MARKET COMMENTARY - Fredric W. Williams
There and Back Again…
“Go back? No good at all! Go sideways? Impossible! Go forward? Only thing to do! On we go!”
- Bilbo Baggins; Riddles In The Dark
Perhaps much like the “memoir” recounting his other-worldly adventures that became the basis for Tolkien’s The Hobbit, Bilbo’s approach to cave navigation could be an apt description of how prudent investors may want to approach the globe’s Covid-impacted capital markets going forward. The precipice that was the image of the equity markets in Q1 was nearly reversed with the vertical ascent of Q2 – although the return ride was anything but smooth, with volatility re-emerging as a fixture of the overall investing landscape. But for those who focused on their longer-term goals, rather than the media’s daily serving of white noise, many have found their persistence thus far has been justified as they stayed the course and participated in the rebound from the March lows.
In our past musings we’ve referenced the interdependency of the economy and the markets, while acknowledging the relatively low direct influence of whatever the political-drama-du- jour might be. Now, in 2020’s version of an unprecedented new normal, the global economy and markets are dependent on a public health issue, and the progress being made to battle that coronavirus, while central banks and sovereign governments do everything they can to keep their respective populaces on economic life-support. Then add to that what has become a new iteration of incendiary politics and we have the added uncertainty of whatever social media bomb blast might get thrown into the mix during this election year’s ongoing jousting…sometimes just the pace of postings makes it hard to even catch your breath.
The capital market’s “Covid-on/Covid-off” reactions to our progress through this uncharted territory has likely created a behavioral finance dynamic where fear-based decisions have
driven some short-term reallocations of capital that could have benefited from a less emotional, and more contextual, view of some broader issues and influences that might have longer term impacts.
From a macro perspective we entered 2020 with far less real estate leverage, and personal debt, than was the case during the ’08-’09 recession; and the current Covid-19 challenges
have seen sharp increases in savings, as well as further reductions in debt, which suggests stronger household balances sheets and the capacity for improved future consumer demand.
And unlike the federal government’s delayed response in ’08-’09, both the Federal Reserve and Congress have been reacting far more quickly to shore up the various components of our economy. Differing from the Great Recession, which was the culmination of excesses in the financial system, coupled with the disproportionate use of leverage, our current recession stems solely from the public health decisions necessary to stem the coronavirus’s spread. In fact, as large as the government’s response has been thus far, there’s an evolving train of thought (even amongst fiscal conservatives) that fiscal and monetary support should be expanded even further to prevent lasting damage to the economy that would require an extended period of time to adequately from which to recover.
Since what we’re experiencing now is not some version of unfettered capitalism that seeks to preserve only the survival of the fittest, the argument is that the federal government, as the only entity able to create money, should absorb the economic “losses” (via borrowing) as a means of preserving the personal purchasing power that can restart the economy and thereby produce the tax revenues that can repay the Covid-19 induced public debt going forward. As we’ve discussed in the past, with two-thirds of our GDP a function of consumer spending, should personal wealth be expended to address a non-economic public health condition, future consumption would suffer and thereby curtail the various tax revenue streams that could accrue to the government to pay off the debt it incurred to bridge the economy to the other side of the virus’s impacts.
This is not to suggest that all this is a bed of roses, or a fait accompli, from a recovery perspective, as we have numerous hurdles to overcome as we progress through this pandemic, not the least of which is how politicized battling the virus has been allowed to become. In addition, we have the interim reality that the reopening of the economy will only sustainably occur if the spread of the virus is slowed, lest it overwhelm our economy’s medical capacity to effectively treat it. We also will have to accept elevated levels of unemployment in those sectors that rely on proximity to deliver their services, like restaurants, various personal services, hospitality and tourism – all of which will contribute to a decline in overall discretionary consumer expenditures over the shorter term.
We’re getting closer to a better understanding of how Covid-19 is going to be managed through this continuum, with focuses on societal practices to flatten the curve, more effective treatments of the coronavirus itself, followed by an array of preventative vaccine regimens. Treatments, like the use of antibodies and existing drug cocktails, along with a number of vaccine development projects, are all fast-tracked works in progress where results are expected later this year or early next. Which leaves us with the front-end personal practices to contain the spread of the virus on a community basis level.
