Fall 2014 Market & Economic Commentary

By: Jim Scheinberg – November 7, 2014

We took an end of summer dip. Turns out the water’s still warm.

In our Summer Economic and Market PIERspective (July 17, 2014), I warned that the unusually low volatility the markets had been enjoying was not likely to continue for long, regardless of our still bullish expectations for equity markets and the global economy as a whole. Though things remained rather calm through the end of the Third Quarter, a confluence of headlines (ebola, ISIS and Eurozone-cooling) spooked the markets. After hitting an all-time high on September 19th, the U.S. stock market (with most of the globe in tow) began a dramatic selloff that would come just a hair short of an “official” 10% correction. The magnitude of the declines weren’t as dramatic as the speed. The S&P 500 sold off the final 7.5% of its 9.5% correction-ette during the last 5 days of its near month long swoon. Those lows were reached intraday on October 15th, a day on which the Dow initially declined 460 points before recovering into the market’s close. What was even more dramatic was that they yield on the 10-year Treasury declined from 2.25% to 1.89% during that same trading session, which was one of the most volatile moves in fixed income that I remember witnessing in my 25 year career. Over the next two weeks, economic data and earnings calmed emotions and the domestic  markets  have fully  recovered,  actually  achieving fresh new highs. But as we said in our October 16 PierAlert, “Volatility is here, as predicted.”

How the Markets Fared

debtThe Yield on the 10-Year Treasury was unchanged  during the quarter at 2½%, trading in a very tight range. With very little movement in the Treasury markets, high quality bonds earned little more than their coupons. Credit spreads widened somewhat, reducing returns in credit sensitive areas of fixed income. The BarCap Aggregate Index was virtually unchanged, giving back most of its yield in price declines and high yield bonds lost close to 2% net. Because of an advance in the value of the U.S. Dollar, international and emerging market debt was lower as well when measured back in dollar- terms. Latin American emerging market bonds sank further, due to Argentina’s second default in 13 years. It’s actually quite remarkable that the decline in emerging market debt globally was isolated solely to the immediate region. In similar times in the past (such as 1994 – Mexico and 1998 -Indonesia) a high profile default like this has widened credit spreads meaningfully for the entire asset class.

equityStocks saw a similar tale of two cities in Q3. Large Cap U.S. Equities were as quiet as the Treasury markets during the quarter, setting modest new highs before beginning their selloff in the last days of September. Smaller companies, however, had a rough go of it with big losses in July and September. International equities also lost ground as fears of a European and Asian slowdown reversed all of Q2’s comeback. Growth stocks edged out more cyclically sensitive value sectors both domestically  as well as in developed international markets.  Commodities dramatically reversed their rally from the first half of the year, losing 12½% in Q3. As fears of a global slowdown mounted in October, commodity prices continued to decline nearly another 6%.

Halloween’s over, should we still be scared?

gobalSince the correctionette was largely caused by fears of a global slowdown, let’s start there first. The European Commission just released its Autumn Forecast for the EU revising GDP growth expectations down to 1.3% in 2014 and 1.5% and 2.0% for 2015 and 2016 respectively. Both the World Bank and the IMF expect slightly lower, but steady growth for China between 7%-7½% for over the coming year. Historically, these forecasts have proved volatile, based on current snapshots of economic activity. Though we at North Pier are seeing these same signs of malaise, especially in the Eurozone, we don’t see the trend accelerating lower into meaningful recession. Rather, we theorize that Europe is likely experiencing the fits and starts recovery the U.S. experienced just a few years ago. Though far too early to call an end to the cooling trend that was evidenced in the final months of the summer, we are seeing initial signs of an upward turn in our forward looking indicators for Europe, China and Japan. While Germany, Ireland and Spain all improved, weakness in Italy and France is slowing growth in the EU.

Surging and Firming

The ISM Report on Business for Manufacturing (ROB) surged to 59 in October (up from 56.6 in September) nearing the highest levels since 2007. New orders, reported at 65.8, suggest that there is more good news to come. The services ROB retreated to a still strong 57.1 vs. 58.6 last month. The readings forecast GDP improvement for the U.S. of 4%-5% for the coming year. With the International ISM data mentioned previously showing at least a base for Europe and China (just above 50) and a positive turn for Japan, we believe conditions are ripe for the U.S. strength to lead global business activity forward.

