New Money Market Fund Rules Mostly Spare Individuals
Thursday, July 24, 2014

New rules for money market funds were approved by the Securities and Exchange Commission (SEC) yesterday after a few years of contentious debate. Some money market funds will have floating net asset values (NAVs) instead of having their NAVs strictly pegged to $1 per share. Redemption restrictions will also be allowed on certain money funds during times of stress. Finally, the SEC will also issue a re-proposal on how it will gauge a fund’s credit-worthiness, using methods other than credit ratings.

The majority of money market funds available to individual investors will not be affected by the new floating NAV rules. This appears to be a compromise the SEC accepted as part of its fight with the fund industry to get the reforms pushed through. The floating NAV rules will apply to institutional prime money market funds and (according to Mike Krasner at iMoneyNet) tax-free institutional funds. This said, “retail” money market funds will continue to be able to peg their NAVs to the $1 per share mark.

Non-government money market funds will “have the ability to impose to fees and (redemption) gates during times of stress.” In other words, the SEC will allow non-government money market funds to restrict the size of withdrawals and/or place redemption fees during periods of stress. This rule is intended to prevent large institutional investors from engaging in what is the equivalent of a bank run and harming individual investors in the process.

If you are unsure whether your money market funds fall into one (or both) of these categories, I strongly suggest calling the fund company and asking. Specifically, you want to know if your fund is an institutional fund, whether the net asset value will begin floating and what, if any, redemption policies will change. Contact information for most fund companies can be found in our mutual fund guide.

You may have to call back more than once to get a clear answer. The SEC is allotting for a two-year phase-in period. This period starts after the new rules are published in the Federal Register.

The new rules are a response to the financial crisis. In 2008, the Reserve Primary Fund “broke the buck” after the Lehman Brothers securities it held suddenly became worthless when the investment bank collapsed. Shares of the money market fund could no longer sustain their $1 per share NAV levels. Other money market funds froze redemptions during the financial crisis, preventing shareholders access to their investment dollars. Proponents argue the new rules will reduce the chances of a "run on the bank" occurring with money market funds.

There has been a lot of disagreement about what reforms should be set in place, and yesterday’s vote reflected the divide. The rules passed on a 3-2 vote with both a Democrat and a Republican commissioner dissenting. I think the intentions behind the rules are good, but I am very cognizant of the risks of unintended consequences.

The Internal Revenue Service has proposed regulations that will give investors the ability to avoid recognizing frequent gains and losses on money market funds with floating NAVs. The tax agency says, “No gain or loss is determined for any particular redemption of a taxpayer’s shares in a floating-NAV money market fund. Without a determination of loss, a particular redemption does not implicate the wash sale rules.” If you choose to recognize a loss, however, you will invoke the wash sale rules. These rules prevent you from deducting a loss on your taxes if you buy substantially the same investment within 30 days after having sold it at a loss. (Here are the proposed tax rule changes for money market funds.)

In the backdrop of this is actively managed ETFs. There is scuttlebutt that money market reform could pave the way for a new breed of actively managed ETFs to receive exemptive relief from the SEC. An explanation as to why is a bit too technical for this week’s commentary, but my editor’s note in the forthcoming August AAII Journal will explain what changes the fund industry are trying to get approved.

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The Week Ahead

More than 150 members of the S&P 500 will report earnings next week. Included in this group are Dow components American Express (AXP), Merck & Co. (MRK) and Pfizer (PFE) on Tuesday; Exxon Mobil (XOM) on Thursday; and Chevron (CVX) and Procter & Gamble (PG) on Friday.

The Federal Open Market Committee will hold a two-day meeting starting on Tuesday. The meeting statement will be released on Wednesday afternoon.

The week's first economic report of note will be the National Association of Realtors June pending home sales index, released on Monday. Tuesday will feature the May S&P Case-Shiller home price index and the Conference Board's July consumer confidence index. The first estimate of second-quarter GDP and the July ADP Employment Report will be released on Wednesday. Thursday will feature the July Chicago PMI. July employment data, including the unemployment rate and the change in nonfarm payrolls, along with June personal income and spending, the July PMI manufacturing index, the University of Michigan's final July consumer sentiment survey, the July ISM manufacturing index and June construction spending will be released on Friday.

The Treasury Department will auction $29 billion of two-year notes on Monday, $35 billion of five-year notes on Tuesday and both $15 billion of floating-rate two-year notes and $29 billion of traditional seven-year notes on Wednesday.

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AAII Sentiment Survey

Pessimism about the short-term direction of stock prices rose to a three-month high in the latest AAII Sentiment Survey. Optimism continued to fall, while neutral sentiment extended its streak of above-average readings to 29 weeks.

Bullish sentiment, expectations that stock prices will rise over the next six months, declined 2.7 percentage points to 29.6%. This is an 11-week low. It is also the 17th time in the past 19 weeks that optimism is below its historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 1.3 percentage points to 40.4%. As noted above, the increase puts neutral sentiment above its historical average of 30.5% for the 29th consecutive week. This is the third-longest streak of readings over 30.5% for neutral sentiment in the survey's history.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 1.5 percentage points to 29.9%. This is the highest level of pessimism recorded by our survey since April 17, 2014. Nonetheless, bearish sentiment remains below its historical average of 30.5% for the 14th straight week and the 37th out of the last 41 weeks.

Neutral sentiment is back up to unusually high levels (more than one standard deviation above its historical average) for the first time in a month. Historically, unusually high neutral sentiment readings have been followed by better-than-average market performance over the proceeding six and 12-month periods. The link is not causal, however.

The bull-bear spread (the difference between bullish and bearish sentiment) turned negative for the first time since early May. The shift follows last Thursday's 1.2% drop in the S&P 500 index, which was the biggest one-day drop since April. Though stock prices have rebounded since then, the decline came at a time when many individual investors have concerns about valuations. Some AAII members are also fretting about the events in the Middle East and Ukraine, the pace of economic growth and Washington politics. Other AAII members remain optimistic about sustained economic growth, the market’s upward trend and the Federal Reserve’s tapering of bond purchases.

This week's special question asked AAII members what sectors or segments they think are excessively overvalued right now. Responses were very mixed. Slightly less than a quarter of all respondents (24%) said either no segment is excessively overvalued or that the overall market is fairly valued right now. About 13% view social media and Internet companies as being excessively overvalued. Technology was named by 12%. Financials and technology were each listed by 9% of respondents. (Some respondents named more than one sector or industry group.)

This week’s Sentiment Survey results:

Bullish: 29.6%, down 2.7 points
Neutral: 40.4%, up 1.3 points
Bearish: 29.9%, up 1.5 points

Historical averages:

Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!