Market & Economic Commentary | Summer 2015

By: Jim Scheinberg – August 6, 2015

It All Sounded Greek to Me. Can Anyone Read Chinese?

Once again Greece and China dominated the headlines in the Second Quarter. Uncertainty about the broader implications for the EU – if a workable solution could not be found for Greece – cast a shadow of doubt over global markets. Unlike the prior incarnations of the European debt crisis in years past, the other PIGS nations (Portugal, Ireland, and Spain) are all seeing strong economic recoveries. Thus, the spread of a potential contagion was absent. The main point of the discussion was more about the confidence in the institution of the EU as a whole. A case of political-ego. Further dampening confidence was the state of the Chinese economy, which appears to be slowing down to a disappointing 6½% growth-rate for the next couple of years. Domestically, the U.S. continued to show economic resiliency. The result was a quarter with muted market moves, either up or down.

How the Markets Fared2Q15 Equity Markets2Q15 Debt Markets

The Federal Reserve seemed to be inching closer towards its first monetary tightening in 8 years. This was likely the reason Treasury yields climbed during the quarter, with the bellwether, 10-Year rising from 1.93% to 2.34%. Losses in high quality bonds resulted in the BarCap Aggregate wiping out all of its gains for the year. Waning confidence in the U.S. economy caused credit spreads to widen modestly. In the high yield arena, coupon returns were completely offset by price declines, resulting a net zero for the period. Emerging market debt improved in all major regions, mostly from currency rebounds against the U.S. Dollar. Commodities in general also rebounded after the trouncing they took over the last few quarters, but still show losses for the year.

Globally, equity markets took a pause. The U.S. large cap indexes were up a fraction of a percent, as were their developed market international peers. There was no leadership from neither the value nor growth side of the spectrum. Domestic small caps faired only a hair better. Here, there was a decisive advantage in the tech and biotech weighted growth areas. International small caps enjoyed the best gains of the quarter. Latin American stocks rebounded about half way after a rough Q1 while the rest of the EM was mostly flat.

Euro DropEx“poor”ts

Exports continued along near the same depressed levels of last quarter. As we discussed in depth in our Spring Commentary, “[t]he currency winds that are Europe’s back are clearly blowing across the Atlantic, right into our face.” This trend in international trade continued in the second quarter. According to the Census Bureau, total exports of goods dropped $43 billion or 5.6% for the first six months of the year compared to the same period in 2014. Usually boring, consumer products companies in the U.S. with seemingly stable sales, like Procter and Gamble, are seeing revenues decline 10% or more year-over-year while European-based companies like AG Bayer are seeing increases of the same amount… in U.S. dollar terms. Their upside surprises in Euros are even more dramatic. It is likely to be another two to three quarters before the year-over-year comparisons are based on this new exchange rate. Until then, earnings reports are likely to be skewed dramatically in both directions.

At Your Service!Parts & Service

The latest Institute of Supply Management Reports on Business confirms our theory. While the international trade sensitive manufacturing sector seems to be struggling to maintain growth, the more domestically focused services side of the U.S. economy is roaring ahead. In the RoB Manufacturing report for July declined to 52.7, still indicating modest growth ahead, but far from the last summer’s peak of 58 (before the Dollar surged against the Euro and other major currencies). This was caused in part by the export data declining to 48, indicating further contraction ahead. As a reminder, a number above 50 suggests expansion; below 50 indicates contraction. More troubling is that the backlog of orders pulled back to 42.5. Prices decreased from 49.5 to 44 in just one month. This suggests that U.S. Exporters are cutting prices (and digging into profit margins) in order to stay competitive with their overseas rivals.

However, the July Non-Manufacturing (AKA services) report surged ahead 4.3 points to 60.3, its highest level post-crisis. This was due to a jump in productions and new orders. Arts, Entertainment & Recreation; Educational Services; and Retail Trade; Real Estate, Rental & Leasing topped the areas of growth. Clearly these are domestically driven industries, which would not be nearly as susceptible to the elevated Dollar as the Manufacturing sectors showing contractions: Wood Products, Primary Metals, Plastics & Rubber Products, Chemical Products; and Machinery.

It’s worth noting that of all the jobs created in the United States this year, virtually all of them have come from the services side of the economy.