North Pier Weather Forecasts for a Warm Winter… Maybe Even Hot.

Initial Jobless Claims are now at a 20 year low, indicating more strength ahead in the labor markets. Non-farm payrolls continue to add around 250,000 jobs a month, a very healthy level. Gains in the labor market now have a well entrenched momentum that will likely carry the unemployment rate (presently 5.9%) continually lower into the coming year. We should see 5% or lower unemployment in the U.S. by the end of 2015.

With the tightening in the labor markets, we are finally seeing some consistency in wage growth, which was previously an area of criticism in the recovery. Hourly earnings have been rising in a range of 2¼% – 2½% year-over-year of late. The average work week also ticked up a hair last month to 34.6 hours worked (a post-crisis high).

Spending GenerU.S.ly

confidenceStrength in jobs and increasing pay would logically bode well for the U.S. consumer; and it has. The Conference Board’s Consumer Confidence Index rose to a post financial crisis high of 94.5 in October from an originally reported 86.0 in September (since upwardly revised to 89). The Michigan Sentiment reading is equally showing post-crisis highs.

Retail Sales have been strong showing a 4.5% improvement from Q3 2013. If upbeat sentiment holds, this Christmas is likely to be a boom for retailers and the economy as a whole. We are also seeing evidence of this confidence in spending for big- ticket items. Durable Goods Orders are running 5% better than last year and new orders are showing a 7.6% increase since October 2013. This is great news for the U.S. auto industry where light vehicle sales have finally reclaimed their long-term normal, pre-crisis levels of 16-18 million sales a year.

libertySanity Checks and Balances

On November 4th, the country returned the Senate majority to the GOP. With the Republicans in control  of both houses of Congress, they will set the legislative agenda in Washington for at least the next two years. With mixed control of the Executive and Legislative branches of government, we are unlikely to see any major policy  initiatives that  would  undermine our current  path  to  prosperity. However, President Obama may increase his already aggressive use of Executive Order, which could throw a wildcard into our prediction, and potentially draw the country into a Constitutional crisis.

PIERing Ahead

pierAdding up the data of the last quarter, we see little reason to revise our macro-level expectations. The underpinnings of the global recovery remain in place, with the U.S. continuing to lead the world into a new era of prosperity. Yes, Eurozone debt and unemployment continues to be a drag on global progress, but strength here in the U.S. as well as the continuing emergence of the consumer class in Asia is likely strong enough to further drive the globe forward. Eventually, this growth should pull Europe out of its anemic economic state. The dread of a reversal in the global economic recovery that rose its spooky little head in the weeks leading up to Halloween was not completely misplaced. But scary things are not uncommon in October as well as the other 11 months of the year. The reality is that Europe’s trajectory is quite similar to our very own fits-and-starts  recovery of 2009-2012. During that era, we had a few scary, but minor decelerations along the way. Most were event driven: the BP Gulf oil spill, the Japanese earthquake and a couple of European Debt crises. However, the strong underpinnings of a U.S. recovery supported these dips and they proved to be short-lived.

The macro-level conditions of the globe should similarly support any short-term  ebb in this era of economic tail- winds.  In the coming years, we foresee that a rising tide truly will lift all ships, regardless if some presently have a few leaks. We will be watching commodity prices closely in the coming quarters for confirmation or contradiction of our theories. If the recent improvement in the global purchasing manager reports hold, then material prices should soon firm alongside them. If so, we expect that the recently downward revisions to European and Asian growth expectations will prove to have been an overreaction. We will update our network with a PierAlert if our monitored indicators show otherwise. In absence of that, however, you can still assume that we aPIER to be on course.

