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2016 Q1 Market Commentary

Dave Butler offers a sports example to help investors apply discipline in a stressful market.

2016 Q1 Market Commentary

2016 Q1 Market Commentary

“What do you regard as the most difficult period in the financial markets during your 25 years in the investment business?”

I am often asked this question, usually by people who already have a framework and opinion as a result of living through one or several market downturns. For example, many older advisors and their clients regard the 1973–1974 bear market as the toughest period in their investment lifetime. Middle-aged investors may consider the tech boom and bust of the late 1990s and early 2000s to be the bellwether event for a generation of investors who assumed they could get rich on one great stock pick. Today, just about everyone remembers the 2008–2009 global financial crisis, having experienced the anxiety of declining investment accounts themselves
or knowing someone who did.

The market decline in early 2016 has much of the same feel as past events. Times like these are never easy for clients or advisors, who must confront their concern that “things just might be different this time.” When in the midst of a market decline, it is natural to sense that the volatility is lasting longer and is worse than anything before. As a result, advisors spend a lot of time talking to their clients in an effort to alleviate elevated concerns and fears.

How do we find the words that might help minimize the fear and anxiety advisors’ clients feel about their investment portfolios and retirement security? As you know, no single word or story can ease their concerns—and certainly not overnight. The more effective course may be for advisors to steadily lead clients down a path from worry to calm through a conversational approach that emphasizes the importance of sticking with their plan.


I had the opportunity a few weeks ago to speak at an advisor’s client event in California. As I was driving to the event, I thought about how
to make the presentation conversational and ensure the concepts of process and discipline resonate with the audience.

The audience was a sports-oriented crowd,
and I had about 15 minutes to get across one important concept that might help them navigate the choppy markets. Then I remembered an article I read about world-class athletes and their approach to success. The author described how the greatest athletes, from Olympians to all-star professionals, focus on process rather than outcome when competing at the highest level. I thought about this in context of my own college athletic experience, which, although not at the Olympic level, involved the same need for calm and
focus during high-pressure moments in
a basketball game.

Imagine yourself playing in a championship basketball game. Your team is trailing by one point. You are fouled just as the game clock goes to zero. You have two free throws. Make both and you win. Miss them and you lose.

What do you do to contain the pressure and focus on the task? The great athletes look to process. While each process may be different, each one reflects a personal routine a player has performed thousands of times in practice. For instance, you start your routine as you approach the free throw line; you take a deep breath and imagine the ball going through the hoop; you step to the line and find the exact spot (usually a nail right behind the painted line) where your right foot will anchor; you look at the back (or front) of the rim and notice the paint peeling or the net missing a connecting loop—or anything else to help you concentrate and calm your mind; and you take the ball from the referee and continue your routine. You dribble twice and flip the ball in the air, take a couple of knee bends, find the grooves on the ball, and spread your fingers across it. You feel the texture of the ball, the rough orange leather and the smooth black rubber on the grooves, and finally time the motion so that your body, the release of the ball, and the follow-through of your hand are all in perfect synch as the ball elevates and descends to the basket.

The effective athlete does not hope for an outcome or get nervous or scared as the moment approaches. He or she immediately falls back on the tried and tested routine performed countless times in a more serene environment (practice). Following the routine dulls the noise of the crowd and brings
clarity of mind.

The same lessons apply to the seasoned investor. A chaotic market is akin to what the visiting team experiences in a gym, where opposing fans and players are doing everything possible to distract you. You stay focused on a routine burned into your nature through coaching and repetitive practice.

The components of the seasoned investor’s routine are similar: the investment policy statement, the regular review of family goals and liquidity needs, and the regular calls an advisor makes during good and bad markets. These and other actions are all part of the process developed to summon that muscle memory needed in stressful times. Just as the great athlete navigates through the moments
of pressure in any athletic event, the actions
are part of the routine that allows the individual to navigate through a chaotic market like we have today.

