This blog's primary author will be in the Northwest working on 401(k)-related issues through next week. He intends to post when he can and will be back to the usual routine on August 26th.
Sometimes all a story needs is a few pictures. In this case, four charts of stocks that were darlings of the momentum crowd. The point here isn't to issue some sort of mordant chuckle about all this. Instead, it's to note that momentum-based investing can be immensely powerful...until it isn't. At which point the reversals can be truly unforgiving. For example...
Potash Corporation of Saskatchewan
These charts are through yesterday's close. At the moment, late Wednesday morning, three of these four (all but SD) are sharply higher in today's trading. Again, the point isn't to suggest that these are permanently broken stocks. We don't pretend to know that. But think in terms of behavioral finance. When did these stocks look most tempting to professional and rank-and-file investors alike? Two or three months ago? When it looked like they could do no wrong and continue higher more or less indefinitely?
Some mid-week material, in world record time*...
* It's the suit.
Over the weekend, Slate published a short Tim Harford item on the imprecision (and, yet, periodic usefulness) of economic forecasts. We don't put much stock in economists' point estimates (e.g., Q4 GDP will grow at 1.2%), but we do appreciate many of their qualitative and more generalized quantitative arguments. Here are a couple telling excerpts from Harford:
When people discover that I am an economist, they rarely ask me for my views on subjects that economists know a bit about--such as how to respond to climate change or pay less at a supermarket. Instead, they ask me what will happen to the economy.
Why is it that people won't take "I don't really know" for an answer? People often chuckle about the forecasting skills of economists, but after the snickers die down, they keep demanding more forecasts. Is there any reason to believe that economists can deliver?
After crunching a few numbers, Harford draws out the following (somewhat tentative) conclusion:
The new data seem to confirm Kay's original finding that economic forecasters all tend to be wrong in the same way. Their incentives to flock together are obvious enough.
What is less clear is why the flight of the flock is so often thought to augur much--but then, some astrologers are also profitably employed.
The curious thing is that forecasters often have something useful to say, but it is rarely conveyed in the numerical forecast itself on which so much attention is lavished. For instance, in December 2006, forecasters were warning of the risks of an oil price spike, a sharp rise in the cost of credit, and a dollar crash. The quantitative forecasts are usually wrong and not terribly helpful when right, but forecasters do say things worth hearing, if only you can work out when to listen.
We thought this was an apt prelude to Monday's Wall Street Journal story on economists' expectations for the second half of 2008, in which Kelly Evans notes that second-half growth projections have come down significantly from where they were at the start of the year.
Taken together, the upshot of these two pieces isn't that economists' new projections are more accurate than their former ones. (In fact, the tendency to extrapolate makes it very difficult to predict turning points in the economic cycle.) Instead, the point is that anyone concerned about the near-term future of economic data would probably do better to think in big-picture contextual terms rather than fine-grained statistical ones. The data matter, of course, but more as a dots of color in an impressionist painting: Not especially precise or realistic in and of themselves, but powerful and revealing when arranged together on a larger canvas.
Tim Harford, "The Wisdom of Crowds?" Slate, August 9, 2008
Kelly Evans, "Economists Expect 2008's Second Half To Be Worse Than First," Wall Street Journal, August 11, 2008
A new week and the bulls seem to have the ball--at least until a new set of headlines crosses the wire...
Back in late May, we posted an item on the story of almost 8 in 10 West Virginia teachers choosing to abandon their 401(k)-style defined contribution plan in favor of rejoining the state's defined-benefit pension system.
In Monday's Wall Street Journal, Jennifer Levitz added more detail to this fascinating case study. Here's part of her opening salvo:
[O]n July 1, after a vote authorized by the state legislature, 14,871 school employees, or 78%, switched to the old-fashioned pension plan.
After the vote, teachers were "jumping up and down and crying in the halls," [union president Judy] Hale says.
The school employees put their mistakes behind them, but their experience stands as a cautionary tale for employers and employees across the country. As large numbers of workers are starting to retire with 401(k) or 401(k)-like plans to support them, what happened in West Virginia is a window into exactly how things can fall apart for workers, and it serves as a wake-up call for figuring out how to avoid having plans go as badly off track as this one did.
As we wrote in May, this story is stuffed with themes applicable to the bigger picture in the American system: "underfunded pensions, employers' cost-conscious transition from DB to DC plans, expensive/under-performing insurance-focused products, poor decision-making by participants, and, as a consequence of all of that and more, grossly inadequate outcomes for rank-and-file participants." The Levitz piece is very much worth reading, but as usual, we ran across a couple of items worth quibbling over.
