| 2nd Qtr.
| 12 Mo.
|10-yr Treas. yield||0.653%||0.70&||-0.047%||2.00%||-1.347%||-1.267%|
|Fed funds rate||0 – 0.25%||0 – 0.25%||n/a||2.25-2.5%||-2.25%||-1.50%|
(stock indices are before dividends; yield and rate changes are absolute changes)
And the roller coaster continues. Following a strong year in 2019 and a tumultuous first quarter, the second quarter saw the Dow and S&P 500 post their best quarter since 1987 and the NASDAQ its best since 1999. At the same time, the economy officially entered recession, ending its 128-month expansion that began in June 2009, and first quarter GDP fell by 4.8%, the first quarterly decline in six years. International stocks held their own even as the US dollar stayed strong, and interest rates settled into a range that will likely last for quite a while.
The impact of the pandemic on employment is a big concern. First-time claims for unemployment were over 45 million over 14 weeks, with continuing claims over 20 million. The economy lost jobs in March for the first time in 10 years and that trend accelerated in April with over 20 million jobs lost and unemployment reaching 14.7%, the worst since the Great Depression. This meant that 10 full years of job gains had been wiped out. Still, those losses were less than expected and in May 2.5 million jobs were added, lowering the unemployment rate to 13.3%. June continued the job recovery, with 4.8 million jobs added and unemployment at 11.1%, both better than expected. These gains, much of which were in leisure and hospitality, may be short-lived as COVID cases have seen a sharp increase as states tried to reopen their businesses and patrons ignored precautions.
The Fed was also at the forefront, announcing $2.3 trillion in loans to business and local governments and initiating the purchase of corporate bonds for the first time. The Paycheck Protection Program provided loans to businesses to keep their payrolls going and one-time tax credits of $1,200 per person were paid out while $600/week was added to state unemployment benefits by the federal government. The Fed made clear its intention to keep rates low through 2022 and went so far as to declare it “was not even thinking about raising rates”. The Fed noted that financial conditions have improved but it will keep buying assets and its balance sheet grew to over $7 trillion. Full-year 2020 GDP was forecast to decline 6.5%, recovering to grow 5% in 2021, and year-end 2020 unemployment was forecast at 9.3%.
Most economic indicators were down during the quarter, as was expected. Indicators of both the service and manufacturing sectors contracted sharply in April (with service ending a 10-year expansion run) with some recovery in May but still not into expansion territory. The proxy for business capital spending was down 5.8% in April and durable goods were down over 17%; transport equipment was down a whopping 47% as Boeing had no orders at all for the month. The European Union announced a $2 trillion aid package, which will strengthen the EU after the Brexit drama weakened it.
With the support of enhanced benefits and massive Fed intervention, the consumer has fared much better than in the Great Recession. Despite declines in May and June, average hourly earnings are still up 5% over the prior year. Consumer confidence is up in June over May, but still ¼ below the pre-pandemic levels. Existing home sales for May were the lowest in over nine years but supply is even tighter and mortgage rates are extremely low, leading to a big increase in pending home sales (to close in the next month). New home sales were up in May and 12% higher than the previous May, and supplies are also tight. Retail sales and consumer spending recovered in May after a dip in April and core consumer inflation (excluding energy and food) was slightly down for three straight months for the first time ever, although the trailing 12 months was still up 1.2%. As consumers hunkered down, the savings rate rose to 32% in May and 23% in June.
Looking Forward (and Backward)
In conversations with clients, a litany of current challenges comes up – social unrest, cultural division, political turmoil, economic disruption, a pandemic that shows little sign of letting up. Except for the pandemic, a thought occurred – except for the big hair and wide ties, are we back in the late 1960’s and early 1970’s?
Here is just a summary of what was going on during those years.
• Growth in GDP was volatile, with high-growth years between actual declines in GDP in 1970, 1974 and 1975.
• Martin Luther King Jr. and Robert Kennedy were both assassinated in 1968. Riots erupted in many cities after King’s death. The Black Panthers and several leftist terrorist groups had violent encounters and bombings over the following ten years. (This was after the so-called Long Hot Summer of 1967, with 159 race riots across the country.)
• The 1968 presidential election included George Wallace as a racist independent candidate. He carried 5 states and captured 13.5% of the popular vote.
• Student protests against the Vietnam War continued for years, including the violence at the 1968 Democratic convention in Chicago and the shootings at Kent State in 1970.
• Unemployment was quite low until 1970 and then rose to between 6% and 8% for most of the following decade. Manufacturing job growth slowed, but still increased slightly, before hitting their big decline in the 1980’s. Inflation was nearly 9% in 1973 and over 12% in 1974, a unique period of “stagflation”, inflation and low growth.
