In my recent New Year letter to our financial planning clients at Guidance, I proposed that investment markets are today less risky than they were in decades past. Whereas once governments and policy makers could largely leave the stock market to do what it likes, in the last decade especially there has been far more preparedness to intervene and support, perhaps not specifically investment markets, but the broader economic and financial system such that stock and bond markets have an implicit safety net that didn’t exist in the past.
Then last week in the GainingChoice weekly email I shared a blog post by Josh Brown that added some great underlying logic as to why the change that I have observed is the new reality.
Josh’s piece was an effort to explain what the Federal Reserve is doing at the moment. In it, he observed that a hugely significant difference in the financial system today to what it was up until the 70s, and perhaps even more recently, is retirement savings systems for workers. Government pensions in retirement are being phased out and employer defined benefit schemes are almost non-existent today. Whether we like it or not, here in Australia 10% of our wage is set aside in our retirement savings account. Whilst the details differ somewhat across countries, the basic architecture is consistent – workers need to provide for their own retirement.
Money put into workers retirement accounts then needs to be invested somewhere. Now stocks aren’t the only option of course, there are bonds, cash, property, and out at the periphery, things like art and crypto. But the majority of retirement savings will find their way into bonds and stocks. Bond markets move up and down but certainly in comparison to stocks, they are relatively stable and so their gyrations have little impact on the economic psyche of the population. Stock markets are however a different beast. As we’ve been reminded in recent weeks, markets can decline rapidly at times, and even though all the data demonstrates that the stock market is a sensible and successful vehicle in which to build wealth, such falls inevitably result in distress for some and sadly some people acting on reflex and taking actions that are contrary to their long-term best interest.
In countries like Australia and the United States, stock markets now directly impact every working citizen as a result of our retirement savings system. A significant stock market crash is no longer ringfenced to just the investing class, whatever that used to mean. Today we are all investors. A large fall will mean retirees have less to spend, and those accumulating wealth feel less financially secure, making them less inclined to put an extension on the house, buy that new car, or just spend that little bit more freely on the weekend. It’s sometimes called the wealth effect. Even though it might be on paper, the wealthier we feel, the more secure we feel, and therefore the more prepared we are to spend. And it’s through that spending that economic activity occurs, creating jobs, creating tax revenue, and making the economic world go round.
The economic intervention we’ve seen in the past few years in the face of the COVID pandemic has been unprecedented. Largely it has been following the playbook that the Japanese economy began implementing in the 1980s. What governments and central bankers are now starting to realise is that their ability to prop up the economy and citizens private wealth is far less constrained than they once assumed. Things like quantitative easing, a solution for when you get to interest rates approaching 0%, would have never even been on the agenda back in the 1980s. Governments handing out money to employed citizens in times of economic stress first occurred in the GFC in 2008 and was more broadly embraced this time around. Once, it was assumed that such policies would bankrupt governments, putting them in a debt spiral that detonated their currencies and impoverished the entire nation. But through Japan’s journey, and our more recent experiences, we now know that need not be the case.
Whilst investment markets are now less risky than they were in the past, that doesn’t mean they’ll never go down. In fact recent experience suggests down periods might unfold more quickly than in the past. But on the flip side, recoveries will be quicker as the government and central bank apparatus click in to sure things up. Even if they do nothing, investors confidence that these institutions could take action if needed may be enough.
I’d love to hear your thoughts. Hit reply to a recent GainingChoice in email.
I should conclude by saying I recognise the possibility that this post may not age well. Oh well, got to say it like you see it.
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