Not So Predictable

Jonathan Clements

I’M STILL WAITING. Along with many others, I have spent much of my investing career expecting five key financial trends to play themselves out—and yet they’ve stubbornly refused to do so.

Sure, these predictions could still come true. But I have my doubts. Maybe these five financial forecasts aren’t the slam dunk they appear:

1. Stocks will revert to average historical valuations. Whether you look at price-earnings ratios, cyclically adjusted price-earnings ratios, dividend yields or Tobin’s Q, today’s stock market is expensive. But this isn’t exactly news.

Indeed, if investors were going to sell because of sky-high valuations, they would have done so long ago. Stocks have been pricey for much of the past quarter century, and yet share prices show no signs of returning to their 100-year average of 16.5 times trailing 12-month reported earnings. It seems that, in our increasingly wealthy world, we simply have too much capital pursuing too few investment opportunities.

This doesn’t mean valuations don’t matter. With P/Es so high and dividend yields so low, stock returns over the next decade will likely be modest—unless shares get yet another big boost from rising valuations. It could happen. But I wouldn’t bank on it.

2. Interest rates are headed higher. Two decades ago, when I was at The Wall Street Journal and the 10-year Treasury note’s yield was double today’s level, I recall talking to a financial advisor about immediate fixed annuities. “I could see buying them for clients,” the advisor allowed. “But I’d want to wait for higher interest rates.”

For many investors, that waiting game has been going on since at least the 1990s. To be fair, interest rates have moved somewhat higher. The 10-year Treasury is now at 2.96%, up from the low of 1.37% in July 2016.

Still, absolute interest rates remain grudgingly low, so nominal bond returns will almost certainly be modest in the years ahead. But just because interest rates are low doesn’t guarantee they’ll go higher. It’s always dangerous to assume that market prices, which reflect the collective wisdom of all investors, are wrong and that you know better. Instead, I would take the market at its word: Whatever interest rates are, that’s the best indicator of where they ought to be.

3. Inflation is coming back. One reason interest rates are low is because inflation, too, is at modest levels. Will it come roaring back?

If the 1930s forever colored the financial attitudes of those who struggled through that miserable decade, I think the same is true—to a lesser degree—for those of us who were around during the 1970s. It was a decade of high inflation, gas shortages, high interest rates and tumbling stock market valuations, and we worry that all of those will return. But will they? History may repeat itself if circumstances are similar—but it doesn’t repeat just for repetition’s sake.

4. Taxes are going up. Along with many others, I’ve long assumed tax rates are unsustainably low and will eventually rise. We already have a $900 billion federal budget deficit and face ever-growing federal expenditures on Social Security and Medicare. Offsetting these fiscal headaches are low interest rates, so servicing the ballooning federal debt hasn’t proven to be too much of a burden—so far.

The upshot: Instead of federal income-tax rates rising, they keep getting cut. True, those falling rates are often accompanied by the loss of other tax goodies, so it’s never quite clear whether folks are better off. Still, what we haven’t seen are big tax increases, despite all the gnashing of teeth over the federal deficit.

5. We’re facing a retirement savings crisis. There’s long been handwringing about the demise of traditional pension plans and the failure of workers to make good use of the 401(k) plans that replaced them.

While I think the concern is justified, I also think we recall a golden era that never existed. For instance, a Social Security Administration study found that among the oldest baby boomers, those born between 1946 and 1950, just 50% of households have traditional pensions—which means 50% don’t. The reality: There was no glorious past when all Americans happily retired with generous monthly checks from their former employers.

My contention: It isn’t that today’s workers are wholly unprepared for retirement. Rather, the problem is that they need to be much better prepared than earlier generations—because they face far longer retirements. This isn’t just a personal finance problem confronting every U.S. household. As I discussed in a recent article, if folks continue to retire in their mid-60s, we’ll have a nation—and, indeed, a world—with too few workers and too many retirees, and we simply won’t be able to produce the goods and services that society needs.

Somehow, we need to persuade Americans to stay in the workforce for longer, not just for their own financial sake, but for the sake of society. We could likely achieve that through some unappetizing combination of higher tax rates, higher inflation, wretched investment returns, and cuts to Social Security and Medicare.

That, of course, touches on all five of the long-expected developments discussed above. But maybe none will come to pass. Maybe, instead, many folks—for a mix of financial and other reasons—will decide they want to work into their late 60s and perhaps even their 70s. That’ll mean more goods and services are produced, and more taxes are paid. That, in turn, will help to restrain inflation and interest rates, while also boosting corporate profits and hence share prices. Result? We may never have to reckon with the five great reckonings that have long been predicted.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

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