I believe there are many stories and anecdotes that parallel the basic needs of an investor, but it is up to the advisor to find one that resonates with a particular client or audience. The example could involve a great violinist, a world-class chef, or even a gardener. In each case, there is a story of discipline behind the person who continually works to perfect the craft and a reminder of how a successful investor can do the same.

Statistics and data are the bedrock for the insights we gain about the capital markets, but it is often the conversational story that can help clients of advisors focus on the simplest and most important tenets of investment success. Regardless of the market or time period, advisors can encourage their clients to maintain the discipline needed to follow a process, which can lead to a great investment experience.

Ten Retirement Plan Resolutions for Plan Sponsors

This edition of our Retirement Plan Services newsletter is a recent publication by John C. Hughes of The ERISA Law Group, P.A. in Boise, ID. He has given 10 important issues for plan sponsors to consider during 2016, and we wanted to share them with you. Enjoy!

1) Adopt a restated and amended “PPA” plan document by April 30, 2016. This applies to those qualified defined contribution plans that are on “preapproved” (i.e., “volume submitter” and “prototype”) documents. In the course of the restatement process, exercise caution to ensure that existing provisions are properly carried over to the new document (or changed, as desired and permitted). We have observed in many (too many) instances that provisions are inadvertently changed or left out during the restatement process. This will result in qualification failures. The restatement is also a good time to “scrub” your document to ensure it is up to date in terms of prior amendments, particularly if the plan will be submitted to the IRS on or before April 30 for a determination letter.

2) Begin to develop a plan of action to transition onto a preapproved document if your plan is individually designed, given that individually designed plans will generally no longer be able to obtain their own determination letters. Several pieces of guidance have been issued on this topic including IRS Notice 2016-03, which was issued on January 4, 2016.

3) Carefully review (and revise, as necessary) your Form 5500 (and audit report) prior to filing. This will decrease the chances that your plan will become the subject of a Department of Labor or IRS audit, investigation, or inquiry.

4) Make sure that you automatically enroll participants if your plan provides for automatic enrollment, and that you are otherwise operating that feature (and any associated automatic escalation feature) in accordance with the plan terms. It is important to actually enroll and/or escalate the right employees at the right time and in the right amounts, and that the proper notices are timely furnished. Often this does not occur, requiring difficult and sometimes costly corrections.

5) Make sure that any plan related documents such as SPDs and quarterly/annual notices that are being furnished electronically to participants are being delivered electronically by legally permissible means. That is, there are acceptable and unacceptable ways to electronically deliver notices and disclosures. These rules are sometimes ignored, which means that under ERISA and the Internal Revenue Code the disclosures have not been made at all.

6) Assess the reasonableness of the fees that are being paid with plan assets. There are new class actions being filed by participants constantly, not to mention the Department of Labor’s keen interest in the issue.

7) Avoid instances of late deposits (and/or identify past instances) so that they are properly reported and corrected. Late deposits continue to be a frequently occurring problem, and a problem that is receiving increased attention from the Department of Labor.

8) Review plan terms and internal processes to ensure that the correct employees are being let into the plan at the right time. For example, it is not permissible to exclude “temps” or “part-time” employees on a blanket basis. Similarly, there are often issues with regard to “leased employees” and/or independent contractors that go unnoticed (and snowball as time goes by).

9) Be conscious of the effect of any corporate transactions. For example, an acquisition may require new employers to affirmatively adopt a plan, or require an amendment to keep new employers out of a plan. In most cases, it is critical to identify these issues and take appropriate action prior to the close of any transaction. Those kinds of problems are difficult to untangle once they occur.

10) Complete ADP/ACP testing so that corrections can be made in early 2016. In performing such tests, ensure that the correct categories of employees are properly considered. For example, sometimes all “highly compensated employees” are improperly categorized, which in turn makes the test results useless. Overall, check in with your recordkeeper to ensure other necessary IRS testing is being properly performed (and documented).

This is by no means an exhaustive list. Unfortunately, the volume and complexity of the laws governing qualified retirement plans (and also nonqualified and welfare plans) is burdensome. This burden rests with the employer plan sponsor, and requires constant oversight and evaluation.