Here's one (emphasis added in bold):
Many workers with retirement accounts have built nest eggs far bigger than they ever imagined possible. But unknowledgeable ones often are far short of comfortable retirements -- and they don't have the option the West Virginia teachers did of appealing to state legislators to get them out of their investing mistakes.
Knowledge is important, and ignorance generally doesn't help plan participants achieve the best possible long-term outcomes. But it isn't just a matter of knowledge; it's also a matter of psychological and behavioral capacity to avoid making big mistakes. The problem for some participants is their sense that they have too much knowledge, and thus that they can outsmart the markets. The picture we see isn't the sophisticated elite among plan participants on one side and the clueless masses of rubes on the other. It's participants of widely varying "sophistication" encountering very much the same set of problems: excessively expensive, under-performing investment choices; emotional whipsaws; and inertia.
One of the dominant themes in the Levitz piece is the role of annuity-based products in the West Virginia defined-contribution plan. This is ugly stuff:
From the start, most employees favored the annuity. Some say they were swayed by [AIG unit]Valic's sales force, which included former educators and school employees who went into the schools during the workday to talk about the option. "These people came during your lunch or during your planning period basically to sell the program," says Debra Elmore, a third-grade teacher in Ansted, W.Va.
Ms. Elmore acknowledges knowing little about investing. "Oh, Lord no," she says. "I had no idea." She set up her account so that 85% of her contributions would go into the fixed-rate annuity. "I just thought, 'Well, these are safe. Let's stay there.' "
"Safe" being a decidedly relative term, apparently. Later in the story, Levitz notes that at one point, more than two-thirds(!) of plan assets were invested in a fixed-rate annuity. But wait. There's more:
AIG spokesman John Pluhowski says the insurance company hires former school employees to sell its products to schools "because the education market is important to us; educators know the needs and concerns of educators." He says the representatives were "not authorized or directed to give investment advice; they were only authorized to sell a fixed-annuity contract."
In other words, some former teachers know how to play to the fears--"concerns" is a classic Orwellian euphemism--of their former colleagues. Beyond that, here's Pluhowski uttering one of the industry's sorriest canards, that "selling" can be separated in any moral, ethical, or practical sense from the giving of "investment advice." Now, we're fully aware that that distinction has had the force of law for many years (in the distinction between brokers and agents who sell and investment advisors who advise). But let's leave the fine artificial regulatory distinctions aside for a moment, shall we? The fact of the matter is that some degree of investment advice is always and forever inseparable from selling. Does Mr. Pluhowski really think--do you think?--that his agents descended on Ms. Elmore and her colleagues and didn't utter a word of advice? "I think you should buy this because it's in your interests; just look at all these features and benefits." Isn't that a form of advice by definition? What's the alternative? "I want you to buy this because it's the only way my boss will pay me." That isn't advice, but it isn't plausible either. Not in this universe, anyway.
Later in the story, Mr. Pluhowski returns:
AIG denies wrongdoing. Mr. Pluhowski declined to specifically discuss the lawsuit or the current state investigation, but says, "We are confident we met the obligations we were contracted to provide." He declined to say how much employees were paid for sales of the annuities, but says that "no plan contributions were used to pay commissions." West Virginia's insurance commissioner investigated Valic's sales practices in 2002 and cleared the company, saying it had found no misrepresentations by Valic agents.
How many disingenuous arguments can one man make in a single Wall Street Journal story? We may be testing the limits here. "No plan contributions were used to pay commissions." Yes indeed. What that means is that when Ms. Elmore deferred $100 into her Valic annuity, she saw $100 appear on her statement. But...but, but, but...the super-generous commissions paid to AIG's sales force have to come from somewhere, right? And where would that be? From Ms. Elmore, of course, over time, as an implicit deduction from her potential returns. The consequence:
Ms. Elmore, 46, says she realized her disappointment in the defined-contribution plan when she received a letter from the state's retirement board in April projecting that, at age 60, she would have a big-enough nest egg to provide her with $1,571 per month for her life. By contrast, the letter projected, if she voted to go back to the defined-benefit plan, she would receive a projected monthly payment between $2,656 and as much as $3,050.
This form of deadweight loss, a consequence of near-monopoly power and consumer ignorance, is especially ugly because it's so enormously consequential and so easily avoidable. As ever, the moral burden is broadly shared: Plan sponsors, participants, and providers simply must do better.
Jennifer Levitz, "When 401(k) Investing Goes Bad," Wall Street Journal, August 4, 2008
Churn, churn, churn...
This isn't the biggest deal in the world, but as language obsessives, we found it at least mildly interesting.
