Dear Reader,

The Mamas & the Papas had a massive hit single of the 1960s…‘California Dreamin’’.

The lyrics were written by John Phillips and Michelle Phillips (one half of The Mamas & the Papas).

Their inspiration came from spending a bleak winter’s day in New York and longing for some LA warmth. 

California Dreamin’ on such a winter’s day.

On Monday, an article in the Financial Times had me instantly humming the song.

The top US pension fund is California Public Employees’ Retirement Scheme (CalPERS).

As reported (emphasis added)…

‘Calpers is to move deeper into private equity and private debt by adopting a bold leverage strategy that the $395bn Californian public sector pension fund believes will help it achieve its ambitious 7 per cent rate of return.

‘In a presentation to the Calpers board, Ben Meng, chief investment officer, said the giant fund would take on additional leverage via borrowings and financial instruments such as equity futures. Leverage could be as high as 20 per cent of the value of the fund, or nearly $80bn based on current assets. The aim is to juice up returns to help the scheme, the largest public pension in the US, achieve its growth target.

‘“Given the current low-yield and low-growth environment, there are only a few asset classes with a long-term expected return clearing the 7 per cent hurdle. Private assets clearly stand out,” Mr Meng said. “Leverage will increase the volatility of returns but Calpers’ long-term horizon should enable us to tolerate this.”

‘Calpers’ assets represent just 71 per cent of what it needs to pay future benefits to the 1.9m police officers, firefighters and other public workers who are members of the scheme.’ 

Deeper into private equity.

Deeper into debt.

Bold leverage strategy.

Chasing ambitious returns in a low yield and low-growth environment.

California Dreamin’.

With this sort of ‘wing and a prayer’ strategy, the future looks as bleak as a New York winter’s day for the 1.9 million CalPERS’ members.

The health (or rather, ill-health) of the US pension system has been of interest to me for some time.

Tens of millions of boomers have planned futures based on retirement income promises being kept.

The problem is, the pension funds (public sector and corporate) do not have sufficient money in the kitty to honour these promises…and this situation exists after a decade-long bull market.

There are significant economic, political and market related consequences lying in wait in these funds.

In my recent book How to Arrange Your Wealth Now for a Post-COVID-19 World, I wrote…

‘Some of the more troubled US private and public sector funds have suspended annual indexation and/or reduced payments or in more dire cases, temporarily ceased payments.

‘The breaking of pension promises has so far been largely contained to smaller municipal funds and company schemes.

‘In the pension ocean, these plans are the plankton, but what about the whales?

‘And in terms of states, they don’t come any bigger than California. 

‘“If California were its own nation, it would be the fifth largest economy in the world. With a GDP of $US2.9 trillion, California would slot between Germany and the United Kingdom in the world’s top economies.”

‘Business Insider

‘CalPERS (California Public Employees’ Retirement System) is the fund that manages the pension and health benefits for California’s public sector employees.

‘The following graphic is from “CalPERS – Comprehensive Annual Financial Report Fiscal Year Ended June 30, 2019”:

‘A few things to note here…

‘The figure of…70.2%...funded. Or to put it another way, CalPERS is 30% UNDERfunded. CalPERS lacks sufficient capital to meet its obligations.

‘How do the administrators plan to fix this rather serious problem?

‘With a two-pronged approach…

‘Assume the fund will deliver a 7% rate of return…each year.

‘The fund’s performance of 6.7% was just shy of the forecast return…so all good…except, these are the very best of times for markets.

‘What awaits when the cycle turns and markets head south?

‘And, the second prong?

‘Tap the taxpayers.’

Well, the US market did turn south in March and has staged a recovery…of sorts.

Even if this recovery holds ground (which is highly doubtful), the road ahead is one of low yield and low growth.

The constant pressure to generate 7% per annum (just to stand a chance of honouring its obligations) is forcing CalPERS to roll-the-dice on a high risk strategy…leveraging into private equity funds that (at times) participate in leveraged buy-outs (LBOs).

Gearing on gearing…hmmm, not sure that’s an appropriate strategy for a pension fund with fixed (and indexed) obligations to its 1.9 million members.

But that just goes to show how desperate things are getting out there.

