Yesterday was a strong day for the Nasdaq 100 index capping off an incredible January 2023. In fact, the WSJ is heralding this performance (+11.5% for the initial month of 2023) as the strongest beginning to a calendar year for the Nasdaq since 2001, when the index rose an amazing 14.2%. But wait! Didn’t that performance occur within a bear market environment (3/2000 – 10/2002) in which the Nasdaq 100 would eventually decline 83% from start to finish? Is this month’s performance the start of a bull market rally or a great month in the continuing saga of last year’s bear market in which the Nasdaq declined -32.5%?
Market participants have certainly cheered every anecdotal piece of evidence potentially indicating that inflation’s peak is long behind us. They fully anticipate that the Fed will soon come to their collective senses by stopping the Fed Fund Rate increases to be soon followed by an easing trend. If they are right, perhaps January’s strong performance will be only the beginning of a sustained rally, but what happens to equities, including the Nasdaq, if the Fed isn’t convinced and they continue to elevate rates? What happens if our current historically strong labor market doesn’t weaken? What if the current level of interest rates isn’t capable of thwarting economic activity? What if? What if? What if?
We are pleased to provide you with the weekly update on the PBGC’s progress in implementing the ARPA legislation. Last week witnessed seven multiemployer plans receiving approval for their SFA applications. In two cases, the Plasterers Local 82 Pension Fund and the Alaska Ironworkers Pension Plan, received approval for their initial applications. These Priority Group 2 funds, both MPRA Suspension eligible, were seeking $20.1 million and $50.4 million, respectively for their combined 1,061 plan participants. The other five plans received approval for supplemental SFA filings.
In addition to the seven approvals cited above, there was one application withdrawn, as the Composition Roofers No. 42 Pension Plan withdrew their initial application (9/30/22 submission) seeking $33.7 million for 495 participants. As we’ve seen in the past, these withdrawn applications tend to get resubmitted quite quickly.
There were no new applications submitted last week and none were denied. There remain 6 potential applications yet to be submitted among the 5 Priority Groups that are eligible to file. February 11, 2023, is earmarked as the starting point for Priority Group 6 applications. Once those applications have been filed, I’m anticipating that the potential 218 additional multiemployer applications will create an avalanche of activity for the PBGC.
It seems to us that the investment community is all in on the idea that inflation has been tamed and that a 2% CPI or PCE is right around the corner. But could this belief be setting investors up for another inflation shock? 2023 has witnessed strong rallies in both bonds and stocks driven by the belief that the Fed has pretty much accomplished its objective. Investors have been driving down yields across the yield curve since mid-October’s peak, and as a result, financial conditions have actually eased quite substantially, which we recently pointed out in our post titled, “Fighting the Fed – What’s the Implication. Falling US rates have led to a sell-off in the US $ relative to the Euro, Yen, and other major currencies.
In addition, gasoline is up nearly 6% so far in January, while copper (up 12%) and other commodities have seen strong rallies as the weaker $ and lower import prices combine to spur on demand. Furthermore, the historically strong labor market is encouraging folks to dine out more according to the OpenTable seated diners index which has been rising recently. Both rents and used cars have seen price increases since November. All of this taken together will likely make the Federal Reserve’s job much more challenging. So as my picture above depicts, will the market get its soft landing or will the investment community land squarely on its collective head? Are you prepared for a possible market reversal?
I believe that Pension America would be well served by adopting the SWAN strategy. These majestic birds embody a serenity that anyone would appreciate that has to deal with the uncertainty of the capital markets and the damage that they can create for plan sponsors of defined benefit pension plans. I have to believe that the asset consultants who serve these plan sponsors would also appreciate the SWAN strategy that enhances the probability of success while dramatically minimizing the volatility around potential outcomes.
What is the SWAN strategy? Simply put, it is a “Sleep Well At Night” strategy that Ron Ryan and Ryan ALM, Inc. (Cash Flow Marching) have been espousing for decades. How comforting would it be for the plan sponsor and their advisor(s) to know that no matter what happens in the markets- good, bad, and/or ugly -, the necessary liquidity has been secured to meet the promises to their plan participants for some prescribed period of time whether that be the next 5-, 7-, 10- years or more. Furthermore, in this period of great uncertainty due to rising US interest rates fueled by inflationary pressures, wouldn’t it be incredibly reassuring that the SWAN strategy isn’t impacted by changes in US interest rates, as a Cash Flow Matching strategy carefully funds (secures) the future value of benefits and expenses, which are not interest rate sensitive.
