Mon 21 Aug 2006
The new Pension Reform Act, known on the street as the 401K law, will obviously cause major downward pressures on manufacturing and airline stocks which will need to divert signifiant resources into their pensions over the next 7 years or more to meet the new requirements. The law will also be a major lift to firms like Fidelity and Vanguard who offer 401K services (however both companies are privately held, so there’s no equity investment opportunity to be had there). The real question is: will the rise in 401K contributions be a major contributor to a future stock market rally?
Current 401K participation is around 65%. Many reports that I read and heard soon after the passage of the new Pension Reform Act state that the goal of this act is to raise 401K participation to over 90% of the workforce. Additionally, with manufacturing, airline and other pension companies potentially contributing billions more into their pensions over the next few years, this will serve as another source of cash flowing into the system. I believe the large caps will benefit most from the rise in 401K and pension contributions due to the market-cap weighted options in most 401K plans. There also could be a significant boost in the bond market purchases due to the increase in 401K contributions, thus raising the price of bonds and lowering the yields.
401Ks emphasize the big and generic options in the market much more since most 401K plans offer very few options, and those that are offered are “safe” options. Even when 401Ks offer a wide range of options such as small-cap and micro-cap funds, many people will not purchase these options due to lack of familiarity or understanding. With the current investing guidance offerred to the general public, I see major emphasis on large cap and bonds coming down the pike.
August 21st, 2006 at 9:22 am
Some other companies that would benefit besides Fidelity and Vanguard…
Janus (JNS), Hewitt (HEW), many of the stocks in the asset management business, some of the big banks (Bank of America, Citigroup, JP Morgan, etc.), or the exchanges themselves like NYSE (NYX), Nasdaq (NDAQ).
August 21st, 2006 at 9:53 am
What’s interesting is that I looked at some of these asset management businesses and many seem to have gapped upward on or around 8/15. I find this timeline to be interesting:
The Pension Reform Act 2006 was introduced on July 28, 2006. The day prior to this introduction, TROW and CNS gapped up, but interestingly many other funds on listed in the “asset management business” link you posted above had very choppy performance over the same period and into the next week.
President announced his plans to sign the Pension Reform Act 2006 into law on August 4. Most of the stocks you listed on the “asset management business” had a significant trading day that covered a wider range of prices than normal with a small spike in volume.
However, 8/16/2006 seemed to be the day when most of the investment world saw this bill as coming to a vote and the stocks of nearly all the “asset management business” rose sharply. What will be interesting is whether the gains logged between 8/16 and 8/18 on these funds are finished running up. If not, the I see this as an interesting tale in how the market approaches pending legislation that will have a direct benefit on the bottom line. Here’s my executive summary:
1st phase: Legislation is introduced. The news alone propels a few key players to sharply rise. Typically it’s not a major news story when legislation is introduced, so there’s not likely wide-spread knowledge of this news item.
2nd phase: Legislation is seen as gaining momentum and “might” make it to a vote. There’s some activity based on this news, but likely mostly from people already in the know (those who invested heavily when the legislation was first announced) and mostly from them solidifying their position.
3rd phase: The law is clearly going to pass and the general public is becoming aware of the bill. The affected stocks enjoy a nice rise.
What bothers me is that most of these stocks did not show strong volume from 8/16 – 8/18. Where were the institutional investors? Maybe I’m overinflating the effect of this bill on the 401K firms. Or, Fidelity and Vanguard are going to take the lions share of the profits from this and there’s not much the investment community can do to make a buck off of that.
August 21st, 2006 at 11:31 am
If you want to take your analysis a step further… how did these stocks compare to the rest of the market that day? How did they compare to their sector (financial services)?
If it was a huge down day for the market but these guys were up even a little it would be a sign that there was relative strength.
There’s also a potential for “buy the rumor, sell the news” where some traders have bought in anticipation of the legislation, thus the price gains would be reflected prior to the official news.