Long gone are the traditional pension portfolios that were heavily weighted in safe and secure government bonds.

Now, they’re going further and further out on the risk curve. Trying desperately to not slip further down into UNDERfunded territory.

This has all the look and feel of a gambling addict who keeps upping the ante to win back lost dollars.

But can Private Equity win where others lose?

On 24 February 2020, Bain & Company published a report titled‘ Public vs. Private Equity Returns: Is PE Losing Its Advantage?’.

This chart from the report compares the performance of US Buyout Funds (PE) — red bar — with the Public Market Equivalent (listed) funds.

Over the past decade, there’s a split hair between the performance of unlisted PE and listed PME.

Over a longer term — 15–30 years — Private Equity is a clear outperformer. However, was that outperformance due to a lot of low hanging fruit in the earlier years?

As the Bain & Co report states (emphasis added)…

‘While a 15% average annual return net of fees is impressive even by private equity’s own high standard, parity with public markets is not what PE investors are paying for.

‘The institutions that allocate increasing portions of their portfolios to buyout funds have good reason to expect a premium.

‘They lock up their money for a period of years with the presumption that professional managers will generate alpha through innovative value-creation strategies and leverage. All things being equal, public equities offer more liquidity at less cost.

‘To a large degree, this [merging in performance] is a function of maturity.

‘As private equity’s relative outperformance attracts increasing amounts of capital from investors, competition for a limited number of high-quality assets increases, driving up average purchase price multiples. Buying at premium prices makes it ever more challenging to create value during ownership and exit with an acceptable return.’

In this low yield and low growth environment everyone will be trawling over the same ground looking for the hidden gems…sparking bidding wars for those high quality assets that have the potential to defy the trend.

Can PE justify its exorbitant fees in this highly competitive and reversion-to-the-mean environment?

For the sake of those 1.9 million CalPERS’ members I sincerely hope so.

But I’m doubtful.

If the last decade was all sunshine for markets, the coming decade is the contrasting winter.

Leverage upon leverage is going to leave CalPERS facing a bleak future.

Perhaps the CalPERS’ members can borrow the famous tune for their own ballad of lament…

‘All the values are down
And the outlook is grey
I think we need to talk
About the coming day
When your pension is cut 
Because CalPERS cannot pay.

‘California dreamin’
On such a bleak day.’

Regards,

Vern Gowdie, Editor, The Rum Rebellion

The Different Sides of the ‘Black Lives Matter’
By Bill Bonner

Week 14 of the Quarantine

‘It was impossible to save the great Republic. She was rotten to the heart. Lust of conquest had long ago done its work. Trampling on the helpless abroad had taught her, by a natural process, to endure with apathy the like at home.’

Mark Twain

Here at the Diary, we’re not Republicans or Democrats…libertarians…or even anarchists. We just don’t like anyone telling us what to do.

We have a hard enough time trying to figure out what to do ourselves — with full knowledge of our own desires and circumstances. The last thing we need is an order from some jackass in Washington.

Besides, people who want to tell you what to do are always those whose ideas are imbecilic…as illustrated by the latest imperatives. They are not only high-handed, but contradictory. More on that in a minute.

First, the news…

Record debt

Wall Street started out in a downward swoon yesterday. Then, would you believe it, the Federal Reserve did something completely asinine…and the stock market turned around. The Associated Press reports:

‘Stocks swung solidly higher on Wall Street in afternoon trading Monday after the Federal Reserve said it would begin buying individual corporate bonds, the central bank’s latest move to prop up volatile financial markets through the economic fallout of the coronavirus pandemic.’

US corporations are borrowing more money this year than ever before…raising the total level of corporate debt to over $17 trillion and bringing the total debt in the country to $75 trillion.

But despite record debt, everybody’s still borrowing. Why?

No turning back

One reason is obvious: they need the money. When the feds shut down the economy, companies needed to refinance their old debts…and add new ones.

And now, no one doubts the determination of the Fed to keep lending — at artificially low interest rates, of course.

The recovery will take time…if it happens at all.