IRS Announces 2015 Cost-of-Living Adjustments

By: Brant Griffin – November 6, 2014

On October 23, 2014 the IRS announced this year’s retirement-related cost of living adjustments. Because the cost- of-living index met it’s statutory threshold for increase, many retirement related definitions and contribution limits will experience a minor increase in tax year 2015. Changes are mostly focused on qualified plan contribution limits and definitions, as IRA limits remain unchanged. Highlights include the following:


Guidance on Deferred Annuities in Target Date Funds

By: Brant Griffin – November 6, 2014

asppaOriginally published by the ASPPA Government Affairs Committee 

On October 24, 2014, the IRS and DOL issued coordinated guidance in the form of  Notice 2014-66 and a DOL Information Letter, which detailed rules for qualified defined contribution plans to invest in deferred annuities within a target date fund (TDF) series.  If certain conditions are met, the Notice allows a TDF series to be evaluated for the nondiscrimination requirements of IRC §401(a)(4), treating the entire series of TDFs as a single right or feature, even if any individual TDF would not satisfy the requirements on its own.


TDFs were designed to be a simple and coherent investment strategy for retirement savers by adjusting their asset allocation mix to become more conservative as the target date approaches. These investment products have gained far-reaching acceptance since the passage of the Pension Protection Act of 2006, which provided the statutory authority for plan sponsors to enroll workers automatically. The legislation further paved the way for TDFs to be used as Qualifying Default Investment Alternatives (QDIAs), receiving the contributions of participants in the absence of an affirmative investment election. As a result, TDFs have become nearly ubiquitous offerings in defined contribution plans reaching $621 billion in plan assets at 2013 year end (according to Morningstar).

Treasury Regulation §1.401(a)(4)-4 provides that optional forms of benefit, ancillary benefits, and other benefits, rights, and features must be available to a group of employees that satisfies the nondiscriminatory classification requirement of IRC §410(b). The traditional concern in having TDFs hold investments of deferred annuities is that the TDFs would need to be limited to the individuals in the TDF’s age-band, which might result in a TDF being disproportionately utilized by older employees (who are more likely to be highly compensated).  This possibility causes practitioners to question whether limiting specific TDFs to older participants would violate the current availability or effective availability requirement for benefits, rights, and features under the regulations.

IRS Guidance

IRS Notice 2014-66 addresses this matter for a TDF series investing in deferred annuities, by providing an alternative method to satisfy the non-discrimination requirements.  A TDF series is eligible to use the alternative nondiscrimination requirements if the following conditions are satisfied:

  • The TDF series is designed to serve as a single integrated investment offering, with the same investment manager and the same generally accepted investment theories applied across the TDF series.
  • The deferred annuities invested within the TDF series do not provide a guaranteed lifetime withdrawal benefit or guaranteed minimum withdrawal benefit feature.
  • The TDF does not invest in employer securities that are not readily tradable on an established securities market.
  • Each individual TDF is treated in the same manner in regards to rights and features other than its mix of investments (such as fees and administrative expenses).

If the TDF series is eligible for the alternative method of satisfying the non-discrimination requirements, then the TDF series may be treated as a single right or feature for purposes of satisfying the requirements of IRC §401(a)(4) and Treasury Regulation §1.401(a)(4)-4.

DOL Guidance

Alongside the IRS Notice, the DOL crafted a communication to the Treasury confirming that TDFs, which included unallocated deferred annuities among their investments, would not cause the funds to fail to meet the requirements of the QDIA regulations (29 CFR 2550.404c-5). Furthermore, the letter stated the DOL’s opinion that the selection of a TDF with a mix of unallocated annuity contracts would satisfy the requirements of ERISA §404(a)(1)(B) if:

  • The TDF’s investment manager has been properly designated as an ERISA §3(38) investment manager, and
  • The designated investment manager complies with each of the conditions of the annuity selection safe harbor (29 CFR §2550.404a-4).

The DOL further stressed that a plan sponsor would retain a fiduciary obligation to “prudently select the investment manager and monitor the selection at reasonable intervals, in such a manner as may be reasonably expected to ensure that the investment manager’s performance has been in compliance with the terms of the Plan and statutory standards, and satisfies the needs of the Plan”.


This IRS Notice and the DOL Letter follow the final regulations issued on July 1, 2014, which permit the use of longevity annuities (annuities that provide payments that begin at an advanced age) in defined contribution plans.  This cross-agency effort highlights the broader public policy goal of encouraging the use of lifetime income products by defined contribution plans.

The guidance will not only have an impact on employee investment outcomes, but will have broad implications for plan fiduciaries as well. The guidance demonstrates that TDFs are continually evolving, which makes monitoring and selecting TDFs even more challenging.