Last month 401(k)Specialist published “Don’t Fail to Protect Financially Naïve 401k Beneficiaries” in which I reprimand regulators and fiduciaries for failing to protect naïve beneficiaries when they are near retirement.
I warn that baby boomers will spend most of this decade in the “Risk Zone” and might never recover from an imminent recession that I believe will begin in this decade.
In this article, I examine the likelihood of a correction in stock and bond markets occurring in this decade and the possibility that a severe downturn could last a long time, much longer than it would take for people near retirement to recover. Recessions are not the same as market crashes, but I discuss them in this article as if they were identical because one usually causes the other.
The mere possibility of ruining lives should motivate fiduciaries to move defaulted beneficiaries out of harm’s way. Still, these beneficiaries remain exposed to substantial risk in target-date funds as they near retirement, with 90% in risky assets consisting of 55% equities plus 35% risky long-term bonds. To underscore the importance of protecting beneficiaries at this perilous time, I discuss why markets are likely to crash soon and the potential extent of the damage.
This is not just market timing; it’s risk management in the Risk Zone.
The next crash will not be short-lived nor inconsequential. Beneficiaries will be shocked that they are not protected. Regulators will want to “fix” the problem, just as they did in 2009. TDF barn doors will shut after the horses bolt.
Stock and bond market crashes are overdue
Three years ago, Forbes published Recession Is Overdue By 4.5 Years, Here’s How To Prepare. Revisiting the logic in this article three years later, we are now overdue by 7.5 years primarily because we are in the longest bull market ever, especially if we brush aside the March 2020 nosedive as a fleeting pandemic blip.
The Forbes article reported that business cycles run about 4.5 years on average, give or take a year or two. A typical cycle begins with three years of expansion followed by one to five years of contraction (recession). As shown in the following exhibit, the current expansion is three times longer than historical norms. All expansions end. History says that the end of this current expansion is long overdue.
The Forbes article predicted a loss that reverses excess gains:
All the statistics above is to explain a simple concept. A booming economy will lead to a recession because the economy will overheat or create a bubble that will burst. The longer we artificially extend our expansion or economic boom, the bigger the recession we create. The natural business cycle’s economic boom will create more wealth than the recession will erode. When we artificially affect the economy, we throw the natural business cycle out of order. Thus, we may lose more than the wealth we’ve created during the economic boom.
But what will end this unprecedented expansion? In “ZIRP Danger: Zero Interest Rate Policy Impact on What’s Ahead, I say what everybody knows—that ZIRP has artificially buoyed up stocks and bond prices—but it has to end soon. I foresee:
The most likely spoiler is the Zero Interest Rate Policy (ZIRP) termination since rising interest rates decimate stock and bond values. The reduction in bond values is straightforward because bond prices fall when yields rise.
The impact on stock prices is more nuanced. Investment analysts estimate a fair stock value by projecting earnings and then discounting those back to today.
So, if interest rates rise, the discounted present value of future earnings declines, making a stock worth less. In fact, current low-interest rates (ZIRP) are the common justification for high stock prices, implying that stock prices would be lower if interest rates were higher.
In addition to the ultimate end of ZIRP, there is a whole host of threats to the US economy, any one of which will send it into recession. The economy is teetering on the brink of disaster for a variety of reasons. Economic tectonic plates are shifting.
The depth and length of the next crash
V-shaped versus U-shaped is the common distinction between recovery cycles. The following graph shows that the last recovery took place last year and the whole peak-to-peak cycle lasted just seven months. This was the fastest V-shaped recovery ever.
The graph also shows an exceptionally long U-shaped recovery. The peak-to-peak cycle from 1929-1959 lasted 31 years.
Note that the stock market, as measured by the Dow Index, suffered a sustained 40% loss from its 1929 peak that lasted for the 20 years 1931-1950. Recovery took at least 20 years, a lifetime to most baby boomers.
A repeat of this U pattern will decimate baby boomers because most do not have 20 years to recover, and they will be spending in the throes of a disaster, exacerbating the problem.
So, which will it be? U or V? The U-shaped history in the exhibit followed the excesses of the “Roaring 20s.” We are now in the decade following the “Roaring 2010s.” The similarity argues for a long and painful U-shaped recovery, starting in this decade and extending into the next decade and maybe even beyond.
Conclusion
In my previous article, I wrote the following regarding beneficiaries who have defaulted their investment decision to their employer:
“It is arguably unconscionable that sequence of returns risk, with its ability to derail a participant’s dignified retirement, is not addressed and quantified by regulators and plan fiduciaries.”
This article removes the typical current excuse that regulators and fiduciaries believe the next crash will be short and painless. This is not a realistic belief. The Fed will not save the day this time because it can’t—it’s exhausted its moves.
The next crash is likely to be a deep U-shape. It will be excruciating for those currently unprotected in the Risk Zone who unwittingly rely on their fiduciaries’ prudence.
Most importantly, the practice of using risky target-date funds must stop because there are safe, prudent choices. There was only $200 billion in target-date funds when the 2008 crash occurred, and baby boomers were not in the Risk Zone at that time. Today there’s $3 trillion in TDFs, and 78 million baby boomers are in the Risk Zone.
Both the stakes and the risks are extraordinarily higher than they were in the 2008 crash. The crash that is coming soon could be a doozy.
Ron Surz is CEO of Target Date Solutions (TDS), co-host of the Baby Boomer Investing Show (BBIS), and author of the book "Baby Boomer Investing in the Perilous Decade of the 2020s." TDS licenses target-date fund usage of Ron’s patented Safe Landing Glide Path® (SLGP) that actually protects beneficiaries as they approach retirement. Individual investors can follow the SLGP at Age Sage, an educational interactive website. The BBIS educates baby boomers on the risks and rewards in contemporary investing, and Ron’s book is a tour of these shows. He can be reached at Ron@TargetDateSolutions.com.
