Bob’s Journal for 1/23

Vanguard Pays $106 Million in Target Date Fund Settlement

The Vanguard Group agreed to pay more than $106 million to settle allegations by the Securities and Exchange Commission (SEC) that it made misleading statements to shareholders about its target date funds.

The statements concerned estimates of capital gains distributions and the tax consequences stemming from changes in Vanguard’s target date funds.

In December 2020, Vanguard lowered the minimum initial investment for the institutional funds in the series of Vanguard Target Retirement funds. The institutional funds have lower expense ratios than the retail funds.

After the expense reduction, a large number of investors decided to switch from the retail funds to institutional funds. A consequence was that the retail funds had to sell assets to meet the redemption demands. Many of the sales were of appreciated assets, and that resulted in realized gains for the retail funds.

Those gains eventually increased taxable distributions to shareholders who continued to hold the retail funds in taxable accounts.

The SEC and a group of state securities regulators determined that Vanguard hadn’t accurately described to investors the potential tax risks and consequences associated with the target date funds held in taxable accounts.

The settlement amount will be transferred to a fund that will distribute it to affected shareholders.

A potential disadvantage of investing in any mutual fund is that the actions of some shareholders can affect other shareholders.

A meaningful percentage of shareholders can redeem a fund’s shares at any time. The fund might have to sell investments to meet the redemptions.

When the sales are of investments that have appreciated, the fund has realized gains it often must pass through to shareholders or that increase the taxable amount of future distributions.

The remaining shareholders have no control over the taxable distributions and might not know about them until after it is too late to act. It’s a risk of owning mutual funds in taxable accounts.

The consequence can be especially bad for shareholders who recently purchased fund shares. They weren’t shareholders when much of the appreciation in the assets occurred. But they’ll have taxable distributions when the gains are distributed. In effect, they’ll be taxed for having part of their principal returned.

Very Few Stocks Are Responsible for the Market’s Long-Term Returns

A tiny percentage of stocks account for the long-term returns of the stock indexes.

That’s the conclusion of updated research from Hendrik Bessembinder of Arizona State University. I discussed the earlier version of Bessembinder’s research in Bob’s Journal of August 24, 2023.

The updated research, recently summarized in Barron’s, continued to track the performance since 1926 of all publicly traded stocks (29,078 of them) in the database of the Center for Research in Security Prices.

It found that a dollar invested in all stocks in 1926 grew to $229.40 at the end of 2023.

But through 2023, 51.6% of stocks lost money, generating a median negative return of 7.41% over the period.

Despite the large percentage of losers, the return of all stocks during the period was 22,840%. That return was the result of extremely high returns from a few stocks. In fact, 17 stocks returned over 5,000,000%. One dollar invested in those stocks returned $50,000.

The two stocks with the highest returns since 1926 were in boring, steady businesses.

As in the earlier study, Altria Group (formerly Philip Morris) was the top performer, generating a 16.29% annual return, which turned one dollar into $2.65 million.

In second place was Vulcan Materials, which sells crushed stone, sand and gravel for construction. It returned 14.05% per year over its existence. That turned $1 into $393,492.

Of course, some of the technology stocks that led the market in recent years also registered attractive long-term returns. They can’t beat Altria and Vulcan Materials for long-term compounded returns, because the technology stocks haven’t been around as long.

But over the last 20 years, Nvidia tops the performance chart with a 33.38% annual return. The data end in 2023, so that number doesn’t include Nvidia’s 2024 return of 171.2%. Netflix and Amazon.com also were top performers for recent periods.

Home Depot is a low-profile winner. From its initial public offering in 1981 through the end of 2023, the home improvement retailer turned $1 into $16,627 for a 25.87% annual return over 42 years.

The study provides some lessons for long-term investing. Buy a widely diversified portfolio of stocks and let the winners compound. Another option is to look for solid, steady businesses and hold them for many years.

But long-term studies such as this should be treated carefully by those in or near retirement. Over a shorter period, an investor must worry about sequence of returns risk.