This Newsletter is intended to provide general information only and does not provide legal advice nor create an attorney-client relationship. This Newsletter does not discuss potential exceptions to the above rules. The application of ERISA can differ from client to client. For information regarding the impact of these developments under your particular facts and circumstances, you are advised to seek qualified legal counsel. This material may also be considered attorney advertising under rules of certain jurisdictions.

“Safe Havens” in a Volatile Market

In the fifteenth century people used the phrase “safe haven” to speak of a place where fugitives went to get shelter or protection from their pursuers.  Today we speak of safe havens as places where investors put their cash when they don’t want to take risks. From what or who are these investors running?

Since the beginning of the year the financial markets have seen an increase in volatility over the previous year.  But this volatility may not be out of the ordinary. Investors may be running from something that isn’t really that dangerous.

Traditionally, in times of trouble and increased uncertainty about the economy investors moved capital from stocks to government bonds.  This safe haven investment is proving unhelpful this year.  While still a haven in that you are very unlikely to lose your investment principal, the returns on bonds are at all-time lows. Government bonds currently yield only 1 or 2 percent per year and have not risen in price even with the stock market declines we saw in January and February.

Another traditionally safe investment is precious metals. But here too, current returns are low. The price of gold is up for the year, but unchanged over the past twelve months.

In search of better returns some investors are turning back to real estate, despite large losses for this investing category during the financial crisis of 2008. As of late 2015, the S&P/Case-Shiller U.S. National Home Price Index was 5.3 percent higher year-over-year.[i]  According to the Society of Industrial and Office Realtors, commercial real estate prices are currently rising at about 7 percent per year.[ii]

Before shifting much capital to precious metals, real estate, or any other so-called “alternative investments”, investors should consider if the recent stock market volatility is really that bad.  Is the stock market response to slowing economic conditions and uncertainty surrounding the upcoming presidential election a reasonable adjustment or a sign of impending doom?

It turns out that a large drop in the value of stocks is consistent with only a small change in the forecasted growth rate of earnings.  To explain this, financial economists use a process called the dividend-discount method of stock valuation. Applying this model to today’s market shows the current situation is consistent with just a slightly lower expected growth rate.

Stock investors in the United States and other developed countries have historically earned a 10 percent return over the long-run. It’s not unreasonable to expect this return in the future, but if dividends are going to grow more slowly because the economy is slowing, our economic model predicts a fairly strong change in current prices.

Suppose, for example, a company currently pays a $1 annual dividend and has historically grown this dividend by 5 percent per year.  If investors are looking for a 10 percent long-run return the dividend-discount model then says this stock will sell for $20 ($1 divided by the expected return of 10 percent less the 5 percent growth rate).  Investors in this stock are earning a 5 percent current yield ($1/20) but getting another 5 percent in growth, for a total return of 10 percent.

Suppose now that things change and investors think the company can only grow dividends by 4 percent per year. The stock price has to fall to $16.83 in order to earn them the same 10 percent long-run return (($1/$16.83) + 4 percent = 10 percent).  So, a small reduction in the economic outlook for growth turns into a 16 percent drop in the stock price.  Since the economic outlook can change for many reasons we should expect 10 or 20 percent swings in stock prices relatively often.

And this is only half the story.  Compared to alternative investments, like gold and real estate, stocks aren’t all that risky.

Financial economists measure the investment risk in stocks, bonds, and other assets by their volatility; roughly the frequency and magnitude of price changes.  The statistical measure of this concept is called standard deviation.

Since 2006 the standard deviation of the return on stocks in the Standard & Poor’s 500 index is 14 percent using monthly price data.[iii]  Over the same period, returns on gold had a slightly higher standard deviation of 15 percent[iv], while the volatility in real estate was 22 percent as measured by the Wilshire US Real Estate Investment Trust index.[v] Metals and real estate are risky investments; that is, there is little protection in these so-called alternative investment classes.

