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Market Town Hall 5/27/20

Transcript:

Maureen: Welcome and thank you for joining HCM’s call with Doug Johnson and Mike Hengehold. Today is May 27th, on this call Doug and Mike will give you an update on recent market moves. Update the progress on the economic reopening and touch on the discussion around the vaccine news. Your lines are muted, we ask that you please keep them muted and send your questions into our email box at info@HCMwealthadvisors.com.

Since there is a historic rocket launch happening tonight at 4:30 we will keep this call to around 20 minutes. And because of that, we will not have time to address individual questions, but that does not mean that they won't get answered. If you sent in a question, one of our advisors will reach out to you to discuss it.

And with that, I will turn this call over to Mike and Doug. Mike.

Mike: Alrighty. Hello everybody, welcome. With keeping with our practice, what I'd like to do is start with a positive focus. And regardless of where anybody comes down on the need for the national COVID quarantine, it's certainly good that things are starting to loosen up a little bit.

Businesses are getting back up and running, people are getting back to work, and we're starting to see our families and friends again. Being able to get back together, even if that does mean masks and a little social distancing from time to time. So that's the positive focus. What I'd like to do really is just with no further ado, ask Doug to go ahead and get started with his review. Doug.

Doug: Great. Mike, can you hear me?

Mike: I can, yes.

Doug: Okay, great. Alright, well apparently there is a rocket launch at 4:30, but it looks like the market might've strapped itself onto that rocket a little bit prematurely, because we had quite a finish into the close today.

So, just to kind of give a quick update of what we're seeing. You know, despite very significant economic headwinds, even with some of the reopening’s that we've seen, the market continues to grind higher. We cleared the 3000 level for the first time yesterday since March. And we actually traded below that a little bit today, but then, you know, right around 11 o'clock, it seems like everything reversed and has been pretty strong throughout the day.

So, on a positive note, we're starting to see some participation from some of the pockets of the market that had been laggard. Particularly in the small cap and value sectors. Normally coming out of a recession in the beginning of recovery, you would see those cyclical type names start to lead and outperform.

And from the bottom, on March 23rd, we haven't really seen that, in a significant way, up until about, you know, maybe the middle of last week. And we've really seen it pronounced in the past few days. So, why that's important, is because usually those type of value names are more tied into economic growth. And if the belief is that we are going to see strong growth going forward, then those names should run and start to outperform. So, we started to see that a little bit, and if that continues that would be a pretty good sign for the market.

However, on the fixed income side, 10-year treasury rates have remained somewhat range-bound. Between about 0.55% and 0.75%. Historically, you would, if the market was expecting strong growth going forward, you would tend to see rates moving up. With the concern about inflation through that growth. But, we haven't really seen that happen.

Now, some of that may be due to the fact that the fed has kind of distorted the bond market, with all of their intervention. But, one of the big themes that we've talked about is these kind of growing divergences. One between the economy, one between the market. Now you're kind of seeing one that's on the market and, the fixed income market.

And, you know, historically the fixed income market has been right more times than wrong. And what the fixed income market is saying right now is that, you know, growth going forward is not going to be robust. But again, the amount of set intervention, specifically in the bond market, may have caused that indicator to be a little bit skewed.

So, one interesting thing that we've also seen is most of the market moves over the past few weeks are taking place in the overnight sessions, the futures market. I think over the last 16 days, not counting today, there was almost 144 points that were added to the S and P 500 after market hours, while a loss of 18 points occurred during market hours.

Now, I think that's probably more of an interesting fact than anything else. And it all counts at the end of the day, but it's interesting to note how we're seeing a significant divergence of trading between when markets are open and when markets are closed.

Finally, you know, on the evaluation front, we still remain extremely stretched with, for price earnings multiples, close to 24.

Which again, is a level that we haven't seen since the kind of tech bubble in 2000. Basically what that is saying is you're, you know, you're willing to pay almost 24 times for $1 of earnings going forward. And in a market or an economy that seems like it is facing an extraordinary amount of risk still. It seems somewhat extraordinary that the investors are willing to pay those multiples. But nonetheless, there it is.