Watching our political leaders wrestle with these realities sometimes reminds one of a Tom Petty song about the naivete of new-comers in Hollywood’s absence-of-reality world:
“Into the great wide open
Under them skies of blue
Into the great wide open
A rebel without a clue”
- Tom Petty and The Heartbreakers, 1991
For us to move to a conversation about the trajectory of our economic recovery, we need to have our populace address the front-end public health policies that accept the scientific realities of how to most effectively contain the virus’s spread, thereby allowing for the safe exchange of goods and service that is the basis of our economy. Social distancing, sanitizing and masks are not political commentary – they are the best ways for us to protect ourselves and each other…which buys us time for treatments and vaccines to be developed and deployed, thereby affording our society the opportunity to move past this pandemic and into an improving version of normalcy that will be the start of the road back.
More than ever, and for a number of reasons and perspectives, we are all in this together.
CAPITAL MARKETS OVERVIEW - Francis J. Davies, III
Domestic and Global Market Recap
The second quarter combined a mature economic cycle, trade wars, political division, and a global pandemic to produce the best US stock market performance in over 20 years. That is some alchemy.
The bounce back from the lows of March, when the market hit bottom during the start of the coronavirus pandemic, was as fierce as the decline had been. The S&P 500 gained 20% in the quarter to cut its loss for 2020 to 4%. The Nasdaq Composite rose over 30% with an increase of 12% for the year, its best quarter since 2001.
Obviously, the market rise was not based on fundamentals. The Federal Reserve went to extreme lengths to stimulate financial markets. On March 23, with interest rates close to zero, they announced an expanded quantitative easing program that will include buying longer- term treasuries, bond funds and even individual corporate debt within the mandate, on an open-ended basis. This new chapter in printing money has earned the nickname “QE infinity.” The Fed also announced aggressive credit facilities for businesses, large employers, and “Main Street.” This is in addition to the $3 trillion CARES Act.
The first two quarters of the year could not have been more different. Q1 delivered the worst quarterly return since 2008, 34% between February 19 and March 23. From that bottom, the S&P 500 rose 42%, making Q2 the best quarter since 1998. It has been an extraordinarily thin advance, dominated by a few mega cap technology stocks. Digging a little deeper, there are still hundreds of large-cap U.S. stocks with double-digit declines for the year. Consumer spending fell 6.8%, and the retail and airline industries, both big employers, are suffering.
Along with rising equity prices has come high levels of volatility. The market behaved erratically in the second quarter. For example, in the first week of June, the Dow rose 6.8%.
It then fell 5.5% in the second week. The S&P 500 has had 17 days a gain or loss of 4% or more. The yearly average from 1928-2019 is a little over 3 such days.
Global stock markets participated in the comeback with the MSCI World index gaining 19.4%. Developed stock markets rose vs. a 18.1% gain for emerging markets as an appetite for risk increased. Eurozone shares posted strong gains in Q2 as lockdown restrictions were eased. UK equities rose over the period. After weakness in early April, the Japanese equity market recovered to record a total return of 11.3%.
In China, economic activity continued to recover, while the stock market slightly underperformed, after a strong move in Q1. Geopolitical tensions hurt equity performance in Hong Kong after China imposed its national security law. Emerging market equities rallied, helped by global monetary and fiscal stimulus. They had their strongest quarterly return in over a decade, with US dollar weakness amplifying returns. However, there was an acceleration in the number of new daily cases of Covid-19 in some EM countries.
US government bonds saw little movement on the heels of the Federal Reserve’s abrupt decision to move the Fed funds target to near zero. The yield curve maintained a positive slope; the 2-year closing the quarter with a 0.16% yield, the 10-year at 0.66%, and the 30- year had a 1.41% yield. The debt market sold after a stronger than expected jobs report in early June but reversed the move later in the month. The risk-on nature of the market was seen in corporate bond action as they outperformed government bonds, significantly tightening their spreads. The investment grade bond spread was cut in half, from 3.15% to 1.61%. High yield bond prices moved significantly higher and their spread to government paper plunged 2.00%.
In commodities, the raw material markets made a comeback in the second quarter led by energy as oil-producing countries agreed temporary production cuts. Brent crude futures soared more than 80% in the quarter. Industrial metals also had a positive quarter, with iron ore and copper the leaders. Precious metals advanced too, particularly silver. The agriculture sector posted a negative return, with coffee and wheat prices notably weak. Real assets like gold (+14%) and real estate benefited from the lavish supply of capital.
