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July 22, 2005

The Pension Crisis is Upon Us
by David Chapman

For a number of years now there have been alarm bells sounded about the huge growing under funded liabilities of both US and Canadian employee pension plans. At stake are billions of dollars that both US and Canadian corporations have not provided to employee pension plans and as a result the pensions of millions of workers in both countries are at risk. We might add that this phenomena is not limited to North America as millions of workers pensions are at stake in Europe as well. Even as bad as many Canadian pension funds are they can take little comfort in the knowledge that in the US it is worse. The reason is more conservative or realistic assumptions for future investment returns for Canadian pension plans then in the US.

Small comfort it is when one discovers that over half of 1200 Canadian corporations have reported they are under funded and of these over half of them are under funded by more than 10%. They include some of the best known names that should not come as a surprise including Nortel (NT-TSX), Bombardier (BBD.SV.B-TSX) and of course Ace Aviation (Air Canada) (ACE.B-TSX). But others while well known are not listed companies such as the Ontario Municipal Employees (OMERS) and the huge Ontario Teachers Pension Plan.

In the US the situation is even worse. It is no surprise that the bankrupt airlines such as Continental and United have major under funded problems. Indeed United Airlines passed their pension plan over to the government's Pension Benefit Guarantee Corporation (PBGC) which itself is $23 billion in deficit. The airline sector alone is under funded by $31 billion on a termination basis but so are many of American's largest corporations. Some include General Motors (GM) $47 billion, Ford Motor (F) $22 billion, (both these numbers are worst case assumptions - Executive Intelligence Review May 27, 2005) while others include Lockheed Martin (LMT) $4.88 billion, DuPont (DD) $3.5 billion, Pfizer (PFE) $2.98 billion, IBM (IBM) $7.38 billion, Exxon Mobil (XOM) $11.5 billion and many more (GMLSRC Pension Shortfalls - June 23, 2005).

Of course the under funding is not just corporations. The Canada Pension Plan has noted problems but recent adjustments to it should ensure that Canadians would receive at least a minimum payout. Possibly not so lucky are Americans where President Bush has said it is full of worthless IOU's (no kidding as if US Treasuries are worthless IOU's or maybe he is signalling the biggest default in history) as he pushed reform of Social Security and wanted to hand over a portion to the stock market through the investment dealers.

But pushing some amount of Social Security onto the stock market is not necessarily the solution. Indeed it could make it worse. President's Bush's privatization of social security is going no where in congress and has proven to be a hard sell with the people.

Social Security can be placed on a sound footing with some adjustments to contributions but everyone should realize that this is just for a minimum basic pension. The real pensions lie in the thousands of both private and public pension plans. Here the chances of saving them are not as clear. In John Maudlin's article "Public Pensions, Public Disasters" (John Maudlin weekly E-letter June 17, 2005 John@FrontLineThoughts.com) he said "Let's do a little back of the napkin math". John said that the companies assume about 8-9% forward earnings in their plans. While median plans earned 10.8% last year you're still in trouble because you are still under funded. Most portfolios are 60% stock and 40% bonds. Assuming bonds earn 5% then you must earn 10% every year in stocks to achieve your goals.

Tricky according to Maudlin. S&P 500 earnings show only average of 7% growth in the past ten years which included the bubble years of the late 1990's and the mild recession of early 2000's. So in order to get 10% on the stock market P/E multiples which remain at or near record highs will have to get even higher over the next several years. Over longer periods of time earnings in a best case scenario are more likely to grow even less at 6%. Since we are already at all-time highs of earnings to GDP it is not likely to produce any where near the desired results.

Estimated deficits of roughly 1100 companies with under funding of at least $50 million that have reported to the PBGC was estimated at around $354 billion in 2004 representing roughly a 69% funded ratio. These pension funds covered roughly 15 million workers and retirees. PBGC estimate that the total corporate under funding is about $450 billion and growing at roughly 25% per year at current rates. Add in shortfalls of municipal and state pension funds and shortfalls are edging a trillion dollars (public pension shortfalls estimated at $700 billion). At current rates of under funding the trillion dollar problem will very soon be a two trillion dollar problem given low interest rates and sluggish growth in the stock market.

Maudlin sees little hope of escaping the problem. Indeed it gets worse as firms dump their problem on the PBGC as United Airlines already has. All that does is shift the problem from United's books to the tax payer. There is only three ways that we can see out of this problem. One is that inflation takes hold and inflates the problem away. Second millions of workers will have to accept sharply less than they were promised and some may get little to nothing (outright repudiation). Thirdly if corporations were to actually pick up the problem or be legislated to fix the problem corporate profits will be sharply reduced, non-existent or outright losses for years to come. That would not please shareholders and the stock market would either flat line for years or go down.

And trying to legislate the problem is where lawmakers are trying to go. In the US a bill has been initiated known as H.R. 2327 that proposes to impose a 6-month moratorium on terminations of plans. This would include plans such as United Airlines and its dumping on the PBGC. In Canada the Liberal government has introduced legislation that would require companies in bankruptcy to pay pension plan contributions before paying debts to secured lenders. The bill would also prioritize unpaid wages by bankrupts for some amounts to workers. Finally the bill would create additional insurance funds for unpaid workers. Bankrupt companies would be obligated to pay wage arrears and pension payments before paying secured lenders.