So we can run to the investing haven of bonds and get a return that is currently below the rate of inflation, and never likely to be above it, or we can turn to the haven of metals and real estate and not be any safer.

Yes, the economic and political outlook is uncertain. But the greatest safety from whatever is pursuing your investment portfolio is simply the long-run value of stocks.

Peter R. Crabb, Ph.D.Peter R. Crabb, Ph.D.
Professor of Finance and Economics
Department of Business and Economics
School of Business, Northwest Nazarene University
[email protected]

Dr. Crabb holds a Ph.D. in Economics from the University of Oregon and an MBA in Finance from the University of Colorado.  His research in economics and finance is published in the Journal of Business, the Journal of Microfinance, and the International Review of Economics and Finance, among others.  Dr. Crabb lives with his wife, Ann, and their four children in Canyon County, Idaho. Dr. Crabb’s regular Financial Economics column is published by the Idaho Statesman. Previous work experience includes international trade, banking, and investments.

The views expressed are those solely of the author and do not represent Northwest Nazarene University or R|W Investment Management.

Making the Most of Your Retirement Plan

Your company’s retirement plan is a smart way to save for a secure financial future. Below are a few helpful hints to help you reach your goals.

Do participate today. Each day you wait is less money you will have at retirement.Don’t let emotion rule. Remember that the market fluctuates and that you are in this for the long term.
Do diversify* your investments. Consider your age and your tolerance to risk.Don’t “listen to your neighbor.” Consider the source of such investment advice.
Do contribute enough to receive the full benefits of the employer match (if offered).Don’t time the market. This is a dangerous game to play.
Do rebalance your investment allocation regularly.Don’t chase returns. It won’t get you any closer to where you need to be.

Remember, you are in control of your retirement savings – so be pro-active!

If you have any questions or are unsure how to invest your money, contact your benefits department or call your retirement plan consultant, R|W Investment Management at 208-297-5445.

*Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.
Investments are not guaranteed and are subject to investment risk including the possible loss of principal.
The “Retirement Times” is published monthly by Retirement Plan Advisory Group’s Marketing team. This material is intended for informational purposes only and should not be construed as legal advice and is not intended to replace the advice of a qualified attorney, tax adviser, investment professional or insurance agent. (c) 2015. Retirement Plan Advisory Group. 401k-2011-19 ACR#148881 08/15

The Rise of Short-Term Rates

Market Commentary Q4 2015

Q4 2015 Market Commentary

While many market participants were waiting for the “inevitable” rise in short-term interest rates expected when the Federal Reserve tightened its monetary policy, some investors may have missed the increase in short-term rates already underway as a result of market forces.

Looking at the zero- to two-year segment of the yield curve—the segment that many believe will be most affected whenever the Fed “normalizes interest rates”—it may be surprising to see how much rates have increased since 2013.

In fact, the yield on the 2-Year US Treasury note has nearly doubled since the beginning of 2015, rising from 0.45% in January to almost 0.90% in late November.* The yield on the 1-Year US Treasury note more than tripled, from 0.15% to more than 0.50% over the same period. The 6-Month US Treasury bill’s yield rose from a low of 0.03% in May to over 0.30% in late November. Yet, despite the higher rates, we have not experienced the conjectured financial storm in the fixed income market.

The question of how far the Fed will go in raising its overnight target rate is still open. Similarly, we can ask ourselves a more complex question: Will the market lead the Fed or is the Fed leading the market through setting expectations?


