the Supreme Court and 401k plans

On Monday, the Supreme Court made a narrow ruling on a technical point that may have far-reaching implications.

Participants in the 401k plan offered by Edison International, a California utility, sued the company claiming that it stocked the plan with “retail” versions of investment products that charge higher management fees than the lower-cost  “institutional” versions that it could have chosen instead.

The company defended itself by successfully arguing in a lower court that the statute of limitations for bringing such a lawsuit had expired.  The Supreme Court said the lower courts were mistaken.  An employer has a continuing duty to supervise its 401k offerings.  So even though years had passed since the 401k offerings were placed in the plan, the statute of limitations had not expired.

So the case goes back to the lower court, where presumably the question of whether Edison was right to offer a higher cost product than it might otherwise have.

Was this a mistake?

Why wouldn’t any company have the lowest cost share possible in the 401k plan?

The short answer is that the company receives a portion of the management fee in return for allowing the higher charges.

Typically the company argues that the fee-splitting helps cover the costs of administering the 401k plan.  In practical terms,thought, the move doesn’t eliminate the costs.  It shifts them from the company to the plan participants.

If the Wall Street Journal is correct, this is the case with Edison, which is reported as pointing out that the fee-splitting is disclosed in plan documents.

I have two thoughts:

–the sales pitch from the investment company providing the 401k services probably sounded good at the time.  The 401k would be inexpensive (free?) to Edison.  High fees would shift the cost onto employees instead–which makes sense, the seller might argue, since employees are the beneficiaries of the plan.

On the other hand, to anyone without a tin ear, this sounds bad.  The amounts of money are likely relatively small.  Edison is probably spending more on legal bills than it “saved” by choosing the plan structure it did.  And if it turns out that Edison is profiting from the arrangement rather than just covering costs, the reputational damage could be very great.

–fee-splitting arrangements on Wall Street are far more common than I think most people realize.  This case could have wide ramifications for the investment management industry if the courts ultimately decide that Edison acted improperly.



an Intel (INTC) – Altera (ALTR) deal re-emerging?

Market gossip is that ALTR recently refused a friendly offer from INTC at $53 a share.

Speculation resurfaced yesterday with rumors that talks have started up again.

The catalyst seems to be the fact that serial acquirer Avago (AVGO–I own shares) appears to be considering a bid for ALTR’s rival Xilinx (XLNX).

AVGO seems to have a knack for finding firms that have excellent technology but which, for one reason or another, find it difficult to achieve consistent profit growth.  AVGo buys them, reorganizes them and puts the profit machine into high gear.

In this case, the sub-industry involved is the sleepy world of field programmable gate arrays (FPGAs), dominated by the cozy duopoly of ALTR and little brother XLNX.  AS the name suggests, FPGAs are chips whose program structure is not hard-wired (those are application-specific integrated circuits–ASICs).  So they can be reprogrammed, upgraded, debugged…even after they’ve been put into machines that are now in use.  This allows manufacturers to get, say, cutting-edge telecom equipment into customers’ hands very quickly.  The drawback is cost.

The AVGO move suggests the FPGA arena is about to become considerably more competitive.   AVGO/XLNX would be four times the size of ALTR, implying easier access to capital and the ability to offer a much wider variety of products to customers than ALTR.  This suggests ALTR realizes the status won’t be quo for much longer and it needs to be part of a bigger entity in order to compete.

To my mind, the big winner in all this would be INTC.

inheritance tax changes as a lever for structural change in Japan

value investing and corporate change…

One of the basic tenets of value investing in the US is that when a company is performing badly, one of two favorable events will occur:  either the board of directors will make changes to improve results; or if the board is unwilling or incapable of doing so, a third party will seize control and force improvements to be made.

…hasn’t worked in Japan

Not so in Japan, as many Westerners have learned to their sorrow over the thirty years I have been watching the Japanese economy/market.

Two reasons for this:

culturally it’s abhorrent for any person of low status (e.g., a younger person, a woman or a foreigner) to interfere in any way with–or even to comment less than 100% favorably on–a person of high status.  So change from within isn’t a real possibility.

