8/31/18 – Stocks Keep Moving Higher

Stocks finished August on another strong note. Both indices increased this week on better than expected economic growth news. The latest update to 2nd quarter growth showed the economy grew at a 4.2% annual rate versus the initial estimate of 4.1%. First quarter growth was also revised higher. The US economy grew at a 3.2% annual rate in the first half of the year. The US hasn’t had a calendar year of growth in excess of 3% since 2005. On the week, the Dow gained 0.7% while the S&P 500 increased 0.9%.

Many government pensions struggle from inadequate assets to pay future liabilities. Chicago is one of the worst in the nation. The city’s four pension funds are $28 billion underfunded. To put that into perspective, the funds have total assets of only $10 billion. The pension funds are round 25% funded. To help close this gap, the city is considering issuing $10 billion in debt to lend to the pension fun. The pension fund would then invest that $10 billion. Early reports suggest a 5.25% interest rate on the debt. To make this work, the pension fund would need to generate annualized returns greater than 5.25% over the life of the bond. Given where interest rates are and how much fixed income investments pension funds own, that seems like a pretty high hurdle rate. Over the last ten years, government pension funds have averaged 6-7% a year in investment returns. Assuming a 6.5% annualized return, Chicago would reduce its liability by $125 million a year. That’s not bad, but it doesn’t seem worth the risk of under performing the interest on the debt. It will be interesting to see what Chicago decides and whether other financially strapped pension funds look at similar debt issuance. Read More

Oil increased this week, gaining 2.0% to close at $69.91/barrel. The yield on the 10-yr Treasury moved higher, closing at 2.86% from 2.82% last week. The average rate on a 30-yr fixed rate mortgage moved higher to 4.52%, from 4.51% last week.

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