Meanwhile, people will need money to pay their bills…and keep their stock prices high. Any reduction in money printing by the Fed will cause stock prices to fall…which will force the Fed to find new and more reckless ways to lend. Sooner or later, for example, they will begin buying stocks as well as bonds.

There will be no turning back, in other words. No V-shaped recovery. No return to normal. No honest capitalism.

Instead, full speed ahead…to cronyism (whose bonds are they gonna buy, after all?), money printing (the money has to come from somewhere), and rip-offs (how does the average citizen get in on this? What?…He can’t?)…

…until the train runs off the rails.

But, like Scarlett O’Hara, we will worry about that tomorrow.

Social contract

Today, what we’re looking at is the ‘social contract’ that holds the US empire together. And we do so gingerly…like probing the earth with a bayonet, trying to find a landmine before we step on it.

Of course, the ‘social contract’ is a myth…there is no such contract. We never saw it. We never agreed to it. And what kind of ‘contract’ can be forced upon people…and then changed, at will, by one of the parties but not the other?

Still, some myths are important. We are all ‘created equal’ and can expect ‘equal rights under the law’ were foundational principles of the US.

And the ‘social contract’, vague as it was, summed up the basic bargain: The feds treat us fairly, and we let them take our money and boss us around.

On that, almost everyone has been in agreement since the get-go.

Stand together

But over time, the bargain has shifted…little by little…in the feds’ favour.

Senator George Frisbie Hoar saw it coming in 1898. Thanks to its foreign wars, he predicted the US would be:

‘Transformed from a Republic founded on the Declaration of Independence, guided by the counsels of Washington, the hope of the poor, the refuge of the oppressed, into a vulgar, commonplace empire founded on physical force, controlling subject races and vassal states, in which one class must forever rule and the other classes must forever obey.’

One of the lessons of history is that an army used to trample ‘on the helpless abroad’ will one day be used to trample on the helpless at home. And there is never a lack of ‘crises’ at home that need to be trampled on.

COVID-19 needed to be stamped out immediately. So said nearly everyone in the elite — the clergy, the politicians, the media, the scientists…the great and the good. All stood together to sentence everyone to house arrest, whether or not they were likely to be infected or to infect anyone else.

Neither the First Amendment (guaranteeing the right to assembly)…nor the Sixth Amendment (guaranteeing a fair and speedy trial before punishment)…nor the Ninth Amendment (guaranteeing your rights that are not specifically in the Constitution)…nor any customary, normal, or common law or common sense principle allowing you to come and go as you please…

…nor the need for people to earn a living…go to church…or bury their dead with a bit of dignity and decency…

…nothing was deemed so important that you should be allowed to venture out of your home (except, perhaps, for buying food, alcohol, or lottery tickets…)

New imperative

And then, on 25 May…all of a sudden…we were told that we could go outside in large numbers. Why? To support Black Lives Matter!

Suddenly, the coronavirus was not such a threat, after all. And this was a cause worth (other people) dying for! Here’s journalist Glenn Greenwald reporting in The Intercept:

‘The epidemiologist Jennifer Nuzzo proclaimed last week that “we should always evaluate the risks and benefits of efforts to control the virus” – exactly the risk-benefit calculus that has been declared off-limits since February. With that license to balance arrogated unto herself, Dr. Nuzzo concluded that “in this moment the public health risks of not protesting to demand an end to systemic racism greatly exceed the harms of the virus.” In other words, if you care about public health, you should not remain at home out of fear of contracting or transmitting the coronavirus but do the opposite: leave your home to participate in these protests.’

Well, which is it? Is every life worth saving — even if it means shutting down the whole economy and banning church services? Or do Black Lives Matter more…even when Black lives are exactly those most likely to be lost?

This new imperative was made in spite of the well-advertised ‘fact’ that Black people were particularly susceptible to COVID-19…and that the victims of the disease resulting from these mass rallies would most likely be disproportionately Black.

Lots of dots

What are we to make of all this? Do the elite scientists, journalists, and social activists care about Black lives? Or not?

And what’s this got to do with our foreign wars…with the social contract…with the economic breakdown, money printing, and the end of the American empire?

Lots of dots to connect, in other words.

Stay tuned…

Regards,

Bill Bonner, For The Rum Rebellion