On August 5th, the Alight Solutions 401(k) Index reported a high level of trading activity—2.78-times the normal level—towards fixed income. The trading spike came after a two-day drop in the S&P 500 of nearly 3.7%.
According to Rob Austin, vice president and director of research for Alight Solutions, the spike in trading activity was about as surprising as it was well-timed.
“Followers of the index will know that when we see the market tumble we tend to see trading activity spike towards fixed-income,” Austin says. “While we expected to see the spike in trading, I will say I was a little bit surprised with this one. The reason is that so far this year, as the market had been going up, people had mostly been selling out of equities and into fixed income.”
Generally speaking, that’s the “correct” thing to be doing, selling assets while they are priced high and buying assets that are discounted.
“So, leading up to this week, people were demonstrating more positive trading behaviors for 2019,” Austin says. “But sure enough, the market dipped this week, and we saw three-times the trading of an average day, and the money was going out of depressed equities and into inflated fixed income. So, it’s disappointing.”
Important to point out is the fact that these ill-timed trades are still occurring in a small fraction of accounts. The average day of trading as measured by the Alight Solutions 401(k) Index is 0.016% of balances trading per day.
“What we saw on Monday was 0.044% of balances trading,” Austin says. “In absolute terms, it’s still quite a small percentage of balances that end up getting traded at the wrong time. Of course, it’s still a shame that this is happening. Even if it’s a small number of people we want them to avoid these negative behaviors.”
Thinking About the Trade War, and ‘Stuckflation’
Reflecting on the current global market conditions, Bob Browne, chief investment officer, Northern Trust, is much more neutrally minded than alarmist, noting that his base-case expectation for the next several years does not include a likely recession. However, beyond the trade tensions between the U.S. and China, Browne is concerned about an emerging market dynamic he calls “stuckflation.” This refers to the idea that inflation will be stuck at lower levels over the next decade than one would expect based on the historic behavior of the markets. Low inflation, he says, can have a ripple effect in the economy, impacting interest rates and many other important factors.
“We believe that muted growth in global demand and timid policy responses suggest low inflation is here to stay for some time,” Browne says. “Most major central banks continue to miss their 2% inflation targets, and supply-side forces driving this dynamic remain strong. Technological innovations, along with vast troves of data, are enhancing price discovery and optimization techniques globally. This is reflected in low interest rates and flat yield curves.”
Putting the argument in different terms, Browne cites the example of how Amazon has disrupted the online retailer marketplace.
“Even though Amazon says it is considering paying its workers $15 as a minimum wage, which would support inflation, it’s also using new technologies to drive long-term costs out of it business model. Amazon is, in this way, putting incredible competitive pressures on the online and in-person retail industries at large,” Browne says. “That’s just one example of how a large, powerful firm is using technology to keep prices lower. This drives competitors to do similar things, leading to deflationary pressure. The other important factor here is that it has become very easy for any of us today to simply Google what is the right price for this television or that coat. These are two systematic factors that will lead to lower inflation.”
For retirement plan investors, inflation is often seen as a negative—how do you keep up with inflation and beat inflation? With that thought in mind, it might not seem like bad news for long-term investors that inflation will be stuck at low levels. On the other hand, however, basic economics indicates that controlled inflation is an important part of a healthy global economy that is growing.
“It’s not a bad environment to take debt, as rates remain relatively low today and we think they will [remain so] for some time,” Browne says. “But as a retiree thinking about income in this environment, you’ll be hard pressed to find adequate income just from bonds and safe assets. You’re going to have to take more risk to meet the funding needs. The search for yield is going to put the focus on high quality stocks, real estate investment trusts [REITs], high quality fixed income, and other investments that can generate decent income.”
Zooming into the China-U.S. relationship, Browne says this is “a really big deal for the markets,” and it will by all accounts remain so.
“What has happened in 2019 is that the two largest economies in the world have changed the tone and the nature of their relationship,” Browne says. “Until recently, the marketplace expected the U.S. and China would, year over year, continue to integrate and overlap their economic systems. Increasingly, it seems the two spheres are instead pulling apart. They won’t ever separate completely but they won’t be overlapping as much as the market was assuming.”
As Browne and others explain, investors seem to increasingly believe there is less of an opportunity for China and the U.S. to end up in a win-win situation.
“There is more of a sense that both sides view each other as a competitive threat, and this has changed the relationship fundamentally looking forward,” Browne says. “[Plan sponsors] have to get used to this as another part of the new normal. It remains to be seen how much long-term economic growth could be taken out of the global economy as a result of the declining symmetry. It’s also another deflationary force.”
Long-Term Perspective Remains Critical
Bob Waid, managing director at Wilshire Associates, points out that the recent market moves have had an outsized impact on those with greater exposure to the global markets.
“Even before the recent bout of market volatility, international equities had underperformed for the year,” Waid says. “You typically hope that global diversification pays off, but in this case it didn’t. Another factor is that, when you have high volatility, there are money managers out there that are going to take defensive moves that then cause investors to underperform the market when the upside comes. All of these things have tied together this year.”
According to Waid, diversification into private equity funds has also negatively impacted institutional investors so far in 2019, but he expects the situation to be temporary.
“One of the themes that you hear all the time from really successful investors is that you have to have a long-term perspective and you have to stay the course,” Waid explains. “You will be rewarded for your courage to ride it out. This proved to be true in a big way for people who rode out the Great Recession. It’s true right now as well. Those people who stayed the course from Q4 2018 through the last few weeks have done well. It’s the whipsaw days in the market that cause people to make poor decisions.”
During bouts of market volatility, pensions and perpetual trusts such as university endowments have an inherent advantage over individual accounts.
“Retail individuals like you and me, we’re looking at retiring sometime,” Waid observes. “For this reason, we may not always have the luxury of a 10-plus year view. We have to make sure we aren’t exposing ourselves at the wrong time. For anyone who is on the younger side, you can act like a pension and keep that long-term view. Jack Bogle used to always tell me, buy the entire market and hold it forever and you’ll do great. It’s a bit tongue in cheek but it’s an important lesson.”
Retirement investors, in this way, find a fundamental tension between addressing sequence of returns risk versus taking advantage of what markets do in the long-term, which is go up. It’s a huge challenge for the defined contribution (DC) plan space to balance near-retirees’ need for continued growth with their need to avoid losses near the retirement date.
“Sometimes when we talk about solving this tension between solving sequence of returns risk and taking advantage of long-term market growth, people start to think this sounds like market timing. But really it’s not,” Waid adds. “It’s about understanding when you have to shift form risk assets to safer assets in a rational way. It’s having a strategic plan in place and not trading on fear near retirement. It’s not an easy message to get across to novice investors. It’s why dollar cost averaging investing from the retail perspective typically pays off, because you take the emotion out.”