Market Town Hall 5/13/20
Maureen: Welcome and thank you for joining HCM’S call with Doug Johnson and Mike Hengehold. Today is May 13th, this is Maureen Everhart with HCM. On this call today, Doug and Mike will give an update on recent market moves. They will give planning ideas for a low interest rate environment. And chart the progress of States reopening.
They will also address any client questions that have come in. Your lines are muted, and we ask that you please keep your lines muted and send your questions into our email box at info@HCMwealthadvisors.com. We will do our best to keep this call around 30 minutes and with that I will turn this over to Mike and Doug.
Mike: Thanks Maureen. Hello everybody and thank you very much for joining us today. As has become our custom, I'd like to begin the call with a brief positive focus and then we'll get into the meat of our subject matter. Two different things, primarily.
One, I saw on the news recently that Pfizer wants to expand human trials for COVID-19 vaccine. Hopefully in September to thousands of people. And if that proves to be safe and effective, they believe they can have millions of doses ready by October. So that's not really enough for the general population. But it's certainly a great thing for those on the frontline, healthcare workers, things of that nature. And obviously that could keep building as flu season starts to get back in gear.
On that same line, I've counted I believe, eight candidates for coronavirus vaccines that are in clinical development now. And Pfizer is not the only one that may be ready to test in early fall. So hopefully a vaccine is sooner than we had originally thought, because obviously that's the silver bullet that's going to allow everything to get back to normal.
The second positive focus that I have, and anybody who has seen the roof of our office building knows were into green. But, for the first of any month, renewable energy from solar, wind, hydro power generated more electricity than coal during April. That's according to the U.S. energy information association. That stretch of out production began, I think it was on March 25th. And ran all the way through the end of testing in early May. So, hopefully that's a good sign.
So that'll take care of that. What I want to do now is introduce Doug. Doug of course, is our senior investment strategist and he'll update us on the market, some economic activity since our last call. So Doug, are you there?
Doug: I am, can you hear me?
Mike: I can, loud and clear. Thank you.
Doug: All right, great. Thanks Mike.
So, a lot to cover today. Especially with the price action in the last two days, I think it's kind of caught a lot of people's attention. So, we'll touch on his may things as we can, before I turn it back over to Mike. So, the first thing that I thought I would point out today, that I found interesting. And I think if I gave it as a pop quiz, a lot of people probably fail it.
But on April 14th, so last month, approximately 30 days ago, the S and P 500 was trading at a level of 2,846 points. Today at the close, the S and P 500 closed at 2,820 points. So that's 16 points lower than it did about a month ago.
I think a lot of people would be surprised by that. Because, their answers, my guess would be that the market's up 5% or 10%, over the last month. When in fact it is actually somewhat flat. So, you know, we talk a lot about the emotions of the market, both bull and bear. But I think sometimes it's good to take a step back and see, you know, exactly what is really going on.
And as we've talked about, kind of the pattern of what you would see in a bear market. Where you see the swift initial selloff, followed by a pretty violent rally, which eventually tops out is as the economic rally kind of sets in. And then you're in for the slow, long grind. We're not saying that we're about to enter that, but nothing that we've seen right now is out of the ordinary, in terms of what that looks like.
So, in terms of a market versus economy, we're continuing to see this massive divergence between the two. You had a jobs report last week that had 20.5 million people on it, which easily beat the worst report that we’ve seen. And that corresponded to an unemployment rate of approximately 14.7%.
Now the peak of the great financial crisis was about 10%. And buried in the report, was some language around the possibility that the number in fact could be higher, both on the total number and as a percentage. Now, it's not necessarily shocking considering that the economy's just been closed down, but when we talk about demand destruction and an economy that is driven primarily by the consumer. When you have an unemployment rate that high, it's naturally going to cause some issues.
In addition, we had a consumer price index and producer price index numbers that came out that were very deflationary. Again, not a surprise. But as we start to put, you know, I guess real pictures behind this kind of economic calamity. It's going to be harder to ignore those figures. So, you know, as I mentioned before, the current pattern is playing out as we'd seen in the past. But we haven't really seen a divergence this wide, maybe ever.
You know, we talk a lot about valuations. Currently you have the market trading at about 20 times it's forward 12-month PE. Now, PE just stands for price to earnings ratio. It's a way to describe basically how much an investor is willing to pay for a dollar of future earnings. And when those ratios are very high, the market is considered expensive, when they're low, they're considered cheap. And we talk a lot about valuations because, well in the short term, they don't necessarily tell us a whole lot about what might happen at different entry points, then if you're buying into an expensive market. The probability of having a higher return over the next 10 years is going to be much lower.