With so many benefits to help one sleep like a baby, why is CFM not being used more often? With bond yields up significantly, why aren’t pension plans adjusting their risk profiles to create an environment with a higher probability of success and less uncertainty? As plan sponsors have moved significantly more assets into alternatives, why haven’t they adopted a bifurcated approach to asset allocation that creates a liquidity bucket and a growth bucket instead of placing all their eggs in one bucket with a singular focus on the ROA? During periods of great uncertainty, such as the one we are currently living through, liquidity can become difficult to find, as all assets seem to correlate to 1. Having a bifurcated approach (liquidity assets and growth assets) to asset allocation ensures that benefits and expenses have been secured chronologically for a certain period of time (i.e. 5 to 10 years) until the allocation is exhausted.
Managing a pension plan should be like operating an insurance company or lottery system. You have an obligation (liability) that has been promised. Fund that liability with certainty and don’t rely on the markets and all of the uncertainty that comes with that to accomplish your objective. You will Sleep Well At Night (SWAN)!
2022 proved to be a very good year for active large-cap (LC) US equity managers relative to the S&P 500 even if few managers made money on an absolute basis. For the first time since 2009, a majority of LC equity managers outperformed. It has been a long-time coming, but it shouldn’t be surprising.
Chart from Strategas Securities
The outperformance is a direct reflection of portfolio construction biases inherent in most equity strategies. First, the S&P 500 is a capitalization-weighted large-cap index that is driven by momentum. For the past 10+ years, Technology stocks lead the market and thus the S&P 500. This sector concentration and mega-cap biases made it very difficult for the average equity manager to outperform given their more equal-weighted exposure. Few managers construct portfolios with a cap weighting preferring to invest more equally in their portfolios. This creates an average cap weighting that tends to be much smaller than the index. Furthermore, most US equity managers overweight Value as a screening tool choosing portfolio holdings based on some relative price comparison – P/B, P/E, P/CF, P/S, and/or P/FCF. Again, the S&P 500 is a fully invested, momentum-driven, capitalization-weighted index that will beat a significant majority of managers in rising equity markets that have been enjoyed nearly annually since 2009.
So what happened in 2022? Well, we finally had a market that favored both Value and small-cap. With regard to Value, the S&P 500 Value index declined -5.1% in 2022, while the S&P 500 Growth Index was down a whopping -29.4%. With regard to small cap, the magnitude of the outperformance was more muted, but it still contributed to the outperformance of active managers relative to the S&P 500, as the S&P 600 was down -16.1% versus the S&P 500’s -18.1%. More important, the equal-weighted S&P 500 was down only -11.5%. Furthermore, we have a declining equity market that favored any firm that had a cash reserve, even a small one.
When all three market influences present themselves, it isn’t surprising that a majority of equity managers will outperform. What is surprising is the fact that only 61.6% of managers did. This gets back to the problem of fees. Not only do managers need to beat the S&P 500, but they need to do that after fees, which can be a difficult hurdle given how modest an index fee can be (< 5 bps).
What is the probability that these trends persist? As the graph below suggests, the Growth vs Value “cycle” tends to be lengthy. In this case, Growth’s underperformance has just begun. If previous cycles are any window into the future, it appears that Value has much more room to outperform. If that’s the case, it may be time to shift to more active equity strategies.
Graph by Ryan ALM, Inc.
Did you take some profits from your Growth manager(s) when it reached its most recent peak relative performance?
Things are getting more interesting. For the first time, the PBGC has denied an application on the basis that the fund did not qualify as a Priority Group 2 plan. The Bakery Drivers Local 550 and Industry Pension Fund was seeking slightly more than $132 million for its 1,122 participants. The fund had described itself as a Critical and Declining Plan. The PBGC rejected their initial application. I don’t know if they qualify for SFA under a different priority grouping, but we will monitor this situation given this unique outcome.
In other news, two more plans had supplemental applications approved. The Pension Plan of the Printers League – Graphic Communications International Union Local 119B, New York Pension Fund and the Teamsters Local 641 Pension Plan will receive $15,928,030 and $96,092,818, respectively, for their combined 4,823 participants. The Teamsters application was a revised supplemental filing.