While these long-term returns are impressive, stocks went through extended bear markets, such as the depression and the period of 1966-1982. The period from 2000-2011 also wasn’t good for most of the stocks.

Someone who retired early in one of those periods and owns primarily stocks could run out of money before the market rebounds.

The Latest Employment Data Need a Careful Look

The employment situation reports for December, issued in early January, surprised investors and moved the investment markets.

The headline number in the report was that 256,000 new jobs were created in December. That was well above the 165,000 new jobs that were expected and the 212,000 created in November.

After the report was issued, stock prices tumbled and interest rates rose.

But a look at the details indicates the headline number made the economy appear stronger than it is.

Job growth recently has been concentrated in sectors that aren’t correlated with overall economic growth, such as government employment and health care.

Those sectors depend largely on government spending and created more jobs than other sectors for much of 2024.

A lot of that job growth was in state and local government jobs. That growth is likely to be slower in 2025.

Health care job growth has been better than in many other sectors of the private economy. But it has slowed sharply and continues to weaken.

Also, retail sales were a big contributor to December’s job growth. That likely was seasonal hiring that will fade in coming months.

Information services generated strong job growth, but it is less than 2% of total jobs.

Employment in sectors that are sensitive to the economy or interest rates has been weak and looks unlikely to rebound. Weak sectors include residential housing and manufacturing.

Also, the economy has been self-regulating over the last year or so.

When the latest economic data is strong, market interest rates rise, even if the Fed plans to reduce short-term rates. Higher interest rates slow economic growth and make subsequent data weaker.

Market interest rates increased after the employment reports (and were rising before that). So, it’s likely growth will be lower in the coming months.

This isn’t to say the labor market is weak or that we are on the verge of a recession. The point is the economy probably isn’t as strong as the latest employment reports suggested. Investors and policymakers shouldn’t overreact.

The Data

The Leading Economic Indicators from The Conference Board declined by 0.1% to 101.6 in December. November’s reading was revised higher to a 0.4% increase. The index declined 1.3% in the second half of 2024.

The Coincident Economic Index increased 0.4% in December and 0.2% in November.

The Conference Board announced that after taking all the data into consideration it expects real GDP to increase by 2.3% in 2025.

The Housing Market Index of the NAHB rose to 47 in January, the highest level in nine months, up from 46 in both December and November.

Despite improvements in current sales conditions and the amount of prospective buyer traffic, home builders reduced their expectations of sales over the next six months because of higher interest rates.

Housing starts increased 15.8% in December after declining 3.7% in November.

Housing starts of apartments increased 58.9% in December while single-family home starts rose 3.3%.

The Philadelphia Fed Manufacturing Index jumped to positive 44.3 in January from negative 10.9 in December.

Industrial production was 0.9% higher in December after a 0.2% rise in November. The 12-month growth rate in industrial production was 0.5% through December and negative 0.6% through November.

Manufacturing production rose 0.6% in December and 0.4% in November. Manufacturing production was unchanged over the 12 months ending in December after being down 0.6% through November.

Retail sales increased 0.4% in December, the lowest increase in four months, after rising 0.8% in November. Excluding autos and gasoline, retail sales increased 0.3% in December and 0.2% in November.

New unemployment claims increased by 14,000 to 217,000 in the latest week. New claims the previous week were an 11-month low.

Continuing claims, which lag a week behind new claims, decreased to 1.859 million from 1.867 million. The recent peak was 1.908 million continuing claims in early November.

The Markets

The S&P 500 rose 3.58% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 3.56%. The Russell 2000 increased 4.58%. The All-Country World Index (excluding U.S. stocks) added 3.66%. Emerging market equities advanced 3.08%.

Long-term treasuries gained 3.14% for the week. Investment-grade bonds increased 2.07%. Treasury Inflation-Protected Securities (TIPS) added 0.94%. High-yield bonds rose 1.35%.

In the currency arena, the U.S. dollar declined 1.08%.

Energy-based commodities increased 0.26%. Broader-based commodities rose 0.78%. Gold gained 2.41%.

Bob’s News & Updates

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