The dollar index lost 1.76% in Q2, although it was still 1.35% higher for the year. The dollar is normally the global safe-haven, but the coronavirus has changed that.
The S&P 500 traded for 21.6 times weighted consensus forward earnings estimates at the close June 30, up from 18.3 at the end of 2019. The P/E ratio is up, despite the 4% loss in the S&P 500 for the first 6 months of 2020 as earnings estimates drop. Within the S&P 500, 180 companies have withdrawn their 2020 forecasts. Interest rates are the justification for high stock price/earnings multiples. Earnings for S&P 500 companies have stagnated since 2014. The bulk of U.S. stock gains have come from the expansion of the price-to-earnings ratio. The market leader, Apple had revenue growth of 1.5% in 2019 and the stock gained 83%. So far in 2020, Apple has posted 0.5% sales growth with global iPhone sales down 8% in Q1 and the stock is at an all-time high.
The market is looking past the scar tissue on the economy. There is no precedent to current times. The last significant pandemic was in 1918 and the global economy, central banks, and technology are antithetical to that world. It is different this time. People will not be returning to their offices. Commercial real estate, average rents, development – the list of effected enterprises is endless. Cars will be used less. Tolls will take in less money. People will not willingly pack into concerts, subways, museums, planes, restaurants. Free space is a luxury. Someone will have to pay for it. with consumer spending falling 6.8%. Web presence was even more important while remote work and meetings became acceptable.
Small-business revenue has not improved much since re-openings began and depends on a clearer direction in the pandemic response; many have shuttered their doors forever. That may not affect the stock market, but it will hurt the economy. It is difficult to see a way forward until the virus is on the decline, there is better therapeutic protocol, or a vaccine is widely dispensed. Working parents will remain at home until they feel it is safe for their children to return to schools and day-care centers. Over the past weeks, Arkansas, Arizona, South Carolina, Georgia, and Texas all reported a record number of daily Covid-19 infections. A relative lack of health infrastructure in parts of rural America and economic devastation from the Covid-19 closures mean that already vulnerable communities could be overwhelmed. The 2020 election combined with social unrest and China tension creates a recipe for continued volatility in the second half of the year.
SECTOR OVERVIEW - Richard “Chip” Harlow
US stocks rebounded during the quarter as investors came to terms with the reality of living with COVID-19. Businesses have been slowly reopening, albeit not at capacity and with new social distancing guidelines. The true economic impact is still uncertain, but it appears the impacts will not be a worst-case scenario. As the quarter ended, there was a resurgence of cases, particularly in the South and in California. It remains to be seen how this resurgence will play out. The large dispersion between individual sector performance continued, as investors positioned themselves for potential winners and losers to this new normal. All sectors saw positive gains during the quarter but only two sectors, Consumer Discretionary and Technology, were able to rebound enough to turn positive for the year-to-date numbers. Energy stocks were a tale of two quarters, leading the way down in the first quarter and almost leading the bounce up with a 30.5% pop during the second quarter. Energy is still down 35.3% for the year.
Leaders: Technology
Technology rebounded sharply during the 2nd quarter, bouncing 30.5%, thus turning positive for the year by 15%. Technology software companies led technology higher, followed by hardware and storage. This makes sense as companies continue to enable remote work environments and consumers adjust to working and shopping from home. The sector has perhaps got ahead of itself with a forward P/E ratio of 24.9 vs. a 20-year average 19.1, but investors seem to be betting that Technology will continue to do well as companies around the globe continue to adjust.
Leaders: Consumer Discretionary
Consumer Discretionary was the best performing sector during Q2, with a 32.9% return and turning positive for the year with a 7.2% YTD. The sector is heavily skewed towards the Internet and Direct Marketing segment, with approximately 25% being attributed to one company, Amazon. Online sales through Amazon have risen exponentially due to the pandemic. Amazon’s stock alone has risen 50%+ since the beginning of the year. Hotels, Restaurants, Autos, and Department Stores are some other segments within Consumer Discretionary. These segments have not fared as well as the pandemic has curtailed their operations in varying degrees making the sector performance very misleading since most of the it can be attributed to Amazon.