–in the early 1990s, as the sun was setting on Japanese industry, the Diet passed laws that make it impossible for a foreign firm to buy a large Japanese company without the latter’s consent–which is rarely, if ever, given.

The resulting enshrinement of the status quo circa 1980 has resulted in a quarter century of economic stagnation.

Abenomics to the rescue?

Abenomics, which intends to raise Japan from its torpor, consists of three “arrows”–massive currency devaluation, substantial deficit government spending and radical reform of business practices.

Now more than two years in, the devaluation and spending arrows have been fired, at great cost to Japan’s national wealth–and great benefit to old-style Japanese export companies.  But there’s been no progress on reform.  The laws preventing change of control remain in place.  And there’s zero sign that corporations–many of whose pockets have been filled to the brim by arrows 1 and 2, are voluntarily modernizing their businesses.  Mr. Abe’s failure to make any more than the most cosmetic changes in corporate governance in Japan is behind my belief that Abenomics will end in tears.

One ray of sunshine, though.

Japan raised its inheritance tax laws at the end of last year, as the Financial Times reported yesterday.  The change affects three million small and medium-sized companies.

The top rate for inheritance tax is 55%, with payment due by the heir ten months after the death of the former holder.   This development is prompting small business owners to consider how to improve their operations to make their firms salable in the event the owner dies.  More important, it’s making them open to overtures from Western private equity firms for the first time.  Increasing competition from small firms may well force their larger brethren to reform as well.

For Japan’s sake, let’s hope this is the thin edge of the wedge.



cyclical growth vs. secular (ii)

Same topic as yesterday, different starting point.

When the monetary authority begins to tighten policy by raising interest rates, it does so for two reasons:

–the domestic economy is giving signs of overheating, that is, of growing at an unsustainably high rate, and needs to be reined back in before runaway inflation results

–too much money is sloshing around in the system, and finding its way into more and more speculative investments.

For stock market investors, the tightening process implies two things:

–the rate of profit growth in business cycle-sensitive industries is peaking and will begin to decline, and

–playing the greater fool theory by holding crazily speculative investments will no longer work as excess money is siphoned out of the economy.

However the Fed proceeds, the second effect will surely happen, I believe.  But the US economy can scarcely be said to be overheating.  Despite this–and the Fed’s promised vigilance to prevent a meaningful slowdown in economic activity, I think all stocks–and cyclical ones in particular–will be affected.


…because the Fed tapping on the brakes lessens/removes the ability of investors to dream of a possible openended future cyclically driven upsurge in profit growth.  Whether specifically aimed at this or not, Fed action will have the effect of tempering Wall Street’s avaricious dreams.

What about dollar weakness, EU growth, China…?

In every cycle there are special factors.  They don’t change the overall tone of the market, though.

The main effect of a weaker dollar and stronger EU economic performance will be to increase the attractiveness of EU stocks, and of US names–principally in Staples and IT–with large EU exposure.  Look for the stocks with big holes in December and March quarterly income statements.

As for China, who knows?   My guess is that the Chinese economy won’t deteriorate further from here.  But the main China story , as I see it, will be the country’s gradual shift to consumer  demand-drive growth along with the substitution of local products for imports.  To me, both aspects suggest that well-known US, EU and Japanese China plays won’t regain their former glory.

My bottom line:  the shift from cyclical to secular may be more modest than usual this time, but it will still be there.  A more conservative mindset argues against further price earnings multiple expansion for the market.  So future market gains will depend entirely on earnings growth. The larger immediate effect will likely be in the loss of market support for very speculative stocks.


cyclical growth vs. secular: which to choose now?

cyclical and secular

The rhythmic cyclical economic progression from recession to expansion and back again affects everything the global economy.  Yes, there are sectors like Materials that go through their own long boom and bust cycles that can last decades.  There are also public Utilities that supply water or electricity that are well-insulated from cyclical fluctuations.

Despite these (relatively minor, in my view) complications, it’s useful for stock market investors to distinguish between companies whose profits are linked mostly to the business cycle–say,  a cement plant, or a supermarket or a department store–and those whose success is more a product of their own innovation or of being positioned in the slipstream of structural change–like Apple, or Amazon or Facebook are/have been.