So, we haven't seen a 20 times forward earnings numbers since 2002, if that gives you any idea. So, in an environment where we're facing very, very dire economic situations. It seems very odd that the investors are willing to pay that much money for what will likely be a contraction. So, you know, when we talk about this divergence, that's kind of what we're referencing.
And it's kind of odd that socks seem to be maybe the one good, that people feel compelled to buy more of as it gets more expensive. It could be a psychology thing. Other people, you know, they will wait for prices to get lower. But we kind of get sucked into this idea that, you know, as prices move higher, we have this tendency to want to buy more.
So, one thing that popped up this week, that hadn't been brought up before, was this concept of negative interest rates. And I won't get too far into it. I'll leave some of that for Mike and the planning part of the call. But what you had was the fed funds futures, which is basically just a market that predicts where short term interest rates are going to be in the future. You had the rate actually go negative. As early as, I believe it was October or November of this year.
Now there's a lot of reasons why this is significant. One being an environment that has negative rates is certainly not conducive, or of the belief that you're going to see strong economic growth. If we saw a massive year recovery, the economy just snapped back and everything was fine, you would tend to see rates move higher. But in fact, you're seeing the exact opposite. You're seeing them predicted to actually go below zero. Europe has had negative rates now, for several years, and it hasn't necessarily been a successful endeavor.
But what was once thought impossible in the U.S. is now, you know, becoming somewhat of a reality. The fed chairman Powell this morning held a press conference, and didn't address it directly, but, did take a question on it and said that, in his opinion, the fed was not even considering the possibility of negative rates.
Now, take that for what it's worth. They've also said in the past they wouldn't buy corporate bonds or do a lot of things until they're done under these circumstances. But, when he said that, it wasn't necessarily the thing the market was excited to hear about, because negative rates of course mean more stimulus. Maybe not in a direct way, but an indirect way.
Which again, could be positive for stocks. So, the last two days you've seen a combination of the market kind of selling off pretty swiftly. On the idea that, you know, this negative rate thing may happen. And the fact that now you're starting to see a resurgence of an issue that we dealt with all of last summer. And that I was so ready to be done with, writing about, talking about now it seems like it's going to be front and center again. Which is the infamous trade deal with China. Supposedly this was agreed on, the phase one deal was signed. And now there's a lot of chatter going on around a renegotiation around this deal. Or actual sanctions being held against the Chinese, as almost a retaliation in a way for them kind of dragging their feet on the release of information, based on the virus.
Now, this is all kind of new, so it could just be empty threats. But nonetheless, in a market that has a lot of stuff to worry about, this is probably not something else that we need to be dealing with right now.
But nonetheless, there it is. And the market has certainly reacted very strongly over the past two days to that news. And to the fact that, you know, it may be waking up a little bit to the economic route that's right ahead of us, that we may not see this return to normal right away. And I think a lot of that optimism has been priced into the market right now, which is a term I hate to use. But I think in this case it does make sense.
So, touching on that, you know, we've seen some States that have reopened in some capacity or another. One thing that I did find interesting was the dining app, open table, released some data of certain States. And what it showed was that based on last year at this time, that restaurant occupancy is right around 10% of what it was.
In addition, the TSA, transportation security association, publishes passenger data each day, shows the number of travelers going through airports. Last year, at this time, the average number was close to 2.4 million travelers per day, right now it's right around 200,000. So, we would expect those numbers to slowly go up.
But I think that kind of paints a picture right now of what we're facing, in a sense that States are reopening. We now have the ability to go and do all of these things, maybe not the same way that we used to. But we're starting to see that, and right now we still only have about 10% of what we had a year ago. Now, some may look at that and say, well, we've got 90% more to cover. You know, if that happens, great. But, we think that's a sign that this is going to be a little bit more of a challenge than we'd expected.
So lastly, I just want to touch briefly on a topic that we addressed in the last call. But I wanted to take it a step further. So, last call, we had mentioned that some of the market internals that we pay attention to, had started to improve. Now, some of that was a function of just prices increasing. But some of it was, the fact that you started to see some small cap participation, you started to see some energy participation. You started to see some participation from parts of the market that has historically been leaders coming out of very bad timeframes.
