State and local pensions flash a contrarian signal.
Don't Do As We Say
There’s good news for stocks in The Pew Charitable Trusts report, "State Public Pension Investments Shift Over Past 30 Years."
The document covers the investment policies of the nation's state- and local-government pension funds. To put it kindly, these $3 trillion funds have not been brilliantly managed. Collectively, they held almost no stocks entering the bullish 1950s and 1960s (I’m not sure how the 1950s qualify as “the past 30 years,” but I’m grateful that Pew included the data), discovered equities just in time to catch the 1973-74 bear market, and lightened up before the bull market of the '80s.
As the chart shows, state and local pensions have during the past 20 years become more enthusiastic about equities. Given their track record, that affection would not seem to be a favorable sign. Indeed, when I first looked at the Pew report, I began to outline a column titled, “A Stock Market Warning.”
Then I realized that the green bars, representing equities and alternatives, might increasingly consist of alternatives. (In the earlier years, those bars would have been essentially all equities, as alternative assets were uncommon even among institutions until relatively recently.) If so, then what at first appeared to be a negative sign would instead be a positive. Such a shift would indicate that state and local pensions, so often wrong about stocks in the past, have recently swapped out of stocks.
Voila! Four pages later, Pew illustrates the funds’ alternatives exposure:
Just what an optimist would hope. In the six years from 2006 until 2012, state and local pension funds more than doubled their allocations to alternatives, while slashing their exposure to stocks. These changes not only reaffirmed the reliability of state and local pension funds as a contrarian sign, as the funds were aggressive entering the 2008 market crash and then more conservative during the ensuring rally, but they also offer some comfort looking forward. As of two years ago, the right people were wary of stocks. While it's possible that they since have become more enthusiastic, their funds' allocations usually move slowly. The signal likely remains positive.
It's tempting to treat this institutional retreat from stocks as the indicator for intermediate-term stock performance. Such things do occur. Consider the early 1980s. After choking asset prices with many years’ worth of interest-rate hikes, the Federal Reserve was preparing to reverse the trend. In hindsight, that decision overwhelmed all other effects. For the next several years, because of the decline in interest rates, stock prices would almost certainly rise.