How so?

In the simplest terms, the first group does particularly well as economic recovery springs out of recession. The latter typically begin to come into their own a year or two into an economic/stock market upswing, when demand pent up by recessionary fears is satisfied and economies settle into a slower, more sustainable growth pace.  In the case of the Great Recession, this process has taken a much longer time.

At some point, central banks step in to raise interest rates, reining in growth a bit further, and tipping the scales a bit more toward secular growth.

Yes, but…

By these last few keystrokes, the “yes, but”s have begun screaming loudly enough in my head to interrupt my train of thought.

They see where this post is going–how should we structure our portfolios to deal with the coming rise in interest rates in the US?–and the answer is going to be to go with structural growth over cyclical growth.

It isn’t necessarily that simple…

…what if the current slowdown in the US is all about the cold weather and port congestion, and we’ll get catchup in the summer?

–what about the weakening dollar, which is giving more evidence of having peaked against the euro?

–what about the EU picking itself up off the economic floor for the first time in years?

–what if the anti-corruption drive in China is past its worst and growth will pick up there?

–what about the bounceback in oil prices?

–how much do valuations matter?

…or is it?

What I think:

Rising interest rates always have a sobering effect on investors.  It’s a change to a more conservative mindset, rather than a precise calculation of the effect on profits of higher rates.

Valuations matter more than before, especially for smaller, non-mainstream companies.  Investors will take a harsher look at highly indebted companies that are struggling.  The same for startups with little more than a business plan and a prayer–it will be much harder than it is today for them to go public.  PE multiples generally don’t expand; if anything, they contract.  At the very least, investors will take pruning shears to the highest numbers.

To the degree that the US economy remains in low gear, interest in secular growth names will intensify.  However, I also think investors will lose their taste for “me too” smaller stocks.

More tomorrow.







OECD education survey–implications for economic growth

The BBC published the broad outline of a recent OECD survey of educational attainment for 76 countries around the world.  Data will officially be released next week.  My Google search for details suggests other news organization writing about this are simply repeating the BBC story.

The survey is based on testing of 15-year-olds on science and math.  It differs from the OECD’s previous Program for International Student Assessment (PISA) studies–the latest published in 2012–in two ways:

–it includes an extra 11 countries, and

–it doesn’t have the third PISA test, reading.

The US finished 28th.


Pending the full release of data, this may actually be a perverse kind of “good” news.  In the 2012 rankings, the US finished with average showings in science and reading, and below average marks (in 36th place) in math.

Generally speaking, the US beats out Latin America but loses to the EU and Asia.  As can be seen from the interactive chart in the BBC article, China, India and most of Africa aren’t included.

These surveys are presumed to be important (I think they in fact are) both because they give an indication of equality of opportunity within a given country (the US is below average but making some progress) and international economic competitiveness (unclear to me whether the US is mired in average or is slipping).


More when the actual report is out.


a surprising reaction to a so-so jobs report …trading computers at work?

Last Friday, the Bureau of Labor Statistics released, as usual, its monthly employment report for April.  The numbers were good, but not surprisingly so.  The Employment Situation said the economy added 223,000 new positions in April– +213,000 in the private sector and +10,000 in government.

The revisions to prior months’ data were strongly negative, though–+2,000 jobs for February and -41,000 for an already weak March.

Wage gains remained in the +2%/year range;  the unemployment rate was stable at 5.4%.

My reaction was that the figures were about what the market had expected.  The headline figure, ex revisions, was exactly in line with economists’ estimates.  Nothing else changed much.


…the S&P rose steadily during the day end ended up by 1.3%.

Yea, I’ve been retired for some time.  But I can’t imagine any of the portfolio managers I knew/know buying stocks on this report (because it contained no new information).

Yet the market didn’t just shrug the report off.  Instead, it went up a lot.  Assuming the market went up on the Employment Situation–and I think it did–the market reacted to a just-as-expected report rather than discounting it in advance, as usually happens.

Why did the market behave this way?  I don’t know.  All I can come up with is that computers, not people, are the main actors, and that the decision rules they’re using aren’t very good.

Something to think about …and keep an eye on, since this behavior runs so counter to prior experience.