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The stock market's big run lately has its foundation in record profitability for many companies. Anything that endangers that profitability could spell an end to the upward trajectory of stocks.
A recent report detailing the current status of corporate pension plans among U.S. companies could be exactly the catalyst that bearish investors have been looking for to push the market down. The bad news for pensions could sap billions of dollars from corporate profits, putting future growth prospects at risk and potentially bringing an end to the market's bull run since the March 2009 lows.
Why low rates are bad for pensions
As the report from Fitch Ratings details, corporate defined-benefit pension plans are in a world of hurt. But the reason isn't what you'd probably expect.
During the 2008 market meltdown, corporate pensions took a hit for obvious reasons. With the stock market down, the value of pension-plan investments fell dramatically, leaving many pension plans underfunded. Yet since then, stocks have skyrocketed. So why are pension plans still in trouble?
The explanation comes from the way that accountants calculate pension plan liabilities. Because the payouts that pensions have to make run far into the future, the plan has to determine how much it should set aside now to cover those future payments. To do so, it uses an assumed discount rate that's based on yields of fixed-income securities.
With bond yields way down, the calculated amount necessary to cover pension obligations has gone up -- sharply in some cases. Fitch says the rate drop alone could add 10% to 20% to pension liabilities for some companies.
Haves and have-nots
Of course, many companies have a lot of cash on their balance sheets. For them, the main hit is an accounting-related one: They'll see earnings suffer from one-time pension charges.
But the report identified several companies that have weak balance sheets, poor credit ratings, and severe underfunding. They include the following:
GAAP Pension Funding Status
|Goodyear Tire (NYSE: GT )||67%|
|Alcoa (NYSE: AA )||77%|
|SUPERVALU (NYSE: SVU )||75%|
|Meritor (NYSE: MTOR )||71%|
|Sears Holdings (Nasdaq: SHLD )||76%|
Source: Fitch Ratings.
Many of these entries should come as no surprise. Sears in particular has struggled recently, announcing plans to close stores after a poor holiday season. Alcoa has suffered from low aluminum prices, while SUPERVALU has had to revamp its plans to expand its Save-A-Lot store chain.
Goodyear Tire and Meritor aren't as well-known, but they face some challenges of their own. Meritor makes truck parts and posted a much wider loss in its most recent quarter, as the company has implemented a wide range of cost-cutting initiatives designed to improve margins. Meanwhile, Goodyear earned a profit but forecast tough times ahead.
A dying breed
For pensions, the problems are pervasive enough that companies are continuing to try to get rid of them entirely. General Motors announced earlier this week that it would move 19,000 salaried workers that currently are part of its traditional pension plan to a 401(k) defined-contribution plan effective Oct. 1. The move reunited those hired before 2001 with later hires, with 10,000 more workers hired in 2001 and later already in the 401(k) plan. The company cited its severe pension underfunding, which amounted to about $10.8 billion as of mid-2011, as a big risk for investors.
Still, even if future workers never get another pension, companies still have to figure out how to handle the obligations they already have. At best, it could greatly reduce profits or turn earnings into losses for some companies. Yet if struggling companies can't cover those obligations -- as some bankrupt companies have done in the past -- then they could end up pushing them onto the Pension Benefit Guaranty Corp. If the PBGC, which is already heavily burdened, has to take on too big a load, then that in turn could cause a much larger crisis.
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