Other Sectors of Note: Health Care
derstandably, there is a lot of focus on this sector. Healthcare’s rebound during the second quarter was in the middle of the pack, rising 13.6% and getting close to breakeven for the year at just under a one percent loss YTD. Biotech companies have been the best segment within Healthcare, as the race for a vaccine continues. Healthcare Services has been the laggard in the sector. This segment is comprised of hospitals, medical practices and nursing and residential facilities. It remains to be seen what long-term effect the pandemic will have on these services, but costs have increased as requirements for screening, disinfecting, testing, and social distancing barriers have become necessities. Almost every part of this sector is actively involved in treating the pandemic, but how that translates to earnings remains to be seen. It does seem probable that Healthcare spending will increase as countries will better prepare themselves moving forward.
FIDUCIARY CORNER - Stephen L. Eddy
The Overshadowed SECURE Act…
Neglected. Overlooked. Both of those words describe the SECURE Act which was passed into law in December 2019. A relatively sweeping reform for retirement plans, it was generally designed to make retirement plan savings vehicles available to as many people as possible. It was immediately overshadowed by COVID-19 and the CARES Act.
In another over-thought Washington acronym, SECURE stands for Setting Every Community Up for Retirement Enhancement. The primary impacts it will have on retirement plans are the following:
- Open participation in Multi-Employer Plans (MEP’s) – unrelated employers would be able to participate in what would be treated as a single plan for ERISA purposes. For plans with similar features, this could eliminate the expense of an audit and a 5500. Insurance companies are pushing these plans on trade associations, with mixed results. The industry seems to be taking a wait-and-see attitude towards adoption. MEP’s are not a fit for most companies.
- Qualified Automatic Contribution Arrangement (QACA) Limit Increase - for plans that have the auto-escalation feature activated, the new maximum limits move from 10% to 15% of comp.
- Small Plan (<100 employees) tax credits – your accountant may be able to generate more tax credits if you sponsor a small plan, as the Act has added a few incentives
- “Permanent” part-time employee participation – beginning in 2021, employees with 3 years of service > 500 hours are eligible to contribute to plans. They can be excluded from the match and discrimination testing so as not to hurt the plan ratios. It will take time to implement as there is no lookback. 2023 will be the first year with eligible part-time participants.
- Qualified distributions for birth or adoption (limit $5,000 per occurrence) – participants can take non-penalized distributions for birth or adoption costs
- Required Minimum Distributions (RMD) age change - the start date for terminated participants to take their minimum distribution has been changed from 70½ to 72 (starting with the 2020 Plan Year)
- Increased filing penalties for late 5500’s etc.
- Lifetime Income focus – Lobbied for by the insurance industry (read annuity issuers), there will be more emphasis and flexibility for lifetime income options to be available in plan investment menus. There is also a requirement that providers show a projected lifetime monthly income number on participant statements. There are many issues with this practice that will take time to work out – What interest rate is used? How often updated? What type of annuity? Etc etc etc. This will lead to some confusion and lots of small print, but it is the first line of demarcation that officially removes the “providing retirement” burden from the shoulders of the plan sponsor and a defined benefit plan to the participant and a defined contribution plan. 401k plans were not meant as replacements for DB plans, only supplements.
- Natural Disaster loan provisions and relief – enacts increased loan allowances of up to $100,000 and more flexible terms for those impacted by natural disasters. The CARES Act provisions regarding COVID-19 loans are a direct offshoot of this.
As always, please reach out to Old Port Advisors if you have any questions or need any clarifications. Be patient and stay safe.
Financial Planning and the Coronavirus - Ben Daigle & Jake Kenyon
Planning for Uncertainties in Retirement
The uncertainties we face in retirement can erode our sense of confidence, potentially undermining our outlook during those years.
Indeed, according to the 2017 Retirement Confidence Survey by the Employee Benefits Research Institute, only 18% of retirees say they are “very confident” about having enough assets to live comfortably in retirement. Almost 40% were either “not too confident” or “not at all confident.”
Today’s retirees face two overarching uncertainties – an uncertain tax structure and market uncertainties. With any plan, it is important to remember that remaining flexible and responsive to changes in the landscape may help you meet the challenges of uncertainty in the years ahead.
