
So, if you did this exercise in 1980, you needed $250k ($50,000/.2)
\n-If you did this exercise in 2000, you needed $1.0MM ($50,000/.05)
\n-If you did this exercise in 2015, you needed $2.5MM ($50,000/.02)
\nSee, what\u2019s happening?
\n\n
The way the math works, the lower the yield goes, the more money we need. \u00a0Halve returns again and the liability goes up to $5m\u2026
\n\n
The more time goes by, the more you need. \u00a0The more you need, the higher the price of the assets you are buying and hence the lower the expected return. \u00a0And hence the more you need. \u00a0If you are unfunded, your\u00a0\u201chole\u201d just gets bigger and bigger\u2026You are in a trap you may never get out of. \u00a0No wonder you don\u2019t feel great about your situation.
\nNow, imagine if you were going through this same exercise along with millions of other people in your exact same situation in developed markets around the world\u2026.All chasing basically the same financial assets. \u00a0They are all in a massive prisoner\u2019s dilemna with each other. \u00a0The more they bid, the more they need.
\nThis is what is happening right now. \u00a0All the DMs are aging. \u00a0This is a global phenomenon. \u00a0Insurance companies, pension funds and others trying to store assets for the next 30 years are screaming for returns. \u00a0And we are thus seeing correlation amongst DM financial assets skyrocket.
\nIt explains so many things:
\n-This is why CAPE has been inflated for 30 years running. \u00a0
\n-This is why there is a never-ending bid to E-minis. \u00a0The\u00a0\u201cplunge protection team\u201d are boomers looking to fund their retirement, not some government bogeyman.
\n-This explains why all financial assets are in a\u00a0\u201cbubble\u201d; they are just substitutes for each other in the quest to get funded.
\n-This is why low bond yields in Europe infected US bond yields. \u00a0Dutch pension funds in a hole just want yield & they could care less about F/X risk\u2026
\n-This is why Hussman just gets wronger and wronger.
\n-This also explains volatility in the back end of the yield curve. \u00a0Pensions dominate this space; when yields go down, their unfunded liability shoots up and they chase yields lower. \u00a0When yields back up their unfunded liability goes down massively and we get liquidity holes in the back end like we just saw in Euro 30yr rates. \u00a0They are effectively very short gamma in the back end. \u00a0(Which means also that all boomers are short gamma on their liability\u2026)
\n\n
The boomers are in a hole and chasing a carrot that just gets farther and farther away\u2026.Don\u2019t bet any time soon that financial assets are going lower. \u00a0The boomers aren\u2019t going away.
\nThis is why it is quite painful being a Gen Xer. \u00a0The boomers have literally drained all value out of financial assets in their desperation to fund their unfunded liability.
\nThis is a demographic shift we have NEVER seen. \u00a0That is why CAPE has NEVER been this high for this long.
\n\n
Shiller doesn\u2019t understand the valuation and thinks it may crash. \u00a0It won\u2019t crash until all the boomers are funded\u2026.Sure, there may be temporary selloffs, particularly in risk assets. \u00a0But any sell-off is a boon to these guys. \u00a0They are effectively short them.
\nShiller needs to walk into a Financial Advisor\u2019s office and spend a day and he will immediately understand what is happening. \u00a0It\u2019s not lack of confidence in the future. \u00a0On the contrary, it\u2019s confidence in a LONG future for boomers.
\nShiller gets so close in that interview to hitting on this\u2026.without going there. \u00a0He keeps saying people need to save more because returns will be lower. \u00a0He doesn\u2019t make the connection to the circular loop of what this does to asset prices; i.e., more funds chase limited assets, driving the expect returns on those assets still lower. \u00a0 I found myself screaming when I read the interview. \u00a0As an options trader, I understand this negative gamma intuitively.
\nIn many ways, the boomer\u2019s have given us a free put on financial assets: they basically have to buy them at lower prices. \u00a0When we see panic sell-offs, we should literally all start front-running the boomers.
\n\n
What will solve this? \u00a0Increasing the retirement age. \u00a0This will have a massive effect on the perceived unfunded liability. \u00a0Social security in theory could help, but there aren\u2019t enough young workers to pay for the boomer\u2019s retirement. \u00a0
\nWe as a global society need to wake up to the fact that a life expectancy of 100 is not consistent with a retirement age of 65-70 (or for government/military, 45, but don\u2019t get me started on that\u2026).
\nThe other thing that this opens up which I won\u2019t go into is this: is the Central Bank rate repression effectively increasing the angst among the boomers with regard to their unfunded liability?
\nMany have this view and I am sympathetic. \u00a0After all, if CDs yielded 5-10% like they did 10-20 years ago, a potential retiree would feel less pressure to save for retirement. \u00a0If you are 70 and rolling CDs at zero, you are hating life. \u00a0[Imagine how you would feel if you were a Swiss 70 year old who is very close to PAYING interest on his/her bank deposits? ]
\nSo, yes, Mr. Shiller, people don\u2019t feel confident about the future. \u00a0But it is because the financial asset prices are telling them they can\u2019t fund it\u2026
\nAnd it will end badly, but not because asset prices crash. \u00a0If anything, this is what Boomers are rooting for so they can buy them cheaper! \u00a0From everything I\u2019ve read and understand there are trillions really upset they missed the bargains of 2008/2009 and desperately hoping it happens again.
\n