Highlights from the August 18, 2021 recorded webinar featuring Brian Sommers, CFA, Principal and Chief Investment Officer and Rod Diaz, CRPS, AIFA, Retirement Plan Manager

The Economy and Market Update with Brian Sommers

The economy:

• The U.S. economy has made enormous progress since the COVID lockdowns but still has a long way to go to recover pandemic-related losses. The recovery recently has been more mixed. Consumers with cash to spend have spurred activity in the services sector, including in box office receipts, hotel occupancy, restaurants, and commercial flights. Activity is greater than in 2020 but not to pre-pandemic levels. The job market is recovering and manufacturing data remains strong in U.S. and most of developed world.

• Obstacles to full recovery include:

– Emergence of Delta variant has people cautious about circulating in public; there are concerns that we could even face more shutdowns.

– Manufacturing activity is increasing but the rate of change is slow.

– Consumer demand has slowed since its initial surge.

• The increase in spending on services has been partially offset by less spending on durable goods in recent months. Households are likely to continue spending on services they missed during pandemic; however, that will be at the expense of spending on big-ticket items.

• The world’s central banks are reducing stimulus spending, so the boost that provided will be smaller going forward.

• We believe we might have already experienced peak growth in terms of the recovery.

The labor market:

• Some sectors are experiencing worker shortages. The U.S. has 10 million job openings and 9 million people unemployed. Not often do you find both those numbers elevated at the same time. In many cases, the skills of job seekers don’t match the available jobs. Also some are hesitant to return to their jobs during the ongoing pandemic, especially in service sectors. Many parents can’t find adequate daycare to allow them to go back to work. And some people have higher net incomes collecting stimulus and unemployment than working and paying for commuting and childcare. These issues will disappear as we get beyond pandemic conditions, unemployment benefits fade away, and stimulus checks stop coming.

Inflation:

• Restarting business activity is creating inflationary pressures brought on by supply chain disruption, higher raw material costs, shipping constraints, and a tight labor market. Inflationary pressures are likely to be temporary; prices will stabilize although at higher levels than previous to the pandemic. As well, the Fed will taper bond purchases by the end of this year or early next year so that stimulus to inflation will be less.

• Some prices are already falling, like lumber and used autos. Recent data show core inflation rose less than expected, prices in transportation services fell, prices for used cars and apparel were flat. Inflationary pressures are lessening as we move into the final quarter of the year.

• Japan spending on infrastructure skyrocket in recent decades but inflation remained modest. There were some spikes but then inflation fall back to zero. As well, Japan has been dealing with the issue of an aging population, which is extending to the rest of the developed world. As debt has skyrocketed in Japan, spending that would have gone to spur growth has gone to service debt. That could be the case in other developed countries, and will cause both the level of growth and inflation to remain low. We are more concerned about slow growth than inflation.

The equity markets:

• Stock prices surged after the sell-off in March 2020. Investors anticipated better earnings as economic activity returned.

• Real GDP is 2.6 percent below Potential GDP, that is, where we would have been if growth had continued without the pandemic-related interruption.

• With valuations stretched, returns might be less than expected going forward. Corporate earnings need to continue to be very strong over next months to justify current valuations. Although earnings should continue to grow, if economic growth slows as we anticipate, that might slow the rises in stock prices. So far, corporate earnings have been very strong. Stocks will likely move higher but at a slower pace.

• Companies that have beat forecasts on both earnings and revenue have seen their stock prices barely budge since their earnings announcements. Most companies are issuing caution in their guidance because they believe growth will slow, but also because stock prices anticipated and already reflect growth.

Fixed income markets:

• Bonds had been rallying and yields falling until recently. The yield on a 10-year U.S. Treasury is now hovering around 1.2 percent. The Fed’s characterizes the current inflation pressures are transitory, and does not expect to hike rates until 2023. So yields will remain in a tight range. Bond prices are likely to tread water and eek out very modest returns in the coming months.

>Best practices for Plan Sponsors with Rod Diaz

Ten best practices for improving your retirement plans:

1. Consider open architecture platforms: Provide access to many different investments as opposed to being limited to one provider’s branded investments.

2. Examine plan fees: Fees can be hidden. Work with your financial advisor to comb through and identify actual fees.

3. Monitor your investment options: Plan sponsors must be able to demonstrate procedural prudence in selecting and monitoring the plan’s investments. It is also wise to have an investment policy in place.

4. Track the timeliness of participant deferral deposits: Your standard to date is what the Department of Labor (DOL) will expect you to continue to do. Last year the DOL fined employers more than $3 billion, mainly due to late deposits.

5. Review your plan design periodically: New laws and rules improve plans for both employees and employers, like Roth deferrals, matches, safe harbors, and methods that allow you to target profit-sharing distributions.

6. Explore advanced design solutions: Consider cash balance plans to get more dollars to higher-paid, more senior members of the company. It is an intricate design and requires a third party administrator.

7. Consider outsourcing your fiduciary liability: Engage a qualified third party advisor.

8. Confirm that you have an adequate ERISA bond: Your a fidelity bond must cover minimally 10 percent of the amount of funds in your plan to protect against fraud or dishonesty on the part of persons handling plan funds. You must confirm on an annual basis that you have an adequate bond.

9. Consider compliance with 404(c): You have to give employees a choice of investment options, communicate to them about their investment options, and allow them to make changes.

10. Use a qualified default investment alternative: Without a default alternative, the plan fiduciary is liable for investment losses for employees who do not make investment choices.

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