The last year of lockdown life has left many Americans longing for change. What many really want is to chuck the pandemic, and they are starting to get their chance.
But today’s reopening world is colliding with a demographic reality that was crystal clear a decade ago. Even then, it was apparent that the 2020s would begin just as the big bulge of the baby boom generation was turning 65 years old, placing new stresses on America’s entitlement systems at the same time that all the 10-year Treasury bonds sold to finance trillion-dollar deficits from the Great Recession would need to be refinanced.
Labor economists were also predicting a looming shortage of workers back in 2010. What no one anticipated was that a pandemic would render previous deficits almost trivial in size, or that a 12-year bull market for financial assets would leave many clients of financial advisors far wealthier than they ever expected.
There’s now a tenuous connection between labor markets and financial markets, but however that plays out in the next few years, it is likely to define the post-pandemic world. For some who can afford it and others who can’t, a take-that-job-and-shove-it mentality has suddenly prevailed. And financial advisors are finding themselves in a prime spot to watch this behavioral and economic change unfold.
In Fort Worth, Texas, Michelle Connell, president of Portia Capital Management, has seen surging home prices in the Dallas/Fort Worth metroplex influence clients’ retirement decisions. “For the last year, home prices increased on average 9% for the metroplex,” she says. “However, where it’s interesting is that local home prices have increased on average 58% over the past five years.”
An influx of businesses from both coasts has led to a higher population in Texas, and these people are now competing for the state’s finite housing supply. “I have had local clients that were pushed towards an earlier retirement due to the significant increase in their homes’ value,” she reports. “They decided to sell their homes and relocate to smaller homes in quieter and less populated areas of the country.”
She’s also seen an M&A boom of sorts among her clients who own businesses, a trend driven by the rich valuations for the underlying businesses and the inability of the families to pass those companies on to heirs. This year, there’s a third reason they might be pushed to sell their businesses—the potential for much higher taxes.
That prospect for affluent Americans is prompting Connell to advise many early retirees to double-check their living expense estimates during retirement. The threat of inflation also now has them asking whether their estimated IRA distributions are going to be enough for their golden years. “We are also looking at the possibility of much higher taxes for all income levels. Retirees that will probably be most affected are those that are middle to upper middle class,” Connell notes.
Affluent retirees simply don’t spend most of their after-tax income. “It’s obvious who can bend more as taxes, inflation and interest rates rise,” she says.
A recent survey by the Chicago-based Spectrem Group found that just under a quarter of Americans with assets above $25 million have purchased a new home or some other type of real estate since the pandemic began. Some may be looking to move, possibly to a lower-tax state, while others are looking to profit off dislocations caused by Covid-19, Spectrem suggested. Mass-affluent citizens face a more limited array of options, but they are also weighing changes in residency.
Tom Connelly, president and chief investment officer of Versant Capital Management in Phoenix, has witnessed clients and employees deciding to move more frequently than usual. “It’s more than a coincidence. They may have been thinking about it,” he says. But people “are getting antsy.”
Some people considering retirement have accelerated their plans, Connelly reports. Most of his business-owner clients looking to grow are either finding it difficult to find the right employees or people who want to work at all.
Richard Florida and Joel Kotkin, two professors of urban studies, recently speculated in the Manhattan Institute’s City Journal that America may be witnessing the biggest geographic shift since the flight to the suburbs after World War II. Big cities were already being squeezed by affordability problems before the pandemic permitted people to work from home more efficiently. Yet Florida and Kotkin add that major population movements can be self-correcting. As prices in the suburbs and exurbs soar, bargains become available in the cities.
Some see echoes of the housing boom that followed the September 11 terrorist attacks. It all began innocently enough, as Americans realized “life is short” and asked themselves what was really important. Often, the answer turned out to be family and friends. What better way to enjoy loved ones than by buying a bigger house or adding a new wing to one’s existing home?
Savings As The Big Tell
Economists of all stripes believe we are in the foothills of a big upward slope in short-term spending pushed by pent-up demand after a year when many people’s favorite spending outlets were shut. Airline bookings are rising, as they are for cruise lines, hotels and restaurant reservations.
But it’s important to note where Americans’ savings rates finally settle after the pandemic ends, because the savings number holds vast implications for clients, advisors and markets alike. For a few months during the pandemic, the rate spiked to 27%, albeit with the aid of government checks. While some of that money flowed into the stock market, households also focused on paying down debt last year.
In the decade before 2020, the savings rate had climbed to about 8%, nearly double what it was in the years leading up to the 2008 financial crisis. Anecdotal evidence suggests the Covid-driven housing boom of the last year was financed on a more solid foundation, with larger down payments and fewer dodgy mortgages.
Last year’s recession was unlike any other in both its sharp, deep drop and its brief duration. “We’ve never had a severe recession like we had [last] year because we’ve never had a lockdown,” Ed Yardeni of Yardeni Research told attendees at John Mauldin’s Strategic Investment Conference in May. “Even people who lost jobs and got checks couldn’t spend it all.”
Most recessions, Yardeni said, are caused by credit crunches. But despite the massive issuance of government and corporate debt as a response to the pandemic, there hasn’t been a credit crisis. Remarkably, the junk bond market has seen very few defaults.
Yet there is another side to the savings story. Liz Ann Sonders, chief market strategist at Charles Schwab & Co., told attendees at the same conference that savings rates could remain elevated. That often happens after nasty recessions, as it did after the great financial crisis.
“If we don’t see a drop in the savings rate” and fiscal stimulus starts to fade into the rearview mirror, economic growth could sputter, Sonders said. This could result in a short-lived expansion, a stark contrast to the longer growth cycles Americans have grown accustomed to, after seeing only three recessions since 1991.
