Tuesday, March 21, 2017



Glory:

The Department of Labor, through its Employee Benefits Security Administration, is charged with overseeing health, welfare and benefit plans offered by employers.  This includes 401(k) plans.
 
401(k) plans are fairly complex offerings, and are becoming more so.  Participant assets need to be tracked by source, tax characteristics, and vesting schedule, eligible employees need to be communicated with, a variety of required notices and filings need to be tracked, and the plan's investment choices need to be selected to ensure participant choice, and to comply with regulatory guidelines.  Finally, plan trustees are charged with assuring that the plan is run exclusively for the benefit of participants and their beneficiaries, and that the plan is managed with a prudent, documented, process.
 
40 years ago, when 401(k) plans were in their infancy, asset managers such as mutual fund shops identified opportunity, and began making their funds available to plan sponsors.  Over the years, there has been much time, money, and energy expended to identify an "optimal" line up of actively managed funds.
 
The challenge with relying solely on actively managed funds for a 401(k) fund line up is the question of fees and performance.  Whether actively managed funds can consistently outperform passive, index offerings depends on which decade or ten year rolling time period is being measured.  We could quote any number of white papers and studies at this point.  Suffice it to say that, net of fees, very few actively managed funds can outperform their relative index, over long periods of time.
 
An even more fundamental question is, even if we can identify those actively managed funds which outperform over a given measuring period, will most plan participants make the time to educate themselves about the offerings, so they can make intelligent investment choices?  Evaluating participant decisions tells us that most participants want to make as simple a choice as possible, as many participants feel unprepared, even with education, to make good investment choices.
 
This has given rise to the development of easy to use pre-mixed portfolios.  These portfolios typically come in two flavors.  One is age-based, and the other is risk-based.  Age-based portfolios tend to be the easiest for participants.  They can simply check a box indicating they want to use the age-based portfolio, and their money will be invested in a predetermined mix of stock and bond funds, based on their age.  These portfolios are built around age bands that run from very young (18-22), to those near or past retirement (age 66 or 70 plus).
 
The risk-based portfolios require the answering of a few questions and then, the participant funds will be invested in a predetermined mix of stock and bond funds, in portfolios that range from conservative to aggressive.
 
Given most participant's desire to keep things simple, we have found an ideal approach to plan investment design is to populate the age and risk-based portfolios with very low cost index funds.  There is value in having a line up of seven to ten actively managed funds, as there will always be a handful of employees who enjoy selecting their own investment options.  We have found that fewer than 10% of the employee population will choose to select their own funds, and that this population tends to be the older, more experienced employees.
 
With this approach, plan fiduciaries are able to keep investment costs at the low end of the investment spectrum.  While plan costs will vary, depending on average account balance, number of employer locations, and plan services selected, we see few reasons that a plan with $10 million or more in assets should have total operating expenses of greater than 1%. 
 
Peter Lynch managed Fidelity Magellan during the 1980's, chalking up average annual gains of 28.5% for the entire decade.  He's written a few books, and given numerous speeches, and has developed his "cocktail party" theory of where we are in the market cycle.
According to Lynch, the first stage of an upward market, after the market has been down for a while, occurs when he introduces himself as an equity mutual fund manager at the party, and the other attendees nod politely and wander away.  During stage two, new acquaintances linger a bit longer, perhaps long enough to tell him how risky the stock market is, before they move on to talk to the dentist. 
 
During stage three, with the market up 30% from stage one, a crowd of interested parties ignores the dentist, and circles around him all evening.  Any number of individuals tries to inquire, quietly of course, about what stocks they should buy.  During stage four, as the market nears its top, the crowds remain around him, though this time they are telling him what stocks to buy.  Lynch said that when he looks up the dentist's stock tips in the paper, and wishes he had taken the dentist's advice, it's a sure sign the market has reached a top, and is due for a tumble.
 
Quote of the week:
 
"The glory of the workman, still more of a master workman, that he does his work well, ought to be his most precious possession; like the honor of a soldier, dearer to him than life."
                                                                                                                                                                                                
                                                                                                 
Thomas Carlyle
 
 

Tuesday, March 7, 2017






Eight

March 7, 2017



Eight:

What a difference eight years makes!  It was eight years ago today, on Monday, March 9, 2009, that the Dow Jones Industrial Average hit bottom, closing at 6547.  The S&P 500 closed that day at 676.  Last Friday, these indices closed at 21,005 and 2383 respectively, each up by a multiple of more than three in the last eight years.

Many prognosticators spill lots of ink, attempting to divine the direction of the market, most of them with little success.  The challenge seems to be that the market doesn’t correlate well with any specific external indicator.

Some would think that economic policy has an impact on the market, yet studies show the market is agnostic to which political party controls the White House and Congress.  Other factors are sentiment, interest rates, and earnings.

If sentiment were the only indicator, it seems we would be more than halfway to the top of the current bull market.  Sir John Templeton, the country boy from Tennessee who built his career investing outside the U.S., said that “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”  I’ll agree with my friend Jim, who said the current sentiment seems to be somewhere between skepticism and optimism.

Interest rates are low to the extent that orphans, widows, and pensioners can earn nothing on debt.  Therefore, many in this group have invested in the stock market, with a special emphasis on dividend paying stocks.  This has pushed the price/earnings, or P/E ratio of the S&P 500 to 26.75, and the P/E of the DJIA to 21.45, compared to historical averages for these indices of about 15.

Finally, many companies over the last several years have built outsize cash reserves, as there was material uncertainty about the state of government regulation, and its impact on business.  This defensive approach to business led to earnings that were likely lower than they could otherwise have been, if those reserves had instead been invested to grow revenue.  Currently, expectations of promises delivered around a lower corporate tax structure, as well as regulatory and healthcare reform, have fueled stock prices over the last four months.

What’s next?  We don’t know.  The future isn’t given to us, and is at best a promise.  We can say with certainty that at some point we will experience another bear market, defined as a drop in stock prices of 20% or more.  We don’t know the timing of that bear market.   

Over the last eight years, we have had ten pullbacks of 5% or more, with five of those being in correction territory, defined as a 10% drop.  We could have several of these before a bear market sets in, and according to Deutsche Bank, the stock market has a correction of 10% or more every 357 days.  In the meantime, favorable interest rates, sentiment, and the expectation of corporate earnings continue to drive the stock market.

On the economic front, GDP growth for Q4 2016 was positive, up 1.86%, though that was half the rate of the 3rd quarter.  Consumer spending remained strong in Q4, up 2.05%, while the nation’s savings rate stood at 5.6%.  Real disposable income was revised upward for Q4, to +2%.



Last Friday, Janet Yellen, head of the FOMC, seemed to indicate that the Fed had done just about all it could do to stimulate growth, while holding firm on inflation.  Further progress, she seemed to suggest, would need to come from fiscal policy changes – taxes and regulation – rather than further monetary policy actions.

Quote of the week:

“The glory of a workman, still more of a master workman, that he does his work well, ought to be his most precious possession; like the honor of a soldier, dearer to him than life.”
                                                                                                                                                Thomas Carlyle