B (^4) | REPORTONBUSINESS O THEGLOBEANDMAIL | WEDNESDAY,SEPTEMBER11,
OPINION&ANALYSIS
DILBERT
I
get asked constantly about the
extreme degree of risk in the
world today. Of course, my an-
swer is that the level of risk is at an
extreme high, but the thing about
risk is that the range of outcomes
is still known – and it can be
priced.
The real problem is uncertain-
ty: The range of possible out-
comes is not known and, unlike
risk, it cannot be priced. And be-
tween global trade tensions, U.S.
2020 election unknowns (and the
crucial implications for fiscal pol-
icy), Hong Kong strains, Argenti-
na default risk, Brexit, Iran and
North Korea, uncertainty has
rarely been as high as it is today.
This includes other very tense pe-
riods such as the financial crisis,
the tech wreck and 9/11.
The way economists “model”
this out in their GDP equations is
to introduce a “dummy variable”
to capture episodes of extreme
uncertainty – uncertainty that is
reflected in the private sector’s
rising preference for liquidity and
climbing savings rates. At last
count, the drain to global GDP
growth from all this uncertainty
is fast approaching one percent-
age point for both this year and
next.
We also have to factor in the
U.S. Federal Reserve’s policy mis-
step of having tightened too far
this cycle, taking the funds rate at
least 100 basis points above our
estimate of where the neutral rate
is – even if the central bank has
been trimming back of late. This
is one area where I agree with U.S.
President Donald Trump – be-
tween the nine hikes and the
quantitative tightening, the Fed
has effectively tightened policy
by nearly 400 basis points this cy-
cle. When the policy lags are tak-
en into account, rare is the day
that such restraint has not caused
a recession to follow suit.
The 2002-07 expansion was
built on an abundance of liquid-
ity where nearly free money engi-
neered a mortgage and housing
bubble of epic proportions. The
current cycle was fuelled by an
even more dramatic and pro-
longed effort by the central banks
to borrow freely and generate as-
set inflation that in turn would
propel a “wealth effect” on spend-
ing. Well, we got the asset infla-
tion all right, but with it came a
massive widening in wealth in-
equality, which takes us to new
extremes in terms of social insta-
bility. Meanwhile, the impact on
spending was minimal.
In fact, the economic expan-
sion ended up being so feeble that
real GDP, fully more than a dec-
ade into this cycle, is some 15 per
cent below the trendline it would
have been on had this recovery
been anywhere close to normal.
From my lens, the damage is
done. The deepest negative ef-
fects from the U.S.-China trade
war lie ahead, especially this lat-
est round that hits a broad array
of household goods. The recent
macro data have been skewed by
pre-tariff, precautionary spend-
ing by consumers and the same is
the case on the inventory front by
the business sector – the latter
point highlighted in the latest
surveys by the Institute from Sup-
ply Management.
The collapse in business in-
vestment globally, relative to
where desired savings are, has
been the critical factor behind the
slide in market interest rates this
year. That is the explanation that
somehow gets muddled in the de-
bate. Not to mention we are see-
ing deepening deflationary ex-
pectations, which is the only fun-
damental reason why an investor
would buy a long-duration bond
with a negative yield. It should
not be lost on anyone that what
made this cycle unique is that for
the first time ever, an economic
expansion failed to close the out-
put gap.
And now with the leading indi-
cator of the Organization for Eco-
nomic Co-operation and Devel-
opment slipping in each of the
past 18 months, to the lowest level
since 2009, this output gap will
widen and exert downward pres-
sure on prices. That this hap-
pened with global inflation peak-
ing this cycle at an unpreceden-
ted low level of 2 per cent, half the
4-per-cent high of the previous
cycle, and looking at how far in-
flation rates fall in global eco-
nomic downturns, one can surely
be forgiven for maintaining a de-
flationary view and investment
strategy. This is why the rally in
high-quality bonds, rate-sensitive
and non-cyclical equities, gold,
silver and defence-industry
stocks will not end soon, and peri-
odic pullbacks in any of these
should be treated as buying op-
portunities.
While investors focus on how
low U.S. Treasury yields are, what
they fail to see is how high they
are relative to the rest of the
world. These securities have an
average rating of AAA and trade
at a premium to many lesser-
credits around the world. Plus
you get paid in greenbacks, which
tend to be in short supply in peri-
ods of high anxiety and uncer-
tainty.
One other thing about Treasu-
ry notes and bonds – two in fact.
What they have that nothing else
possesses to the same degree are
safety and liquidity. Safety in that
you know full well what you get
paid upon maturity – that is true
even with a negative-yielding
bond, which is akin to putting
your valuables in a safety deposit
box for a fee for safe-keeping.
That’s the theme here – how to be
safe, even for a fee, in uncertain
times. And liquidity is key, be-
cause while it’s close by when
times are good, it’s awfully hard
to find when things get rough.