So, I think that I got a lot of people excited and said, okay, does this raise the possibility of, you know, putting some money back to work. Now over the two weeks that those internals that we've seen, most of them have kind of flattened out or declined. Which isn't necessarily a good sign and it doesn't lead us any closer to actually risking portfolios.
But the part I wanted to touch on was that if we do get to that point, I think it's going to look a lot different than it would in what we would see in a normal bear market. Where you get a prolonged recessionary timeframe, you get a prolonged, you know, kind of market malaise. Where you have the economy essentially cleanse itself. You get a large number of defaults, you get, you know, some natural price action with that. Those defaults, that recession, that slowing and growth kind of flushes through the market. And leads the valuations that across the board, are more attractive and they're especially more attractive in the very risky parts of the market.
So small cap, high yield, emerging market, things like that. Right now, that's not quite the case. You're not really seeing great valuations anywhere, specifically in the large cap space, and we touched on that earlier. You know, small cap valuations are probably close to fair, but in an environment where you're anticipating really, really bad economic growth. I don't know that fair value is worth the risk.
So I think if we did get to the point, and again, I want to emphasize we're not there yet. But if we did get to the point where we decided to start to put some money back to work in this environment, it would be on a much more measured basis. Both in the amount that we put back in and the asset classes that we choose to use. And then we also probably put very tight stop levels, sell levels, on those in case we did kind of see that begin to roll over. But, you know, if what we saw over the past few days continues or we don't continue to see any upward movement, we're probably not going to get there. But at least wanted to lay that scenario out so everybody kind of had an idea of what that might look like.
So, with that Mike, I'll turn it back over to you.
Mike: Alrighty, thank you Doug. I have quite a few things I wanted to mention, and we do have some questions as well. So, I may edit some of my material here and maybe kick some things to the next call.
What I wanted to mention, when Doug was mentioning the market changed over the last 30 days. I just was curious what's happened since our last call. Now, I did this to the Dow, not the S and P, but the Dow is down just about 1,400 points since our last call. So about 5%, 5.5%, something like that. Just to give you a sense that while the feeling may be, one direction, reality is something else.
What I wanted to do was talk about some of the planning opportunities that are being made available because of low interest rates. So, we focus a lot on the market, certainly the market goes through cycles, that's inevitable. But when those cycles happen, sort of like when a door closes, a window opens. And there are a lot of opportunities now around interest rate sensitive things.
So, the first thing I wanted to mention, and these are just sort of in bullet point order. And then if we have time, I'll try and do a lightning round of just some planning reminders. Things we've talked about that I want to keep top of mind for you. So, some of these things everybody knows, but a gentle nudge, a gentle reminder is always helpful to encourage people to take action. Other are going to be a little more complex. And if your situation fits the reminder, then that's something we should probably talk about.
First, in the ‘everybody knows’ camp, higher interest rates. People have higher interest rate debt. Refinancing that debt to lower rates will obviously save you money. That's true for mortgages. Don't forget about private lender, student debt, car loans. If you do have a high interest rate credit cards, consolidating that debt is something that you could look at. All things that could improve your cash flow.
People who are thinking about buying their first home. Or maybe, we have clients that are shopping for second homes. The fact that we're in a recession with low interest rates could provide two opportunities. One, the recession, if it runs a bit, could cause prices in the real estate market to decline. All while low interest rates would make mortgages less expensive.
So that's sort of a double opportunity brought on by low interest rates. And then again, potentially the recession. When we're talking about the possibility of refinancing mortgages or, potentially taking on an additional mortgage. If you are of the mindset that the government, and all the government borrowing, and all the debt, will ultimately bring inflation back into the picture. Then you should be a fan of 30-year mortgages.
So, people often are tempted by a little bit lower rates in shorter term debt. But normally when you run the numbers of taking the longer amortization, if you invest that money and don't spend it, because by amortizing the debt over a longer period, your payments will be lower.
Which is going to create additional monthly cash flow. So that gives you the ability to dollar cost average into an investment portfolio. If you put those two things together, typically the longer amortization is going to make sense. And again, especially when you put that against an inflation backdrop, because remember, the value of the debt is declining, while your cash flow should be keeping pace with inflation.
So, working those things together makes a lot of sense to take the longer term debt. Of course, don't forget about closing costs and shop around because lenders, obviously can charge different things. Money's a commodity, so if you can get it at the lower price, it's good.