The idea of Americans not spending enough money might seem laughable. We’ve always been a nation that has lived up to its means, if not beyond it.
Yet another speaker at the Strategic Investment Conference, David Rosenberg of Toronto-based Rosenberg Research, showed that consumer spending by the cohort over 65 is almost 20% less than it is for the one ages 55 to 64.
Advisory clients are savers by nature, and many financial advisors can attest that retirees sharply curtail their spending when the paychecks stop. Research conducted several years ago by BlackRock’s retirement plan group found that many people two decades into retirement still held on to more than 80% of their 401(k) balances.
Robust stock markets clearly helped those balances, but savings have also been shored up because people change their spending behavior later in life. Retirees with more time on their hands discover new activities like cooking, which is cheaper and healthier than dining out. That’s all fine and well, but if the Woodstock generation suddenly turns into a gang of Ebenezer Scrooges, the ramifications for America’s consumer society could be far-reaching.
Productivity: The Magic Variable
How much people can save depends partly on how fast they return to work, which will dictate the shape of the recovery. Federal Reserve chairman Jay Powell and Treasury Secretary Janet Yellen have both said they want to see unemployment return to pre-Covid levels by the end of 2022.
Virtually all the participants at Mauldin’s event agreed that productivity should spike, as it almost always does when we emerge from a recession. Yardeni called it the “magic variable,” one that could eventually put pressure on wage increases and sustain profit margins.
“Productivity usually jumps 5%” after a recession, says Lacy Hunt, executive vice president and chief economist of Hoisington Investment Management. “It could do better this time.”
He also thinks reinvigorated trade will prompt deflation. During the pandemic, domestic manufacturers gained market share, and Hunt expects exporters to America to slash prices to recapture business.
This may not bode well for the jobs that Powell and Yellen are hoping for. As Rosenberg noted, U.S. output is almost back to within 1% of the level it stood at before the pandemic, even if the composition has changed, now that technology and durable goods sales are higher while travel and leisure business has fallen off.
There are reportedly 8.2 million job openings, almost the identical number of jobs still lost to the pandemic. But even though more jobs are definitely coming, it’s not clear they will reach 7 million or 8 million.
The poor jobs report in May caught virtually all economists off guard and lent credence to the argument that generous stimulus checks are discouraging unemployed workers from re-entering the labor market. Moreover, if the great recession experience is any indicator, it may not be that easy for all the job seekers to reconnect with employers.
The pandemic left the vast majority of skilled, college-educated workers unscathed and the pain fell disproportionately on less-educated, lower-paid people. “If unemployment moves down to 4%, is it spread across industries and wealth categories?” Sonders asked at the Mauldin conference.
Another wild card is whether the three-million-plus people who retired in 2020 can afford to stay out of work. Before the pandemic, people over 65 were the fastest growing sector of the workforce.
Aging populations and shrinking labor forces are a global challenge. Germany and China, the world’s two most powerful exporters, are losing workers faster than America, according to Karen Harris, managing director of global macro trends at Bain & Co.
Lockdown Endgame: A Debt Crisis?
When pandemic life is all over, there is likely to be a major reassessment of America’s response to Covid-19. A growing school of thought holds that there was an overreaction that will cost the country for decades.
Versant Capital’s Connelly notes that the nation spent almost as much in one year to defeat the virus as it did to win World War II. Two decades ago, the national debt stood at $5 trillion. Today, it is approaching $30 trillion, and nearly 40% of that was created in the last year.
The Unites States’s fiscal spending as a percentage of GDP climbed 25% as the government fought the pandemic, while that figure was only 16% in the U.K., 11% in Germany and 5% in China, Harris told attendees at the Strategic Investment Conference. America “set the bar much higher on what we’re willing to spend in an emergency,” she said.
This year, America joined with Canada, the European Union, South Korea and Japan in declaring climate change an emergency, too. How that plays out will be unpredictable, Harris said.
Lockdown critics point to a plethora of problems that harmed wide swaths of the population last year. These range from valuable education lost by the nation’s youth—some places reopened schools in reaction to rising suicide rates—to higher levels of depression in seniors to surges in cancer and heart disease left untreated for too long.
A former chief investment officer of the Arizona State Retirement Fund, Tom Connelly is more familiar with the challenges of matching assets and liabilities than most advisors. While he thinks the measures taken during the financial crisis a decade ago were sound and reasonable, he fears this time fiscal and monetary authorities have gone too far.
“If you look at contingent unfunded government guarantees, it’s nine to 10 times GDP,” he says. “There is a massive refinancing risk. What does it mean for future returns? We haven’t seen the consequences. It’s generational theft.”
Lacy Hunt also has fears about the economy, but they differ significantly from Connelly’s. “This is the sixth debt bubble in U.S. history,” he said at the Strategic Investment Conference.
All these bubbles resulted in deflation or disinflation, and he expects this time to be no different. It’s true that the government sector is eating up savings that ideally should go to generate growth.
But when he looks at the world’s other major economies, Japan, Europe and China, their problems are even worse. In the U.S., the total debt-to-GDP ratio stands at 370%. In Europe, that figure is about 500%, and in Japan it is 650%. All three economic zones are afflicted with birth rates collapsing faster than those in the U.S., Hunt adds. That’s another reason why the “marginal revenue product of debt” is falling faster in the rest of the developed world, he explains.
If there is any scenario we should fear, “it’s Japan, not Weimar Germany,” Yardeni said. Summer school may not be where one wants to be, but at least America is the smartest kid among the dunces.