Don't expect these bills to go anywhere. Either lenders would stop lending to corporations or at the least would demand a far higher interest rate to compensate them. Once again the risk and the problem will be shifted back to the worker who is now discovering his pension plan is not what it he thought it would be and once again we are back to sharply reduced benefits or repudiation the most likely outcome of all of this. And of course years of legal action as workers attempt to regain what is/was? rightfully theirs. Of course some believe certainly in the case of public pension shortfalls that the taxpayer will bail them out. Not likely either as the pressure remains to cut taxes not hike taxes. And then there is the current huge $400 billion plus budget deficits plus many billions more to finance the war in Iraq and Homeland Security where the emphasis has shifted. Add in the $600 billion plus trade and current account deficits and one can almost see the futility of this.

If the current funding shortfall is pensions the future funding shortfalls will soon be on Medicare and Medicaid. And here in Canada the pressure has been on health care for years and never seems to go away despite the fact that Canadians spend far less of a percentage of GDP on health care (roughly 10% vs. 15% in the USA). You combine all the above - tax cuts, pension shortfalls, health care under siege on both sides of the border plus add in sluggish employment with pressure to cut unemployment and welfare benefits and tightened rules for bankruptcy in the US and add back in the huge deficits in budget and trade plus growing costs for Homeland Security and the war and you have the potential for the complete unravelling of the society that was built following the Great Depression and WW2.

Jim Sinclair (www.jsmineset.com) calls it the growth of Authoritarian Free Enterprise. Think of China with the military state and millions of compliant workers who do not have health care plans, pension plans or unemployment insurance. And if you get out of line well jail (or worse) awaits you. Globalization is bringing the results it desired for the corporations of the world. The dismantling of the welfare state. As Sinclair says the in the Authoritarian Free Enterprise system the corporations profit while the workers are set back to the 19th century and North America (and Europe?) becomes a state centered on defence against terrorism and involved in forever wars.

Following the 7/7 bombings in London the central banks flooded the system with funds in order to prevent a market meltdown. This explains the jump since that time as 7/7 turned out to be the low. Grant you our cycles said we should start rising after 7/5 but it doesn't tell us what will cause it or why. Some cycles are now topping out again. Over the next month we have the cycle tops of both 1998 and 1990 (7/20 and 7/16) and the top in 1987 (8/25) followed by the top in 1929 and the secondary top in 2000 (9/1). Respectively that is 7 years, 15 years, 18 years, 76 years and 5 years. 76 years is a derivative of the golden Fibonacci number of .618 (2*.618²) and 5 of course is part of the Fibonacci sequence.

The S&P 500 appears to be marching ever upward in what appears to be an ascending wedge. This pattern is ultimately bearish but we could climb in the wedge for a few more months yet .As can be seen the 1150-1160 zones loom large as major support. Above there is significant resistance currently near 1250 but as we climb up to 1300. The climb has been lethargic with a declining advance/decline line and fewer stocks making 52-week highs all signs of a tired bull market. The VIX volatility indicator continues at or near record lows indicating huge complacency in the market. Bullish sentiment indicators lean on the high side of bullishness.

The bulls have of course been driven by very low interest rates and huge liquidity in the system. With the Chinese Yuan upward revaluation, small though it may be, might be starting the inevitable decline of the US$ and a cut back in demand for US$ denominated debt. Already interest rates have begun to rise in response to the Yuan revaluation. Gold is trying to find stability but remains moribund as well awaiting a clearer sign of a topping US$. The Dow Jones Industrial/Gold ratio remains locked in a sideways pattern, a pattern that suggests only a break to the downside suggesting either higher gold prices or a lower Dow Jones Industrials.

When one sees the pension fund crisis, health care crisis, and other looming financial crisis (debt, trade deficits) as part of a growing pattern one realizes that the rather than being prepared for the new paradigm we are being set up for a big fall. Everyone should ensure that have some gold in their portfolios.

DavidChapman.com
Technical Scoop

Charts and technical commentary by:
David Chapman of Union Securities Ltd.,
69 Yonge Street, Suite 600,
Toronto, Ontario, M5E 1K3
(416) 604-0533
(416) 604-0557 (fax)
1-888-298-7405 (toll free)

David Chapman is a director of Bullion Management Services the manager of the Millennium BullionFund www.bmsinc.ca

Note: The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete.

The information in this report is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does Union Securities Ltd. assume any responsibility or liability. Estimates and projections contained herein are Union's own or obtained from our consultants. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any securities and is intended for distribution only in those jurisdictions where Union Securities Ltd. is registered as an advisor or a dealer in securities. This research material is approved by Union Securities (International) Ltd. which is authorized and regulated by the Financial Services Authority for the conduct of investment business in the U.K. The investments or investment services, which are the subject of this research material are not available for private customers as defined by the Financial Services Authority. Union Securities Ltd. is a controlling shareholder of Union Securities (International) Ltd. and the latter acts as an introducing broker to the former. This report is not intended for, nor should it be distributed to, any persons residing in the USA. The inventories of Union Securities Ltd., Union Securities (International) Ltd. their affiliated companies and the holdings of their respective directors and officers and companies with which they are associated have, or may have, a position or holding in, or may affect transactions in the investments concerned, or related investments. Union Securities Ltd. is a member of the Canadian Investment Protection Fund and the Investment Dealers Association of Canada. Union Securities (International) Ltd. is authorized and regulated by the Financial Services Authority of the U.K.

Copyright © 2002-2008 David Chapman

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