Screen Shot 2015-08-25 at 8.50.37 AM

Homeward Bound

Housing Affordability IndexU.S. home owners continue to benefit from steady, and apparently sustainable growth. Median home prices rose 6.5% over the same time last year, finally eclipsing the peaks of 2006. The Case Shiller data (20 City Index for May) confirmed that strength, showing gains of 1.1% over April and 5% year over year. Existing home sales improved by another 3.2% in June, now to a healthy 5 1/5 million units per month. Many speculate that the higher and higher prices and increased mortgage rates after the Fed raises discount rates will reduce affordability and dampen demand. However, with average mortgage rates still hovering in the low 4% range, there is plenty of room for interest rates to rise before affordability becomes more than a slight physiological factor for buyers. (See chart right) More likely is that with the first rate increases, there will be rush of buyers that don’t want to miss out on historically low borrowing costs.


Captain AmericaAll in all, things are looking pretty good for most Americans these days. The labor markets continue to improve. We continue to average more than 200,000 new jobs a month; a trend that has been steady for several quarters now. This has helped whittle the unemployment rate down to 5.3%. Now that supply in the labor market has come back into balance with demand, personal income is growing nicely. Personal income increased 0.4% in each of the months of April, May, and June. Jobs a-plenty, increased earnings, and growing home values should have the consumers feeling pretty comfy about things, and they do. The University of Michigan Consumer Confidence Survey is still showing that people’s present situation index is well over 100 – a very optimistic level. However, there is something a bit troubling in the survey data; future expectations continue to decline. It seems that Americans are quite happy with their lot today; but are growing dubious that the good times will continue. Whether this is foreshadowing of things to come or simply a case of Post-Traumatic-Crisis-Syndrome remains to be seen. But for now, in the face of troubles in Greece and a slowing Asia, Americans are still standing tall.

PIERing Ahead

We view the Greek story as a major distraction. There is no ‘next country’ to fall anymore. Unless Greece is allowed to exit the Euro, letting their currency devalue to reduce debt and stimulate their economy, the EU will need to continue to bail them out time and time again. Either way, this is a non-issue in our eyes. The Greek economy is smaller than that of the city of Boston’s and roughly one-tenth the size of Germany’s. One way or the other, this issue should fade from the headlines again, as it has in years past.

What is important, but what seems to get shockingly little attention is the story of the U.S. Dollar. The drama of the fall of the Euro seems to have ended in March. Since then, currencies appear to have stabilized around the “new norm.” However, we will continue to see trade and corporate earnings implications in both the European and our domestic economies for the next few quarters. Benefitting from the cheaper Euro, most of the EU is now on track for modest growth. However, Asia looks to be facing a regional headwind, everywhere except for Japan. Domestically, key drivers of growth still look encouraging – some, albeit at more tepid levels. Though U.S. GDP improved to 2.3% in the second quarter, we still believe that expectations for the second half are overly optimistic due to continually weak exports, again created by the strong Dollar. How deep the impact of the trade imbalance turns out to be is unknown. If the domestic components cannot continue to make up the slack for weak trade numbers, a meaningful pullback in the U.S. markets is likely. However, there is a chance that things like strong labor, housing, and consumer spending will more than offset the drag from poor exports. Regardless, we would view any correction as aberrational, and as a buying opportunity. Once year-over-year comparisons fully reflect the new higher valuation of the Dollar, comparisons should improve. At that point, we see a strong acceleration in all U.S. data, both from manufacturing as well as service sector. With a strong U.S. consumer and a strengthening European economy, export-sensitive Asian economies should firm as well. From our PIERspective, all of this should come together by Spring/Summer 2016. At least we Opa!


Fiduciary Commentary | Summer 2015

By: Brant Griffin – August 4, 2015


GavelOn February 24, 2015, the US Supreme Court began hearing arguments in a highly anticipated ERISA plan case. As the first excessive 401(k) fee case heard by the Supreme Court, Tibble vs. Edison International has been closely followed by ERISA practitioners and sponsors. The case went well beyond the frequently discussed topic of plan fees, which many believe was the focal point of this case.

The Court’s findings have significant ramifications to plan fiduciaries and how they monitor plan investments. The central issue under consideration was whether a claim for failing to monitor an investment could proceed even though the fiduciary breach in the selection of the investment occurred outside of ERISA’s six-year statute of limitations period.


Edison International is a holding company for electric utilities and other energy interests. Edison sponsored a 401(k) plan for its 20,000 employees with a value of $3.8 billion during the litigation. The case involves six mutual fund investments that were added to Edison’s 401(k) plan from 1999 to 2002; three funds in 1999 and another three in 2002. These investments were higher cost retail classes of the mutual funds when lower cost, institutional alternatives could have been utilized to reduce participants’ investment expenses.