Another idea if you own bonds. Something everybody knows, especially if you own bonds, sort of the teeter totter effect of when interest rates go up, the price of bonds goes down and when the interest rates go down, the price of bonds goes up. So, what's happened recently with interest rates declining is the premium on bonds has gone up.
So, if you sell a bond, you would have capital gains, presumably. If you bought that bond in a higher interest rate environment, you're going to have capital gains because of the way the teeter totter is moved. Capital gains are taxed at a lower rate, and presumably you can offset those gains by lost harvesting out of your equity portfolio, from the market volatility that comes through the recession.
Then when you repurchase the bonds, similar bonds, not identical bonds, because we don't want wash sale problems. But when you repurchase similar bonds, you'll now be paying new premiums, which are amortizable. And the tax planning advantage here is that, when you sell the premiums that you have, they're taxed at capital gain rates.
When you amortize the premiums that you're purchasing, their deductible at ordinary income rates. And the ordinary income rates can be twice as high as the capital gain rates. So, you can pick up quite an advantage there. So high-income taxpayers can save quite a bit of tax on that investment income.
Other planning opportunities, that are created by the low interest rates exists in the estate planning world. The estate planning world is driven to a large extent, by devices that we use both for charitable and family planning, in determining how much of a transfer qualifies as a gift. How much is going to be included in somebody’s estate.
So, there's two examples. And again, I don't want to get too far into the weeds on this, but if you're in the midst of this planning, these terms will mean something to you. So, grantor retained annuity trust, also known as grass charitable lead annuity trust, also known as CLAT.
All of these have an X factor that is the interest rate. So, you know, both of those have the word annuity in them. So both of them have strings of payments and in the interest rate that's applicable at the time. The IRS refers to a thing called applicable federal rates. And that interest rate moves based on where the market rate is, the lower that rate is the more advantageous these plans become.
So, if you're in the estate planning realm, or if you're thinking that this is something you should do, estate planning is always like pushing the boulder up the hill. It takes a lot of energy to get it started, but low interest rates certainly should be an incentive to getting that process started.
Also, in the estate planning realm, there's a device called intentionally defective grantor trust. We often use these when we're transferring businesses within families. Same basic concept, low interest rates improve the valuation and minimize the taxes associated with these. Private annuities work essentially the same way and for people in business. Or if you have permanent insurance, there's a concept called split dollar life insurance, that is not a type of insurance. Rather, it's a way of sharing the cost and the benefit of the permanent insurance. And the way the gift taxes are calculated with split dollar, involves the interest rate assumptions within the plan. So, the lower the interest rates, the lower the taxes, again, another advantage that can be taken with low interest rates.
And then we do have just a few minutes left. So, I'm going to expedite my lightning round just as some reminders of planning things. Again, these are things we all know already, but it's easy to hear it and let it sit on the shelf. So I'm basically pestering you to take action. Remember, you can pick up the phone, call your advisor, call your CPA, if you don't have a CPA. Remember, we have HG CPAs here. So, we can solve all those needs for you.
So, the first thing is the suspension of 2020 required minimum distribution. If you're in RMD status, you understand how this works. If you're not, but if your parents are over 70 or 72, depending on how close they thread that age, and they're in RMD status, they don't have to take this payments this year. That creates a hole in your tax return, which opens up the opportunity for bracket management and planning.
So, a Roth conversion is a great choice there. Don't forget, in making these decisions that we are just one administration change away from tax rates going up on higher income tax payers. And if that doesn't happen, then rates are scheduled to go up by statute in 2026. And even if none of those things happen for older couples, don't forget that the tax rate on a survivor. So, if one spouse passes away, the survivor becomes single and is subject to much higher tax rates.
So, in thinking through these sorts of tax planning decisions, the fact that an opportunity to take advantage of lower tax rates this year has opened up, is a really good opportunity.
There are some loan options available from IRAs and employer plans. That you can tap into if you are on the other side of the coin and are having financial difficulties because of the Cronavirus problem. So, if you need money, that's something you can do. And again, you can give us a call and we can walk you through that.
There are some charitable donation opportunities. The biggest one is that every year we have some clients that are committed to making a very large gift. Possibly they have a commitment they've made, that they want to wind up. But the tax law gets in the way by limiting the amount of deduction that they can get a benefit from. This year that's been turned off.
So, the tax, although it would be very bad bracket management, if somebody wanted to eliminate their entire taxable income with charitable gifting, they could do that this year. So, if you're, you know, if you're in a situation like that where you would like to make a large gift, again, that would be another subject to discuss, and we'd be happy to do that.
