COLUMN-US savers go all in on 'cult of equity': McGeever

By Jamie McGeever

ORLANDO, Florida, Sept 22 (Reuters) - U.S. pension funds and households have never held more equities as a share of their overall assets, by some measures, raising questions about whether the long-term shift towards stocks has run its course or whether investors have truly undergone a paradigm shift.

There are compelling arguments on both sides of that debate, but what's not in dispute are the numbers.

The share of stocks in U.S. private sector defined contribution (DC) pension plans is now approaching 70%, while equities as a share of U.S. households' financial assets is a record 45.4%.

John Higgins, chief markets economist at Capital Economics, notes that DC pension plans' equity exposure is the highest in at least 75 years. This largely reflects the decades-long shift away from defined benefit (DB) schemes, where the risk of retirement savings lies with the employer, and toward DC plans, where employees assume more of the burden.

Broadly speaking, DB plans tend to invest more in bonds, especially long-dated ones, to match the funds' longer-dated liabilities, while DC plans are equity-heavy, as individuals don't have liabilities to match and so will be more likely to lean towards stocks offering higher returns – and higher risk.

In the 1950s, more than 90% of all U.S. pensions were DB plans, and less than 20 years ago the split was roughly 50-50. But now, almost 80% are DC plans.

In that sense, investors are in a brave new world – and it could be an increasingly risky one, given that DC plans are so highly exposed to Wall Street at a time when U.S. stock market valuations are looking stretched.

FLAGGING RISKS

From a returns perspective, overloading on stocks makes sense for long-term investors because equities usually outperform bonds, especially over the long run.

By some measures, that performance gap is widening, according to figures from Truist Advisory Services' chief markets strategist Keith Lerner and his team.

As of August, the S&P 500's trailing one-year annualized return was nearly 16%, compared with the Bloomberg aggregate bond index's returns of just over 3%. The 12.7 percentage point gap is in the 68th percentile going back seven decades.

Moreover, the S&P 500's returns advantage when measured on a rolling three- and five-year basis is in the 93rd and 95th percentiles, respectively.

How long can equities sustain that level of outperformance over bonds?

NOT SO 'RISK-FREE'

The answer may be "a while".

The near 40-year bull market in bonds appears to be over. Worries about inflation remain, the U.S. federal deficit and public debt are rising, and pension funds' appetite for long-dated bonds may no longer be as voracious as it once was. In short, bonds don't appear quite so 'risk-free' any more.

If stocks do continue to outperform over the long term, that's obviously great news for future retirees with portfolios heavily weighted in that direction.

The danger, of course, is the stock market can fall sharply and very quickly, wiping out large swathes of savings for people just about to retire.

It's also true that many people reduce their exposure to equities in favor of bonds as they near retirement, although that may become less prevalent in the context of a wider paradigm shift in how bonds are viewed.

There's no indication that any dramatic equity market correction is on the horizon, though investors are conscious of how expensive stocks are getting. Still, they keep buying.

Although valuations are "unambiguously high by historical standards", Deutsche Bank analysts just raised their year-end S&P 500 target to 7,000 from 6,550 and next year's earnings per share forecast.

"High allocations to equities don't necessarily mean another major correction in the stock market is imminent. Indeed, our forecast is that the S&P 500 will make further gains this year and next, as enthusiasm for AI continues to grow," says Capital Economics' Higgins. "But high allocations to equities may be flagging trouble ahead."

That's true. But as long as equities keep providing the returns and outperforming bonds, prospective retirees will keep ploughing their pension savings into them.

(The opinions expressed here are those of the author, a columnist for Reuters)