2016: The Year of the Index Annuity
Have you seen the stock market forecasts for the new year? One brokerage firm after another is citing volatility, a lack of earnings, dramatically slower growth and a probable “year to nowhere” in 2016.
As this goes to press, the Dow Jones Industrial Average has been down as much as 1900 points since the first of the year. In only 13 trading days, this is a loss of 9.5%, the worst start to a new year ever in market history. From its peak of over 18,200 points in 2015, the DJIA is now down more than 12%, well into correction territory.
Famed market forecaster and fund manager, John Hussman, has labeled our current valuation levels as unjustifiably high, calling it the most overvalued market since March of 2000, and that is certainly saying something. Mark Hulbert of MarketWatch concurs. Peter Schiff, David Stockman, and many others have all said similar things in recent weeks. Most recently, UBS, RBS,and Société Générale have each issued warnings for sell-offs ranging from -20% to over -75%, dire stuff to be sure. “Sell everything except high quality bonds”, said RBS’ credit team. “This is about return of capital, not return on capital. In a crowded hall, exit doors are small.” Since all brokerage firms make money by attracting capital, this would seem to be advice not in their best interest. Clearly, someone at these firms has decided it will be better for them in the long run if, after such a crash, they can remind the investing world that they were “the first to see this coming…” Guggenheim’s Global Chief Investment Officer, Scott Minerd warns that “…all is not right in the global economy. Issues related to China loom large as concerns mount over the sizeable accumulated debts used to stimulate their economy in the wake of the financial crisis, and to prop up zombie companies and State Owned Enterprises that desperately need to be restructured or closed.”
Even as some of the major brokerage firms are starting to concede that this year will be flat at best, and could be a washout by the time of the election, each of these forecasters point to continued Fed rate hikes (3-4 this year), a global economic slowdown most particularly in China,frighteningly low oil prices world wide amid overproduction and a staggering lack of industrial demand, along with a host of geo-political obstacles. Chief among these is the West’s pathetic response and ineptitude to the world-wide expansion of ISIS and other Islamist terror groups, along with the refugee crisis resulting from the same. None of these are short term obstacles; all will take years, if not a decade, to resolve.
While Hussman’s algorithms point to an S&P 500 that has been overvalued by as much as 55% in light of historic norms, a precipitous 2008-like decline is not necessarily in the cards as he sees it. Rather, Hussman is forecasting a 7-8 year period of volatility, losses, and hard won gains, averaging barely 1% annually. This means the market could be up 18% one year, then down -16% the next, averaging 1% per year amid much volatility and uncertainty. With CD rates already trending at or above the 1% rate, investors looking for safety amid such times may mistakenly feel they will be hard pressed to find much better.
For the last 15 years, our firm has dominated a market niche wherein risk-averse clients have earned market-linked interest during gain years, while maintaining those gains and their principal during years of loss. If Hussman and others are correct, 2016, much like the last 15 years, could once again be The Year of the Index Annuity. In fact, the next 7-8 years viewed in historical hindsight from 2025, could well prove to be The Decade of the Index Annuity. A market that is up 17% one year and down 15% the next—for an average of 1%/year—could net an index annuity owner far more than that over those two years. They would earn market-linked interest (some of the 17%), while retaining those gains without a loss during the following year.
What makes these vehicles work so effectively? The answer is the insurance industry’s innovative use of options (puts and calls), in combination with contractual guarantees and the capital reserve requirements to which only the insurance industry is held. To wit, when a client opens an account, the insurance company is required to collateralize or capital reserve those dollars by regulation and statute. While linked to various market indices (the S&P 500, DJIA, NASDAQ 100, etc.), a client’s money is never at risk within them. Rather, the insurance company has purchased just enough of a put to guarantee against a loss,regardless of how severe, and with the money they have left over, purchase a call that gives them upside on the remainder. This is why, when the market is up 10%, a client may only receive 4-7% in market-linked interest, with the difference having gone to purchase that put at the beginning of their contract year. Still, any vehicle free of market risk that could return 4-7% annually over the next decade is surely an alternative to the 1% average that Hussman is predicting amid the wild swings still to come.
Finally, there have been a number of national TV ad campaigns and local advisors advertising “Guaranteed Lifetime Income” lately. This is industry phraseology for a Fixed Index Annuity specifically designed to leverage either your IRA or non-qualified dollars into a guaranteed lifetime income stream that you cannot outlive. Imagine a scenario wherein an insurance company is able to base such an income immediately on 120% of your current values, or one wherein income begins a few years from now based on what 105% of your money has grown to when compounded at both the index’s annual yield, plus a guaranteed 4% annual credit. Of all of the tools in our financial toolbox, these vehicles are the only solutions offering such strong certainties for your retirement dollars. As Tony Robbins wrote last year in his brilliant work,Money: Master the Game, these products are the only financial vehicles on the planet capable of such claims.
The only remaining question is whether, 10 years from now, you will be happily enjoying such income, or wishing you had heeded the forecasts of Hussman, Soc Gen, RBS and others.
Thomas K. Brueckner, CLTC
President & CEO, Strategic Asset Conservation
Thanks for the great article, Thom. I Am so grateful that your formula has made us a good return every year since 2006! Frank New