Buck Bond Group
Defined benefit market update: Navigating stormy seas

Defined benefit market update: Navigating stormy seas

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The third quarter of 2023 may have been better than the second, but it was still a very difficult environment for investors. Outside of cash, there really was nowhere to hide. Every major asset class lost money, and some experienced double-digit losses. U.S. equities modestly outperformed bonds. Non-U.S. equities posted steep declines due to the strong U.S. dollar.

What drove this? Rising interest rates, spiking inflation, and a re-pricing of assets. Over the course of the year, the price to earnings ratio on the S&P 500 fell from 25 to 18, as investors re-calibrated their willingness to take on risk. For the last decade we’ve had a period of low interest rates, low inflation, low unemployment, and ample liquidity. Together, these combined factors pushed asset prices higher and higher. Now that these tailwinds are receding, the market has been quick to adjust prices to reflect the new expectations. In the third quarter, we witnessed a continuation of this most recent trend.

Asset class returns: Q4 better than Q2, but still lots of red

Markets appear to be finding their footing in the fourth quarter and every asset class has improved. Risk assets have staged a strong rally but year-to-date results through November were still deeply in the red. Perhaps the markets are signaling that they believe this period of interest rate hikes and inflation is peaking. One could also infer that the market does not believe we’re heading into a recession, at least not a severe one.

Interest rate movement

We have seen the most aggressive tightening of monetary policy in four decades, with the Fed Funds rate increasing 4% in nine months. The market is predicting some easing by the end of 2023, but we are in the camp of a pause, not a pivot. Today’s consumer price index (CPI) is not as important as comments from the Fed as inflation still stood at 7.1% through November.

However, we are starting to see the effects of tightening on the housing market with total home sales down significantly and mortgage rates touching 7%. Used car prices are softer and inventory is rebuilding as shipping cost are down 70% and delivery times are back to averages.

The sticky part of inflation will be shelter costs, which could take a year to re-price, as well as service inflation. It will take a bit longer too for labor markets to cool as growth slows and companies adjust their employment levels. Our baseline rate assumption is close to the market’s for 2023, assuming that there aren’t any black swan events from the global tightening of monetary policy.

While yield curve inversion is often a good predictor of recession (usually 12 to 18 months before), it isn’t fool proof. An inverted yield curve, however, is very accurate in predicting below average growth. So, while there is a path for a soft landing, that path is very narrow.

Pension funded status: Expect further volatility

Rising Treasury yields and widening credit spreads (mostly in the first nine months of the year) continued to increase discount rates and reduce pension liability values, but losses from assets have weighed on funding ratios. We estimate that discount rates for plans with a high active population will increase by 2.35%, while discount rates for mature plans will increase by 2.5%. We continue to see differences among funding ratio outcomes in 2022, based on duration of fixed income and the allocation to return seeking assets. In general, plans with longer duration fixed income have not experienced the same improvement in funded status. Year to date, we estimate that a mature plan with a 60% allocation to return seeking assets and a 40% allocation to core fixed income will have experienced a 9.5% increase in funding status.

We expect continued volatility from inflation, geopolitical risk, and the Fed’s actions. This leads us to recommend plans quantify portfolio risk relative to the liabilities by stochastically analyzing key metrics. This analysis will help determine risk/return tolerances and targets.

While diversification has not worked this year, we still believe in it; there will always be periods of higher correlation between asset classes, but overtime we think there are real benefits to remaining diversified. We are recommending patience and sticking to the plan by maintaining a diversified long-term investment strategy and rebalancing to target allocations. Markets can and will move quickly so it’s important to stay invested.

Finally, the pension risk transfer market is on a record setting pace given improved funded status with most deals involving retirees. We recommend that post a risk transfer transaction, plan sponsors review their investment strategy as the remaining liabilities could have a significantly different profile than before the transaction. In addition, given higher rates, pensioners may prefer annuities rather than lump sums. This could change liquidity needs as well as increase PBGC premiums.

New bull market or bear market rally?

After a positive start to the third quarter, markets reversed and then some in the second half of the quarter. In the fourth quarter, markets demonstrated a strong start, but will we see a repeat of the third quarter with a reverse? Markets have been volatile this year, so let’s not count our chickens before they’re hatched. Every bear market experiences periodic rallies.

Throughout this year, we’ve seen how influential the Fed has been on markets — they have moved on nearly every pronouncement and rate hike. Over 2022, FOMC members continued to revise their interest rate forecasts upwards every few months, so expectations of a “pivot” in 2023 could be optimistic.

Recession: the big question mark

Right now, economists put a 60% probability on a recession in the U.S. and a 90% probability on a European recession, so recession may be likely but it’s not necessarily a foregone conclusion. Corporate earnings, wages and payrolls have all been strong, while savings rates and consumer sentiment are declining. Across the pond, they’ve got to make it through a winter where energy, and possibly food, will be scarce.

And of course, we can’t ignore the second largest economy in the world. While China is currently experiencing a slowdown, it might be the first to recover. Geopolitical risk has returned: Given how interconnected the world is today, rising tensions between the U.S. and China will have far-ranging and unpredictable investment implications.


The sooner we get past 2022, the better. It has been an awful year for investors, though from a funded status perspective, it has provided some benefit. As we look forward to 2023, we expect market volatility to continue. That said, equities are more reasonably priced than at the start of 2022. Fixed income yields are also more attractive now than they were one year ago. Volatile certainly requires caution, but it frequently provides opportunity.

The investment products and strategies in this document are for presentation purposes only. Any dissemination, distribution, or duplication of this document or any of its contents without prior written consent from Buck Global, LLC is strictly prohibited. This document does not consider an individual’s or a plan’s specific investment needs. This document is not a solicitation to buy or sell any investment, nor to participate in any type of trading or investment strategy. The purpose of this document is to illustrate hypothetical scenarios with respect to funding and managing pension plans and other guaranteed benefits. Before making any investment decision, you should seek the guidance of a qualified financial or investment advisor such as Buck.

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