*As of November 18, 2015. Source: Barclays Bank PLC.  Adapted from “The Rise of Short-Term Rates,” Issue Brief, November 2015.  Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.  Fixed income securities are subject to increased loss of principal during periods of rising interest rates and may be subject to various other risks, including changes in credit quality, liquidity, prepayments, and other factors. Sector-specific investments can increase these risks.  All expressions of opinion are subject to change. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

Board of Directors’ Liabilities

Virtually all plan documents name the sponsor as “plan administrator.” Typically the Board of Directors of a company (sponsor) is seen as the official governing body of the sponsor, and thus plan document language directs that they, in effect, are the plan administrator. Most Boards of Directors are not involved in the day-to-day operations or decision making in regards to their plans, thus without effective delegation of authority they are likely not following the terms of their plan document and are violating their fiduciary responsibilities. The Board of Directors’ Resolutions documents them following the terms of their plan document and officially delegating authority to a committee. With such delegation they are now only responsible for monitoring the committee (perhaps an annual review of committee meeting minutes) rather than bearing the day-to-day fiduciary responsibility of the plan. A Committee Charter helps to bracket what are, and are not, the fiduciary responsibilities delegated to the Committee and therefore limits their potential liability exposure to only those responsibilities delegated. The Acceptances are meant to bracket the duration of the Committee members’ exposure to liability. They shouldn’t be liable for actions taken prior to becoming fiduciaries, but they may be required to remedy any breaches that occurred prior or failure to do so may be considered a subsequent breach.

This article was derived from “Retirement Times”. The “Retirement Times” is published monthly by Retirement Plan Advisory Group’s marketing team. This material is intended for informational purposes only and should not be construed as legal advice and is not intended to replace the advice of a qualified attorney, tax adviser, investment professional or insurance agent. (c) 2015. Retirement Plan Advisory Group. ACR#161752 11/15.


Specialty Asset Classes in a Retirement Plan Menu

Specialty asset classes are those which do not fall into the “core” group of asset classes. Core asset classes include: U.S. domestic equities, international, and fixed income. For the purpose of this commentary, specialty asset classes consist of the following: technology, health care, emerging markets, and real estate.

While specialty asset classes can provide value when constructing a fully diversified portfolio, their inclusion in a retirement plan as a stand-alone option is potentially problematic. The concern revolves around expanded fiduciary liability exposure created by potential unsophisticated participants utilizing specialty asset class investments inappropriately.

The classic scenario is where a participant nearing retirement learns of attractive returns a co-worker has obtained by investing in a specialty asset class (i.e. Technology in the late 1990’s). Subsequently, the participant decides to invest a significant portion of his/her account balance in the same specialty fund in an attempt to achieve similar returns. Due to volatility inherent in this asset class, the investment experiences a significant loss over the next year and the participant becomes disgruntled and seeks reparation from the plan. The participant may contend that he/she did not receive appropriate education regarding the risks inherent in the investment. And fiduciaries may be liable for allowing an imprudent investment to be offered within their plan.

Note that many core asset class funds do have some exposure to specialty asset classes. International funds may have some emerging markets exposure. Core bond funds may have high yield exposure. Domestic equities may have health care, technology and real estate exposure. This may cause some participants who invest further in specific specialty funds to be unknowingly and inappropriately overweighed in specialty asset classes.

Other concerning issues also exist. In the event of underperformance of a fund (or provider), where fund removal and mapping becomes appropriate, some providers do not have multiple options within a specific specialty class. Where then should these assets be mapped to? There is no clear “fiduciary safe” answer. In addition, many specialty asset classes do not yet have substantial benchmarks to assist in monitoring, a fiduciary responsibility.

The inclusion of specialty asset classes in a retirement plan menu should be considered carefully and subsequently the decision for or against should be well documented in the retirement committee’s meeting minutes. Your plan consultant is happy to help you with this process.


This article was derived from “Retirement Times”. The “Retirement Times” is published monthly by Retirement Plan Advisory Group’s marketing team. This material is intended for informational purposes only and should not be construed as legal advice and is not intended to replace the advice of a qualified attorney, tax adviser, investment professional or insurance agent. (c) 2015. Retirement Plan Advisory Group. ACR#157926 10/15.

Economics is Full of Paradoxes

Economics is full of paradoxes. A paradox is a statement that contradicts itself or defies common sense. Most of the anomalies found in economics are named after the economists that first identified them. Examples include the Edgeworth Paradox, Leontief Paradox, or the Solow Computer Paradox.