So that was the lightning round. We have just a few minutes left, and I want to just touch on some of these questions very quickly. Doug you still out there?
Doug: I am.
Mike: Perfect. Doug are you worried about inflation with all the money that the government is printing?
Doug: So, I think that, you know, inflation has become a hot topic. Certainly, you've heard a lot of people in the news telling you to buy gold as an inflation hedge. I think the thing that's being ignored in all this, is that there still remains an awful lot of debt in the system, both personal and corporate debt. And when that debt is “unproductive” and doesn't lead to significant growth it acts as a counterweight against anything inflationary.
Now, a prolonged recession would certainly cleanse some of that unproductive debt and allow it to kind of flush itself out. Which I think initially would be, you know, somewhat deflationary. But if that were to clear and you continued to have stimulus, in Ernst, that could cause some significant inflation down the road. But for the time being, none of the data suggests that we have any type of imminent inflation right now.
So, am I worried about it the next few months? No, am I worried about it, you know, two to three years from now, maybe?
Mike: Okay, another question.
The president has claimed recently that rich folks are engaged in pump and dump tactics, in the market recently. Is there any truth to this? Are some fat cats engaging in market manipulation via shorts or other tactics?
Doug: So, I'll do my best to be as objective as possible in this. So I think that, you know, when CNBC has anybody on their show and they can make a comment to move a market. It should be considered, you know, manipulatory, but it works both ways. You have, you know,
hedge fund managers coming on at the bottom and saying, “Hey, we think this is a great buying opportunity” and then you find out that they had a meeting with the president 24 hours before that, and vice versa. You had a pretty prominent hedge fund manager today, David Tepper, come out and say, you know, he's never seen stocks this overvalued. And It proceeds to have a pretty significant sell off.
So, I mean, those guys are always going to have that avenue to be able to do things like that. Over a day or two, it might make a difference, but over long term periods, I don't think that they can drive markets wherever they want to go.
And, you know, the other thing is don't forget that the federal reserve and the government has come out and said, “Hey, we're going to buy corporate bonds, we're going to do all these lending programs and we're going to do unlimited stimulus”.
You know, some people could consider that to be somewhat manipulatory, to try to drive prices higher. So, I think there's a lot of gray area there. I'm sure if you looked hard enough, you could find some things that probably wouldn't pass the smell test. But ultimately that's, I think, you know, the environment that we're in and we just have to operate with it.
Mike: So, your comment about buying bonds leads to the last question that we have.
Do you think the fed will eventually buy stocks?
I'm going to answer this first and say, no, not this time. I'm not going to say, I would never say never, but I'm going to say never, unless things get beyond imagination ugly.
But Doug and I may not agree on this. I'm not sure. Doug, do you have a different view of it?
Doug: What I will say is, I hope not. And then when we're going back to the last question, when we're talking about market manipulation. If we have a government entity, actually it’s not even a government, it’s a private bank. That has unlimited ability to print money, that has essentially no price sensitivity either. If you have them coming in and saying, “Hey, we're going to buy stocks”. I don't think that's a great thing to have in a market.
Will it happen? I don't want to say it won't. Especially if we go back and retest the lows that's one of the few kinds of bazooka type instruments that the fed has left.
And unfortunately, you know, fortunately, unfortunately, however you look at it. But there is precedent for it. Not in the U.S. but, the Japanese central bank has been buying equity ETFs for a very long time. And then you have the Swiss national bank, which I saw something the other day said that they were buying stocks. You know, hand over fist, individual stocks, in March when all this stuff was kind of going on.
So, you know, it's kind of a very gray area, and I think we could spend hours talking about it, but I guess my short answer would be, I hope it doesn't happen.
Mike: Okay. And that does it for this call. So in conclusion, again, I'd like to thank everybody for participating and as I do each week. I want to say thanks to everybody who puts themselves elevated risks so that the rest of us can enjoy semi normal existence.
Our next call is scheduled two weeks from today. That's Wednesday, May 27th, I believe. Of course, if news breaks, we'll be reaching out to you one way or another.
And as always, if you have any questions between calls, you need any help, or if there's anything that someone you know or care about needs get us in touch. We'll be happy to help any way we can. And as I always say, there's no strings attached to that. We just want to do what we can. Thanks everybody.
That does it for today. Bye bye.