Liquidityisvitalintheseuncertaintimes
Fromtradespatsto
geopoliticalstrains,
volatilityrulestheday
–butbondsandnotes
canoffersomesafety
DAVID
ROSENBERG
OPINION
ChiefeconomistwithGluskinSheff+
AssociatesInc.andauthorofthe
dailyeconomicnewsletterBreakfast
withDave
Thecollapsein
businessinvestment
globally,relative
towheredesired
savingsare,has
beenthecritical
factorbehindthe
slideinmarket
interestratesthis
year.Thatisthe
explanationthat
somehowgets
muddledinthe
debate.
F
or the past 20 years, many
private-sector companies
across Canada followed the
same risky strategies for their de-
fined-benefit (DB) pension plans
as they did in previous decades.
Unfortunately, over this time
these strategies cost stakeholders
almost $158-billion and jeopar-
dized the retirement security of
millions of Canadians.
As a result, many companies
have abandoned these perilous
approaches, but a surprising
number have not. To better un-
derstand why new strategies are
needed, think of the DB pension
plan as a division of the company
- the DB Pension Division.
A company’s employees lend
the DB Pension Division money in
the form of deferred wages. In re-
turn, the company promises to
provide a pension to those em-
ployees when they retire. Until
then, the DB Pension Division in-
vests this money with the goal of
being able to pay these promised
pensions.
However, many DB Pension Di-
visions are investing this money
in a way that’s mismatched from
the bond-like promises they
made to employees. They make
bets on equity markets and inter-
est rates in the hopes of generat-
ing excess returns that will make
it cheaper to pay these promised
pensions.
Imagine – what do you think
would happen if you went to your
CFO and told her that you had a
great idea for a new business. You
want to borrow money and invest
it in the equity markets to gener-
ate excess returns for sharehol-
ders. I suspect you’d find that it
would be a pretty short and ca-
reer-limiting conversation!
So why would this idea work
for a DB pension plan? What’s
clear is that for the past 20 years, it
has not.
After a lot of ups and downs,
the average DB Pension Division
is essentially in the same place
that it was 20 years ago from a
funded-status perspective.
In fact, the typical company
contributed significant dollars to
its DB Pension Division during
this period. According to Statis-
tics Canada, companies in Canada
contributed almost $158-billion
between 1999 and 2018 to shore
up deficits in their pension plans.
This means that a typical DB Pen-
sion Division earned a negative
return – destroying value for sha-
reholders who invested in the
company.
If the business model had been
successful, the typical DB Pension
Division would be well over 100-
per-cent funded by now and these
$158-billion of contributions
wouldn’t have been required.
It’s not surprising that some
DB Pension Divisions stuck with
their historical business models
over the past 20 years. After all, in-
terest rates were at historic lows
and were widely expected to rise
and equity markets had a long
history of providing excess re-
turns.
So why didn’t things turn out
as expected? The business model
involves making multiple bets on
equity markets, interest rates,
credit conditions, foreign ex-
change rates and life expectancy.
Companies need to win all these
bets consistently as the gains
from good bets can be wiped out
by the losses from bad bets.
Making multiple successful
bets with the DB Pension Division
is very hard to do – especially giv-
en the increased unpredictability
of the markets over the past 20
years. In addition, most compa-
nies rely on the same investment
managers as their competitors,
which doesn’t create a competi-
tive advantage for their sharehol-
ders.
Given these challenges, many
forward-thinking companies areconcluding that the DB Pension
Division’s business model no
longer works – an appropriate
conclusion for a division that’s
been losing money for 20 years.
The first step these companies
take is realizing it’s better to take
risk in their core business rather
than in the DB Pension Division.
General Motors was one of the
first companies to articulate this
strategy. In 2012 Jim Davlin, vice-
president of finance and treasurer
at General Motors, said: “We’re in
the business of making great cars- that’s our core competency. It’s
not managing pension invest-
ments to provide a lifetime in-
come to folks.”
The second step these compa-
nies take is changing the business
model of their DB pension plan to
embrace better risk manage-
ment. These companies are in-
vesting plan assets to match lia-
bilities and/or transferring por-
tions of their plans to insurers
through the purchase of annui-
ties.
The bottom line? Everybody
pays the price for a failed DB Pen-
sion Division. Let’s not lose track
of why we created pension plans
in the first place – to help Cana-
dians be ready for retirement.
Isn’t it time to adopt better risk
management and switch to a
business model that works?TheDBpension-planbusinessmodelhasfailed–andwe’reallpayingaprice
GeneralMotors,whose
Oshawa,Ont.,assembly
plantisseenabove,
wasoneofthefirst
companiestotakerisk
initscorebusiness
ratherthaninits
defined-benefit pension
plan.EDUARDOLIMA/
THECANADIANPRESSBRENTSIMMONS
OPINIONSeniormanagingdirectorandhead,
definedbenefitsolutionsatSunLife