Late yesterday, after the close of trading, we received one of the Wall Street Journal's periodic Market Alerts. Under the headline "Dow Industrials Surge 330 Points as Oil Drops, Fed Stands Pat," we saw this (emphasis added in bold):
The Dow Jones Industrial Average surged 330 points as oil prices continued to fall and the Federal Reserve kept interest rates unchanged. Gains were widespread, with 20 of the average's 30 components advancing on the day.
Like many terms of art, "widespread" is in the eye of the beholder, and yesterday's move higher was clearly substantial. But 20 of 30 Dow stocks moving higher on a day when the index jumped 330 points, doesn't seem especially widespread to us. It just doesn't.
This may seem like quibbling, and to an extent...it is. But language matters, and media characterizations of market developments have consequences for the way rank-and-file investors understand what's happening around them. For what it's worth, we tend to favor precision and nuance over spin and superlatives.
For some time now, two related problems have characterized the private sector's defined-benefit pension system: The underfunding of company pension funds and the freezing or termination of defined-benefit plans altogether.*
In yesterday's Wall Street Journal, Ellen Schultz and Theo Francis drew attention to the unappealing corporate practice of shifting promises of pension benefits for highly-compensated employees' into the company's regular (i.e., tax-advantaged) pension plan. A couple caveats before we go to the excerpts. First, with the exception of Intel, the Journal's "sample" of companies that have engaged in this practice in one way or another isn't exactly a who's-who of corporate America. Second, as we've noted before, we aren't ERISA attorneys and don't even play them on this blog. We'll be asking a couple ERISA experts for their reaction to this story later today.
Here are the key passages from Schultz and Francis (emphasis added in bold):
At a time when scores of companies are freezing pensions for their workers, some are quietly converting their pension plans into resources to finance their executives' retirement benefits and pay.
In recent years, companies from Intel Corp. to CenturyTel Inc. collectively have moved hundreds of millions of dollars of obligations for executive benefits into rank-and-file pension plans. This lets companies capture tax breaks intended for pensions of regular workers and use them to pay for executives' supplemental benefits and compensation.
The practice has drawn scant notice. A close examination by The Wall Street Journal shows how it works and reveals that the maneuver, besides being a dubious use of tax law, risks harming regular workers. It can drain assets from pension plans and make them more likely to fail. Now, with the current bear market in stocks weakening many pension plans, this practice could put more in jeopardy.
How many is impossible to tell. Neither the Internal Revenue Service nor other agencies track this maneuver. Employers generally reveal little about it. Some benefits consultants have warned them not to, in order to forestall a backlash by regulators and lower-level workers.
That last sentence is where things get especially squirrelly. It's yet another reason we see such miserable numbers on things such as "consumer confidence" and responses to "right track/wrong track" questions about the direction of the country.
And taxpayers are on the hook in other ways. When deferred executive salaries and bonuses are part of a pension plan, they can be rolled over into an Individual Retirement Account -- another tax-advantaged vehicle.
This is a big part of the problem: Unintended (by Congress, that is) taxpayer subsidies of pension benefits for highly compensated personnel. There's more, like this exemplary fiduciary practice </snark>:
Generally, only the executives are aware this is being done. Benefits consultants have advised companies to keep quiet to avoid an employee backlash. In material prepared for employers, Robert Schmidt, a consulting actuary with Milliman Inc., said that to "minimize this problem" of employee relations, companies should draw up a memo describing the transfer of supplemental executive benefits to the pension plan and give it "only to employees who are eligible."
Meanwhile, the IRS doesn't have a particularly good handle on this practice:
With too little staffing to check the dozens of pages of actuaries' calculations, the IRS generally accepts the companies' assurances that their pension plans pass the discrimination tests, the official said.
"Under existing rules, there's little we can do anyway. If Congress doesn't like it, it can change the rules." To halt the practice, Congress would have to end the flexibility that companies now have in meeting the IRS nondiscrimination tests.
A spokesman for the IRS said it has no idea how many such pension amendments it has approved or how much money is involved.
Want to brew up a recipe for a serious populist backlash against the well-heeled? Keep doing stuff like this. We'll be back with more on this if we can pass along some expert views.
* The public sector's pension system has generally been plagued by underfunding (which in some cases is also a function of over-committing), but, generally, groups of public sector employees have retained relatively generous pension arrangements. Many of those arrangements are now coming under immense pressure from the taxpaying public. We sense significant--if slow--change afoot in the public sector.
Ellen E. Schultz and Teho Francis, "Companies Tap Pension Plans To Fund Executive Benefits," Wall Street Journal, August 4, 2008