The Tibble plaintiffs, representing current and former 401(k) plan participants and beneficiaries, claimed that Edison and its plan fiduciaries violated ERISA’s fiduciary duty of prudence by investing in the retail fund alternatives when identical, less expensive alternatives were available. In 2010, the U.S. District Court for the Central District of California heard the case. The court ruled with the plaintiffs and found that Edison breached its fiduciary duty of prudence by selecting the pricier retail funds over the lower cost options (noting there was no evidence to support the selection of the more expensive investments). The court granted the plaintiffs a judgment of $370,732 for the damages related to the higher fees in the three retail funds added to the plan in 2002. However, it did not grant damages related to the three funds added in 1999. The court’s decision limited the applicable findings to the investments that had been offered to plan participants within ERISA’s six year limitation period.

In rendering its decision, the district court maintained that Edison’s decisions to add the 1999 funds occurred more than six years before the complaint was filed, and was not eligible to be included in the suit. The decision to deny the claim was based on ERISA law that requires a breach of fiduciary duty claim to be filed no more than six years after “the date of the last action which constitutes a part of the breach or violation” or “in the case of an omission the latest date on which the fiduciary could have cured the breach or violation.” This six year period is considered a statue of repose that, distinct from a statute of limitations, sets an absolute time limitation to seek a lawsuit.

The plaintiffs argued that despite the time period since the 1999 investments were added to the plan, Edison’s fiduciaries had an ongoing duty to prudently monitor the investments, and that evaluation process should have resulted in the removal of the imprudent investments. Therefore, the plaintiff’s charged that there was a continuous violation by the fiduciaries by maintaining imprudent, more costly investments. The district court rejected the plaintiff’s claim, citing their failure to identify new facts and circumstances that would have necessitated a re-evaluation of the investments (thus causing a new, distinct fiduciary breach).

In response to the district court’s ruling, Tibble appealed the decision to the Ninth Circuit. The plaintiff arguments were again met with rejection, as the appellate court upheld the district court’s decision to limit the settlement to the investments added to the plan within the ERISA limitations period. The Ninth Circuit stated that initially choosing the investment for inclusion in the plan triggers the limitations period, unless evidence showed that “changed circumstances” obliged plan fiduciaries to conduct a “full diligence review” of existing funds. The Ninth Circuit supported its decision, saying that the “changed circumstances” requirement gave meaning to ERISA’s six-year limitations period, despite the ongoing fiduciary duty to monitor investments.Money

The appellate court ruling prompted a U.S. Solicitor General’s brief, where Tibble’s argument finally found support. The brief supported the notion that the claim should not be subject to ERISA’s time limitation, and a fiduciary’s ongoing duty to review plan investments was a potential additional breach in the case. The plaintiffs received further support when the Department of Labor argued in favor of the “continuing violation” exception to the six-year period noting that otherwise, ERISA fiduciaries would have no incentive to remove ill-advised investments.

Supreme Court Decision And Opinion

In October 2014, the Supreme Court agreed to review the closely followed 401(k) fee case. The Court opposed the appellate court’s finding that only new, significant “changed circumstances” could initiate a separate fiduciary breach within the repose period. The Court found that there can be a claim of fiduciary breach for the failure to “properly monitor investments and remove imprudent ones” as long as the breach occurred within the six years before filing suit. On May 18, 2015, the U.S. Supreme Court announced its 9-0 decision. In rendering its opinion, the Court found that ERISA, like trust law, imposes upon a plan fiduciary a “continuing duty to monitor trust investments and remove imprudent ones.” The Supreme Court remanded the decision saying that the Ninth Circuit failed to consider the “role of the fiduciary’s duty or prudence under trust law.” Further, it found the duty to continually monitor investments to be distinct from the fiduciary’s duty to prudently select an investment.

In rendering its opinion, the Supreme Court fell short of defining what constitutes a prudent evaluation regiment for the ongoing duties of fiduciaries. However, the Court did mention that “changed circumstances” were not the only scenario wherein there might be a fiduciary failure to monitor and review investments.

Some have argued that the Tibble vs. Edison case is about the duty of plan sponsors to select inexpensive plan investments. Clearly, it is not. ERISA does not require fiduciaries to select the cheapest fund available; rather they must prudently select plan investments. The case is about the thoughtful, ongoing duty to monitor plan investments, including evaluating the multitude of share classes available.

The outcome of the Supreme Court’s decision provides important guidance to fiduciaries. Among them, the common understanding that the duty to monitor plan investments is a fundamental and continuous obligation. Further, there are no separate levels of prudence under ERISA. Prudence is evaluated based on the facts and circumstances of the situation. When monitoring plan investments, the same level of prudence is required as when making the initial investment selection. Fiduciaries have long been reminded that the best way to demonstrate conformity with a prudent investment process is to document their initial and ongoing analysis of investments.