• In the 1972 presidential election, the first time 18-year olds could vote, the Democrats put up George McGovern, who was very liberal for the times. Nixon won re-election in a landslide, only to resign in disgrace less than two years later (and after the vie-president has already resigned due to corruption charges).
• War and race were not the only causes of civil unrest, with the LGBT community rioting after a raid in New York city, Native Americans occupying the community of Wounded Knee, and several prisons experiencing uprisings.
• There may not have been a defining health crisis, but the early 1970’s saw policies which hastened the rise of corporate farming and the increase of sugars in the food supply, which eventually gave rise to the current obesity epidemic. (Look at any group picture from those years and you will see far fewer overweight people.)
Looks pretty bleak, doesn’t it?
Of course, there are vast differences between then and now and how our current challenges will be met remains to be seen. But it is impossible to deny that we have not seen similar problems before, and it is likewise impossible to deny that we got through them, perhaps not ideally but still standing and moving forward.
The combination of the high volatility in the stock market and low interest rates for the foreseeable future has increased interest in creating a portfolio with some return or income “target”. For example, why not just have a portfolio that generates 3% per year in income, whether dividends or interest, and call it a day?
Those arbitrary and artificial constraints cause several problems. As we have often noted, striving for income often results in lower-quality investments, vehicles with unintended consequences or the use of leverage (debt) to gain greater exposure to an investment. All these techniques work to varying degrees, but they always crash in times of economic or market turmoil, which negates any of the advantage of higher income.
Some funds have adopted the idea of “absolute return” with the goal of always having a positive return (say, 2% more than Treasury yields) regardless of market performance or other benchmarks. These funds adopt dome of the same techniques as hedge funds and invest in a wide variety or sectors and types of investments. Unfortunately, these funds have regularly failed to meet their stated return objective and conveniently claim that markets were “exceptional” and so the goal should not apply.
Likewise, there are funds with a stated annual income distribution percentage. Sounds great, until you realize that in many cases part of that distribution is a return of capital; in other words, investors are just getting their own money back in a way that looks like income.
The worst impact, though, is that focusing on these targets creates an unrealistic expectation for the investor. When the portfolio fails to meet the goal, the investor is unhappy regardless of the markets and even if the portfolio is still in position to meet or exceed their long-term financial goals.
We believe it is preferable to first understand the risk associated with various investment options and create a portfolio with a balanced risk level that is consistent with the investor’s tolerance for risk as well as their ability to take risk based on their goals and their other income and investment resources. Then, in any given short or intermediate period, we take what the markets give us and regularly evaluate how the investor stands in relation to those goals. This is an example of the principle we apply to most of our financial planning, which is to control those things you can control and to not only accept but understand the impact of those things you cannot control.
Some of the most obvious consequences of the pandemic shutdown have been the closure of restaurants, bars, and many retail shops. And these are the very businesses that are more likely to be locally owned and have fewer financial resources than national firms to withstand the slowdown.
It’s well documented that small business is a critical part of the economy. For example, it is estimated that over 90% of the business in America are “small” (fewer than 100 employees), and they account for 47% of private employment. Small businesses are much more likely to be owned by women, minorities, veterans and immigrants. On the other hand, most small businesses fail within the first five years, most often from labor challenges or lack of capital.
This is not to say that customers should give locally owned businesses a “free pass” just because they are local. Customers should still require goods and services that meet their needs. But with some support, these small businesses can return to doing what they do best – being flexible, understanding their customer, and meeting their unique needs.
Supporting local businesses is not just about that business, it’s also about the community. Here are some ways the community benefits from successful small businesses.
• Community identity – most communities have a unique character and charm and small businesses reflect and preserve that character and turn it into an advantage.
• Community involvement – small business owners recognize how their decisions impact their neighbors and so they are more likely to sponsor community activities, support local charities and even participate in local educational opportunities. Simply put, they are invested in the community.
• Community health – small businesses develop personal relationships with their customers and support each other in sustaining the local business environment.
• Community financial benefits – local businesses re3cycle a much larger share of their revenue back into the local economy.
• Innovation and competition – small businesses have to stand out from the crowd to survive, which creates a healthy, evolving marketplace and perhaps even lower prices over the long term.
• Sustainability – local businesses tend to require fewer public services and less infrastructure, which creates friendlier business centers and reduces sprawl.
The main arguments for not frequenting small local businesses are convenience and cost. It is true that using local businesses may take a little more effort but most small businesses today have a robust online presence so some effort upfront can prevent wasted time. Since most consumers have been spending much less during the pandemic, the math is pretty simple – if you are spending 20% less overall, you can pay a little more at a local business and still come out ahead.
Most people would include supporting their community as a worthwhile goal. Should that goal be abandoned just so we can buy a lot of cheaper stuff we don’t really need?