Irrational exuberance is unsustainable investor enthusiasm that drives asset prices up to levels that aren’t supported by fundamentals. The term “irrational exuberance” is believed to have been coined by Alan Greenspan in a 1996 speech, “The Challenge of Central Banking in a Democratic Society – http://www.investopedia.com/terms/i/irrationalexuberance.asp
In the course of my duties yesterday I was contacted by a notable tabloid asking what the impact of a 0.25% rise in interest rates would mean for pensions. After a bit of to-ing an fro-ing with my colleagues (who know what they are talking about on this), we came back with an answer which translated into tabloid like this.
An upward move by the Bank of England will signal good news for those looking to buy an annuity with their pension pot.
Annuities are insurance products that provide an income for life.
Aviva, Canada Life and Legal & General have all upped their offerings in anticipation of a rate increase.
Alan… of First Actuarial, says: “If you are purchasing an annuity, a rate rise means you get more pension for your money. A 0.25 per cent rise in interest rates could mean a 3.75 per cent improvement in annuity rates.” And there’s more for pension savers to cheer about.
Alan adds: “Higher interest rates should mean more growth in the economy, which should improve stock-market returns. This means that not just the cost of buying a pension reduces, but also that the amount of money in your pension pot increases.”
Which is what I thought we agreed. But Alan, who is rather more prudent in these matters, would have none of this exuberance and asked for an amendment
“higher interest rates are expected to subdue the economy and act as a brake on growth which is the opposite to the original quote”.
Fortunately for general harmony, the tabloid will run with Alan’s amendments!
Confidence and prudence
Pensions Buzz , Professional Pension’s weekly vox-pop, runs a sentiment index on confidence in where the markets will be in 6 months time, my estimate is always higher and I suspect that Alan’s isn’t. There has to be a bias towards prudence when looking after other people’s money, but with our own – is it wrong to follow the heart not the head?
I find that I am consistently in the top decile in terms of optimism!
My imprudence has led to me enjoying wonderful returns on my pension but I have taken risk. The First Actuarial way is to diversify and accept less upside for more protection on the downside. As with many things, First Actuarial tolerates many opinions (with the proviso that I do not speak for the company).
You will now understand why I do not give investment advice for a living.
Does it matter if I’m wrong.
Well it doesn’t matter to me (much) if the market falls out of bed in the next six months, my state retirement age is 67 and I have every intention of working (if you can call it that) till 2028. In that time, my equity laden pension pot will have many bad days, weeks and even years. But when I get knocked down, I get up again.
So I can live with a degree of uncertainty with my pension pot, with the value of my flat and even with my earnings. I am not a worries.
I sense Alan is more concerned, I suspect he took one look at the words to be published and saw thousands of tabloid readers surrounding his house with placards calling for him to be thrown into the CMA’s deepest dungeon. For Alan, being irrationally exuberant deserves no less.
Were I consigned to that dungeon, I suspect Alan’s tight lips might be bent into an inward smile!
It matters a lot
My version of events (the original version) supposed that interest rates follow a market up, Alan’s – that they are used to keep markets at rational levels.
My hunch is that inflation is likely to remain high for the right reasons, because there is fundamental growth in the economy. Putting interest rates up reflects an economy which – as Carolyn Fairburn puts it “is growing out of austerity”. This makes me cheerful and it’s why I’m a smiley person.
But Alan’s view is clearly different, he sees the growth as irrational and suppressible.
I have lost count of the number of times actuaries have bemoaned the artificial depression of interest rates to stimulate growth, now we are likely to see a rise in interest rates, the warning is that it will be at the expense of growth assets.
That my friends is prudence in action!
You saves your money, you take your choice. We are all free to take what choices we like with out money, but not to take liberties with others. Alan’s prudence is precisely what I’d expect from a good actuary, but it is not my view.
It matters to me that I have my own choice in the matter and that I can say so. It matters too that I have colleagues who can view the glass as half empty – we call it risk tolerance!