The Markets
There is no
substitute for mental preparedness. Just ask any professional athlete or Navy
SEAL. One essential aspect of metal preparation is situational awareness – being
able to identify, process, and understand what is happening around you at any
given time.
That’s been a
challenge for bond investors this year. 2014’s Treasury market rally took
economists (and everyone else) by surprise:
“Treasury yields
lurched higher in May 2013, when the Fed first sketched out a timetable to wind
down its bond-buying program, even though it didn't actually begin the winding
down until seven months later. Yields were expected to keep rising this year as
that program ended and the Fed turned its attention to raising its short-term
policy rate but, instead, yields have fallen as investors still seem enamored
of bonds.”
A Bloomberg survey (August 8-13) found
economists’ median forecast projected 10-year Treasury yields would be 2.7
percent by the end of September. The yield on 10-year U.S. Treasuries finished
last week at 2.34 percent.
It’s likely bond
market surprises may continue during the next few months. In fact, bond
investors may want to mentally prepare themselves for a rough and bumpy ride.
It’s likely analysts and investors will try to anticipate the Federal Reserve plans
for increasing interest rates, and it’s not all that hard to imagine the type
of volatility that could ensue. All you have to do is think back to the ups and
downs that punctuated guesses about when the Fed might begin to end its bond-buying
program.
Barron’s offered the opinion the first rate hike
won’t happen until March of 2015, but that won’t stop anyone from speculating it
could happen earlier. Conjecture, rumor, and supposition are likely to begin
before the Federal Open Market Committee meeting on September 16, 2014.
No matter how
markets twist during the next few months,
investors should keep their wits about them. Being mentally prepared may help.
life
expectancy has been increasing by 15 minutes every hour for the
last 50 years or so in the richer countries around the world,
according to The Economist. That’s an
increase of about 2.5 years per decade.
Longer lifespans are a mixed
blessing. On the one hand, people may enjoy longer lives. On the other, the
longer people live, the greater the chance that longevity risk – the possibility
that life expectancy will exceed expectations – could negatively affect people,
companies, and governments around the world.
One way to measure longevity
risk is by estimating the cost of an aging society. The International Monetary Fund’s (IMF) 2012 Global Financial
Stability Report calculated the potential cost of providing everyone in the
world, age 65 and older, with the average income necessary to maintain his or her
standard of living at its preretirement level. By 2050, assuming a replacement
rate of 60 percent of preretirement income, the cost would be about 11.1
percent of gross domestic product (GDP) in developed economies and 5.9 percent
of GDP in emerging economies – and that doesn’t include increases in health and
long-term care costs. If longevity increases by three years, the estimated
costs go up by almost 50 percent!
Insurance companies,
employers with defined benefit (DB) pension plans, and governments are exposed
to significant longevity risk. Insurers offer products designed to provide
lifetime income. Employer-sponsored DB plans promise lifetime payments to
employees who meet specific criteria. Governments with pension programs have
made similar promises to citizens.
Many entities are looking for
ways to effectively reduce their exposure to longevity risk. One way to manage
longevity risk is to share it. An example would be to develop a “liquid
longevity risk transfer market” where,
“…The “supply” of
longevity risk would meet “demand” for that risk. That is, the risk would be
transferred from those who hold it, including individuals, governments, and
private providers of retirement income, to (re-) insurers, capital market
participants, and private companies that might benefit from unexpected
increases in longevity (providers of long-term care and healthcare, for
example). In theory, the price of longevity risk would adjust to a level at
which the risk would be optimally spread through market transactions.”
The overall longevity risk
market could be sizeable. According to Risk.net,
current global annuity and pension-related longevity risk exposure is between
$15 trillion and $25 trillion.
Weekly Focus – Think About It
“Some cause
happiness wherever they go; others whenever they go.”
--Oscar Wilde,
Irish writer and poet
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