There were two Priority Group 2 applications filed last week. The Local 966 Pension Plan filed a supplemental application seeking an additional $8.3 million in SFA for its 2,356, while the U.T.W.A. – N.J. Union – Employer Pension Plan submitted a revised application that had only been withdrawn last week in which they sought $7.5 million for 449 plan participants. As a reminder, the PBGC has identified 14 plans that they believe qualify under Priority Group 6 (present value of financial assistance in excess of $1 billion) that may begin to file their applications beginning February 11, 2023.
We are pleased to share with you the Ryan ALM, Inc. Q4’22 Newsletter. As you will note, it was an incredibly challenging year for Pension America if your accounting methodology followed GASB accounting standards and less of a challenging year if you used FASB to mark to market your plan’s liabilities. There are other goodies in here including links to some key research insights and the Ryan ALM blog, where we’ve produced nearly 1,200 posts on a variety of pension and economic issues. We encourage your questions and feedback.
The USA is the largest debtor nation in the world with $23.7 trillion outstanding in US Treasury marketable securities. Such debt comes in the form of routine Treasury auctions of Bills, Notes, Bonds, TIPS, and FRN (floating rate notes). The average maturity of such debt is basically unchanged for the last 22 years at an average maturity = 68 months. When interest rates went to historic low levels in 2019 – 2021, a prudent debtor would have refinanced at these very low rates and lengthened maturity significantly. But the US Treasury is very mechanical and for the most part, engages in refundings of expiring debt. A corporate Treasurer would have issued very long bonds of 50 to even 100 years. Although the average interest rate of our debt is low at 2.24%, we have 23.2% of our debt maturing in one year. We issued $15.5 trillion in auction issues in the last 12 months. Every 100 basis points in higher rates equates to an extra $155 billion in extra interest expense.
We’ve just published a Pension Alert that highlights the fact that rising bond yields have closed the gap between the 10-year Treasury Note and the average public fund Return on Asset assumption (ROA) to its narrowest margin in decades. This should be exciting news for the plan sponsor and asset consulting communities, and it should lead to greater exposure to fixed income. As Ron Ryan points out in his “Alert”, a pension fund can achieve roughly 72% of the ROA through an allocation to investment-grade fixed income. How comforting it is for plan sponsors to know that utilizing fixed income to a greater extent significantly reduces the variability of their potential outcomes, as bonds have a much lower standard deviation than do equities and equity-like products.
If the US Federal Reserve is true to its word, US interest rates are likely to continue to rise, with the Federal Funds Rate likely elevating above 5% during this rising rate cycle. As Ron points out, we are huge proponents of using a Cash Flow Matching strategy in lieu of an active total return seeking fixed income mandate which further reduces the uncertainty of achieving a plan’s objective of securing the promised benefits with modest cost and prudent risk. It has been a long time coming, but fixed income is back, and plan sponsors would be wise to use it to a greater extent. Enjoy Ron’s piece, as it is quite inciteful.
We are pleased to provide you with our weekly ARPA update. Is the third time truly the charm? After submitting and withdrawing two previous SFA applications, the Southern California, Arizona, Colorado & Southern Nevada Glaziers, Architectural Metal & Glass Workers Pension Plan has submitted another revised application (1/10/23). The Priority Group 1 plan is seeking $429.6 million in SFA support for its 3,606 plan participants. The PBGC has until May 10, 2023, to act on this application.
In other ARPA news, there were no applications approved or denied during the most recent week. However, there was one application that was withdrawn. The Plasterers and Cement Masons Local No. 94 Pension Fund, a MPRA Suspension plan (Priority Group 2) has withdrawn its application effective January 11, 2023. They were seeking $3.3 million for its 108 participants. There are currently three funds, including the Plasterers, that have withdrawn applications that have yet to refile. In the case of the America’s Family Benefit Retirement Plan, they have previously submitted two applications, while the Ironworkers Local Union No. 16 Pension Plan has yet to resubmit an application following the withdrawal of its initial filing.
As a reminder, February 11, 2023, is the tentative start date for Priority Group 6 plans, those seeking SFA in excess of $1 billion, to begin filing applications. As the chart above highlights, the PBGC is expecting 14 large plans to file during that window. Much more to come!