An Uncertain Tax Structure
- A mounting national debt and the growing liabilities of Social Security and Medicare are straining federal finances. How these challenges will be resolved remains unknown, but higher taxes—along with means-testing for Social Security and Medicare—are obvious possibilities for policymakers.
- Whatever tax rates may be in the future, taxes can be a drag on your savings and may adversely impact your retirement security. Moreover, any reduction of Social Security or Medicare benefits has the potential to place a further strain on your retirement.
- Consequently, we will need to be ever mindful of the changing tax landscape and plan for strategies to manage any impact on your retirement.
An Uncertain Market
- If you know someone who retired (or looked to retire) in 2008 you know what market uncertainty can do to the prospects of retirement.
- Looking at the uncertainties of today we find ourselves asking what will the world look like after the COVID-19 shutdown? How will the economy respond? Will the Euro Zone find its footing? Will U.S. debt be a drag on our economic vitality?
- Over a 30-year period, uncertainties may evaporate or resolve themselves, but new ones historically have emerged. This means understanding that the solutions for one set of economic circumstances may not be appropriate for a new set of circumstances.
- There is no “one size fits all” strategy to mitigate market uncertainties that exist today, and that will ultimately exist in the future. For you, the strategy that is best implemented is the one that fits your specific financial and lifestyle goals. By developing and continuously updating your financial plan, you develop a better understanding of what is needed to achieve your goals and gain confidence in what your financial future holds.
Part of our job as advisors is to attempt to take the emotional aspect out of market uncertainties and reframe them. By viewing the markets from a fundamental standpoint, it allows us to make financial decisions during periods of increased volatility like we’re experiencing now.
While we make these decisions with your long-term goals in mind, we must view them differently depending on what stage of retirement you’re currently in. For folks in the accumulation phase, it’s a time to buy into lower markets and continue/increase saving towards the future. For retirees in the distribution phase, it might be a time to re-run projections and cut back on spending in the short-term. This might mean spending cash on hand versus forcing portfolio liquidations to cover expenses, allowing markets and your portfolio time to sort out the many economic impacts of COVID-19.
Ultimately, preparing for uncertainties is less about knowing what the future holds and more about being able to respond to changes as they unfold. As always, please reach out if you feel your circumstances have changed and you would like to refocus and review your long-term financial goals.
OPA NEWS & COMMUNITY EVENTS
OPA & Another “New Normal” Perspective:
As mentioned last quarter, this space is usually filled with the event calendars for a variety of the non-profit and cultural organizations that we as a firm, our employees, clients or colleagues are involved with. It’s through these events, annual or otherwise, that they further their fundraising efforts and support the ongoing delivery of their missions.
As we’ve learned over the last three months, making progress battling the pandemic has been at the expense of businesses and organizations that have been impacted by social distancing limitations and economic shutdowns. In our Q1 edition we mentioned our region’s extremely important hospitality industry and the challenges it faced, along with those of their workers, when unable to open their doors to guests. And although virtually all sectors of our economy have been adversely impacted by Covid-19, our non-profit sector has been particularly hard hit from the combined effects the inability to hold their usual fund-raising events and the reduced giving levels during this period of economic uncertainty.
The organizations below are far from a complete listing of worthy entities, but in lieu of supporting events that couldn’t occur, OPA has made donations to their missions given their ongoing importance in the fabric of our community.
For the support and mentoring of children, students and the food needed to sustain their physical and mental wellbeing:
- The Locker Project ( http://mainelockerproject.org/get-involved/ )
- Feed Our Scholars ( https://feedourscholars.wordpress.com/ )
- Full Plates Full Potential ( https://www.fullplates.org/emergency-funding/ )
- Boys & Girls Clubs of Maine ( http://www.bgcmaine.org/donate )
- Big Brothers Big Sisters of Southern Maine ( https://www.somebigs.org/ )
To address our community’s food insecurity issues:
- Good Shepard Food Bank ( https://www.gsfb.org/get-involved/donate/ )
- Preble Street Food Pantry ( https://www.preblestreet.org/you-can-help/donate/ )
Supporting infrastructure organizations during periods of societal transition:
- USM Foundation – Student Emergency Fund ( https://usm.maine.edu/foundation )
- Green Memorial AME Zion Church ( https://www.facebook.com/GreenAMEZ/ )
Mercy Hospital – COVID Response (https://northernlighthealth.org/Locations/Foundation/Donation-Opportunities )