Following the financial crisis of 2008 and 2009 economists started paying more attention to what is known as the Paradox of Thrift. This apparently bad outcome in the economy was first attributed to John Maynard Keynes by Paul Samuelson in Samuelson’s widely used economics textbook published in 1948.

The Paradox of Thrift says while saving more of current income may be good for the individual, it is bad for society as a whole.

Keynes believed recessions and periods of slow economic growth like the US has experienced over the past seven years cause households to save too much of their income. When everyone in a society is saving more, the effect is a large drop in demand, which in turn leads to low output and high unemployment. With a greater risk of losing work, households then save even more, leading to a downward cycle in the economy.

Keynes’ antidote for the problem is active fiscal and monetary policies that discourage savings. The idea is if we give people more money and keep interest rates low they will spend more and save less.

Perhaps not surprisingly, Keynes has many followers in government who have tried both fiscal policy and monetary policy with a vengeance. Federal government expenditures have increased 23 percent since 2008.[i] The Federal Reserve has facilitated a 46 percent increase in the money stock over the same period.[ii]

These Keynesian responses to a financial crisis and weak economy have been ineffective. Why? Keynes’ Paradox of Thrift doesn’t fit the current situation.

A key reason why Keynesian economic policy is wrong is due to the multiple ways households can save more of their income. Keynes expected households to hoard cash and other valuables, but today households are not holding onto their cash, they are using it to pay down debt.

A more precise theory for the current situation is Irving Fisher’s debt deflation. Fisher published his theory about the same time as Keynes, but the work received much less recognition.

Fisher predicted that when households start paying off debt in response to some crisis, assets will most often be sold at distressed levels (think housing foreclosure sales), and the velocity of money, or the frequency of its use, will decline.

The situation today more closely matches Fisher’s predictions over those of Keynes. Since the financial crisis household debt as a percent of income is down 17 percent and the velocity of money has dropped by a quarter.[iii]

Unfortunately, many politicians and monetary policy makers still see a problem here. Like the paradox of thrift, they see the lower debt level as good for the individual household but bad for society. Lower debt use and slower turnover of money leads to a reduction in demand for goods and services, thereby producing unemployment and a recession.

Like Keynes, Fisher said these negative consequences for society can only be counteracted by inflation. That is, their theories propose the economy will only stabilize or get back to growing if policymakers somehow get prices to rise.

The US Federal Reserve has been unable to produce this supposedly needed inflation. Overall prices have risen 10 percent since 2008, according to the Federal Reserve’s preferred measure of inflation, and the value of the dollar has risen. The Fed has flooded the market with dollars, but the dollar’s price is not falling. The US dollar has gained 19 percent in value relative to other major currencies like the Yen and Euro since 2008.iii

Fiscal policy did little, if nothing, to lift the economy out of the recession and despite all its efforts, the Federal Reserve has been unable to produce inflation. Like a coaching staff that finds themselves losing at halftime, politicians and the Fed should throw out this playbook.

Today’s fiscal and monetary policy is simply overburdening the economy with taxes.

Government spending needs to decline to reduce the tax burden more government debt has on future generations. The Fed needs to stop fighting world capital markets with the hope it will produce inflation. Inflation is a tax on our savings that just ends up hurting us in the long run.

Stop trying to fight a paradox that is not.  

Peter R. Crabb, Ph.D.Peter R. Crabb, Ph.D.
Professor of Finance and Economics
Department of Business and Economics
School of Business, Northwest Nazarene University
[email protected]

Dr. Crabb holds a Ph.D. in Economics from the University of Oregon and an MBA in Finance from the University of Colorado. His research in economics and finance is published in the Journal of Business, the Journal of Microfinance, and the International Review of Economics and Finance, among others. Dr. Crabb lives with his wife, Ann, and their four children in Canyon County, Idaho.

Dr. Crabb’s regular Financial Economics column is published by the Idaho Statesman.Previous work experience includes international trade, banking, and investments.