American Companies Drowning Under Pension Liabilities

By: InvestmentContrarian

Sasha Cekerevac writes: When it comes to long-term investing, many focus solely on revenues and earnings. While clearly these are extremely important fundamentals when conducting a stock analysis, one rarely mentioned but critical variable is pension liabilities.

Pension liabilities are, by definition, crucial to long-term investing, as costs are spread out over many years. Many investors conduct a stock analysis on a very short-term basis—quarter to quarter. Successful long-term investing means conducting a stock analysis on the next five, 10, even 15 years.

Pension liabilities are a huge issue for many companies. A pension liability is the difference between the amounts of funds the company has in reserves versus the expected payments to retirees. At the end of 2012, American businesses had an estimated combined pension deficit of $347 billion, according to JPMorgan Asset Management. (Source: Monga, V., “Why the corporate pension gap is soaring,” Wall Street Journal, February 25, 2013.)

JPMorgan estimates that, on average, companies have promised $100.00 to retirees, yet they only have $81.00 in reserves. That is a massive gap that needs to be taken into account when conducting a stock analysis for long-term investing.

This is an unintended side effect of the low interest rate environment created by the Federal Reserve. While companies can take advantage of low interest rates when borrowing, they can also end up having a shortfall in the long-term returns of their investments.

Companies are attempting to bridge the gap by adding funds to make up the shortfall. If interest rates stay low, as expected, for a number of years, a stock analysis must take into account the increased provisions of cash used to pay future retirees. This can certainly complicate calculations for long-term investing.

The other issue is the makeup of assets in a pension fund. When conducting a stock analysis in a company, it is important to know if a large percentage of assets are in equities or fixed income. With fixed income yields so low, the price of this type of asset is at extremely high levels. Over the next decade, I expect that interest rates will rise, and these fixed income assets will decline in value.

This decline in asset value can further erode a pension fund, hurting the prospects of a company when considering long-term investing. Stock analysis in this matter is not easy, yet one does need to take every variable into account.

If the company’s pension assets are in equities and the market continues to perform as strong as it has over the last several years, then this deficit on an individual company basis can be illuminated. However, there are no guarantees with future returns. It really comes down to stock analysis on a company-by-company level when considering long-term investing.

What will be interesting over the next year or two will be what the Federal Reserve does regarding monetary policy, and how this changes the pension liability situation. Pension funds that primarily comprise fixed income might suffer significant losses in value. However, the stock market might also suffer a significant decline.

This could be a difficult period of time when calculating long-term investing liabilities, since the future of assets is unknown, yet the liabilities (the retirees) are known. Significant costs could come up, as companies need to boost pension funds, which means less money for current investors.

Stock analysis is never easy when considering long-term investing; and with the uncertainty regarding future monetary policy changes, it will remain difficult to forecast.

One way to help alleviate this uncertainty regarding long-term investing is to focus your stock analysis on companies with relatively small pension liabilities. Many of these companies are younger in nature, so they have lower numbers of potential retirees. In addition, many firms now only provide defined contribution plans in place of defined-benefit plans. This transfers the risk of retirement liabilities from the company to the workers.

Source:http://www.investmentcontrarians.com/sto....

By Sasha Cekerevac, BA
www.investmentcontrarians.com

Investment Contrarians is our daily financial e-letter dedicated to helping investors make money by going against the “herd mentality.”

About Author: Sasha Cekerevac, BA Economics with Finance specialization, is a Senior Editor at Lombardi Financial. He worked for CIBC World Markets for several years before moving to a top hedge fund, with assets under management of over $1.0 billion. He has comprehensive knowledge of institutional money flow; how the big funds analyze and execute their trades in the market. With a thorough understanding of both fundamental and technical subjects, Sasha offers a roadmap into how the markets really function and what to look for as an investor. His newsletters provide an experienced perspective on what the big funds are planning and how you can profit from it. He is the editor of several of Lombardi’s popular financial newsletters, including Payload Stocks and Pump & Dump Alert. See Sasha Cekerevac Article Archives

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