CalPERS Projected Returns vs. Reality

Whenever CalPERS, or any government worker pension fund, suggests that a long-term projected rate of return of 7.75% is realistic and prudent, one needs to consider the following: Across every major stock index in the U.S., and on most indexes in the rest of the world, publicly traded stocks have been down for the last 12 years. Here is a chart of the Dow Jones Industrial Averages staring in January 2000, and running through last week:

What is immediately clear from viewing this chart is that where the index began, nearly 12 years ago, and where it is now, are pretty much the same. To be precise, the Dow entered the week of January 4, 2000 at 11,522, and the Dow entered the week of August 8, 2011 at 11,269 (ref. Yahoo Finance – DJIA 1-2000 to 8-2011). The Dow has actually declined over the past 10.5 years.

Moreover, this loss of equity value should be measured using inflation adjusted dollars, not nominal dollars. If you review the Consumer Price Index from the U.S. Dept. of Labor, you will see that in January 2000 the index stood at 168.8, and in June 2011 (latest figures) the index stood at 225.7. This means that it would take $1.33 today to purchase what $1.00 would have purchased in 2000. From this perspective, the Dow index today would have to stand at 15,406 just to have kept up with inflation. Put another way, in real dollars, the Dow has lost 2.67% per year for the last 11.5 years.

One might argue that the Dow is not representative of the U.S. equities market, because the arcane formula that governs its calculation only incorporates a handful of blue-chip companies. Fine. Let’s take a look at the S&P 500, an index that tracks 500 of the largest publicly traded companies, most of them based in the U.S. and traded on the New York Stock Exchange:

On this chart it is obvious that even in nominal dollars, the S&P 500 is lower today than it was nearly 12 years ago. As it is, the S&P 500 entered the week of January 4, 2000 at 1,441, and the Dow entered the week of August 8, 2011 at 1,179 (ref. Yahoo Finance – S&P 500 1-2000 to 8-2011). When you take into account inflation, the S&P 500 today would have to be at 1,927 just to break even with where it was 11.5 years ago. Put another way, in real dollars, the S&P 500 has lost 4.19% per year for the last 11.5 years.

To be sure, back in 2000, these stock values were elevated because of the internet bubble, which one might argue makes 2000 an unfair choice to pick for the base year. But 2000 was the year when government worker pension benefit formulas, in one government organization after another, were increased from sustainable levels to unsustainable levels, a permanent adjustment based on this bubble. Since 2000, reality has reasserted itself with a vengeance, yet both the government pension fund managers and the union leadership who represent government workers continue to insist that 7.75% is a realistic long-term rate of return. In any event, nobody is arguing that the 2000 stock indexes were overvalued, which skews the last 11.5 years of return data. But are these stock indexes undervalued today?

One way to answer this question is to look at the aggregate price/earnings ratios for the stocks in the S&P 500. For the last half of the 20th century, the aggregate P/E for the S&P 500 was 16.48  (ref. Price to Earnings ratio of the S&P 500 well above historical average,” by Howard Spieler, written in 2002). Turning to data compiled by Robert Schiller from the Yale Dept. of Economics, S&P 500 PE Ratio by Year, one can see that in 2000 the aggregate P/E for the S&P 500 was an unsustainable 43.77. But one can also see that today that ratio is a lower, but still higher than normal 20.34. Corporate earnings are healthy. If there is a rational basis for anyone to expect U.S. equities to go up, I’d like to hear it.

It is in this context that government worker pensions, which taxpayers guarantee when Wall Street’s rosy promises greet reality, must seem a bit extreme to those of us who may only expect to receive social security at age 68. The fact is, government worker pension funds are the biggest players on Wall Street, and the unions who negotiate pension fund benefits for government workers and force taxpayers to pay tithe, are nothing more than collection agents for Wall Street.

Anyone who is just beginning to realize that government worker pension funds, who promise 7.75% returns in an environment of crippling consumer debt and asset deflation, are basically agents of Wall Street with government worker unions as their collection agents and enforcers, should read the July 25th New Yorker article “Mastering the Machine.” In this article, a spectacularly successful hedge fund manager who includes among his clients government worker pension funds, has this to say: “In order to earn more than the market return, you have to take money from somebody else.” This is absolutely true – over the past 10+ years, as Wall Street speculators have gotten spectacularly rich, government worker unions have been bought off with promises by their pension funds of over-market gains. But the indexes have been down during this period. Small investors have indeed been decimated, at the same time as taxpayers have seen increasing amounts of their taxes sent to Wall Street to sustain the solvency of government worker pension funds.

Referring to government employees who retire in their mid-fifties with pensions that average well over $60,000 per year as “working people” is more than an insult to working people who retire in their late sixties with social security benefits that average $15,000 per year, it is a crime, perpetrated by Wall Street, with government worker unions providing the political muscle. More money is paid out each year to retired government workers, who comprise barely 20% of the workforce (but 30% of retirees because they retire so much earlier), than is paid out via Social Security to the entire remaining retired population.

The way to start to reform this mess is to take any taxpayer funded retirement program – such as social security, along with any taxpayer guaranteed retirement program – such as government worker pensions, out of the hands of Wall Street speculators. This would require a pay-as-you-go system, where assessments on current workers are used to pay benefits to retired workers. In turn, this would finally expose Wall Street’s last, biggest con, the idea that somehow 7.75% rates of return can relieve taxpayers of having to pay for government workers to enjoy retirement security literally five times better (or more) than social security.

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