You know, you also have a market cap to GDP at close to 140%. Where historically that normal level has been anywhere between 80% and 100%. So, you know, if we're going just off of fundamentals there's still not a lot to like here.

Tomorrow we've got another round of initial claims, which are expected to be high. Again, though my expectation is you're going to start to see what I would call, some fun with numbers, headlines coming out. To give you an example, this didn't actually happen, you know, the numbers are just made up. But I think you're going to start to see things along these lines. Um, so let's say carnival cruise line, just to pick on them. Have made 2019 bookings of 1 million passengers. Again, these are just fictitious numbers, but the math will work out in the end. Then in April 2020, they had 25,000 total customers. So, a significant drop in business. Now in May, they have a total of 125,000. All right, so an improvement, but it's still a significant difference between the absolute value of last year and the absolute value this year. But what I think you're going to start to see is headlines that read “Carnival bookings exploded by 500%”. So, you read that and you see, wow, they're really doing things well, and they're really getting back to business. When you kind of dig down to it though, you see, alright, everything is not really back to where it was.

So, while growth and recovery is good, we still need to be getting back to the level of where we were last year in order to validate a lot of things that we're seeing right now. And it feels in some ways, like the market's getting a little bit ahead of that, but nonetheless, my expectation is you're going to start to see those headlines pop up. And it may in fact start with the initial claims tomorrow.

So, I want to switch gears a little bit and focus specifically on some of these vaccine updates. So, over the past two weeks, we've seen two new companies’ kind of in the news for what are termed promising drugs. And the two companies were Moderna and Novavax, I think is the correct pronunciation. So, what I will say is that the optimism around these announcements isn't surprising. It seems like every time one comes out, the market kind of shoots up, you know, 1%-2%. Everybody's really excited and thinking, okay, this is it, we're going to get a vaccine.

But at the same time, it's been kind of surprising. The lack of, kind of, people in the field who have come out, and I don't want to say set the record straight but been a little bit more realistic about the timeframe of some of these things. And so yesterday you had the merck CEO coming out. But the normal process to take a drug from what's phase one, which is the very beginning of a process, to phase three, which is the end. To get approval and then to finally get distribution, can take months to years. And the general success rate to complete the entire process, you know, across all drugs, not just vaccines, is around 10%

So, I think these announcements, you know, they're coming out of very small control groups. I think the Moderna one was a test at eight very healthy individuals, and they all had no symptoms. The Novavax one, they didn't have results yet. It was just, “hey, we're going to do a phase one trial.” But it feels like that there's a little bit of over optimism out there in that field.

The merck CEO came out yesterday publicly for the first time. And basically kind of walked us back and said, “Hey, you know, these vaccines are probably going to take anywhere from 12 to 18 months to create a safe and effective treatment”, because they're going to have to test on humans and in a significant group.

So, you know, what I would say there, is that I think there's a lot of optimism around a vaccine being created in the next few weeks or months. And then kind of piggybacking on that, and maybe some have even brought the idea that, you know, should we be investing in some of these companies. Trying to essentially hit a home run, so to speak. Well, I won't get into the Moderna details, but if you want to Google that specific company after the call and kind of read about that story from start to finish. I think it will give a very good kind of caution sign on how some of these things can run.

But the other thing is, let's say that we do have a drug developed, and everyone goes and rushes out to buy the stock. The company is going to be under tremendous pressure, from a public standpoint, to then deliver that vaccine on a global scale as cost-effective as possible. So, the idea that some of these companies are going to be able to just charge whatever they want for this drug, and then make a fortune I think is a little bit misguided.

So, you know, as we continue to see vaccine news popping up and having effective markets. I would just caution everybody to take a step back and maybe try to have some realistic expectations around not only how quickly that can truly happen, but also how it looks as an investment opportunity.

So, the last thing I wanted to touch on, and this is a question that we've been getting from a lot of clients and one that we've asked ourselves internally. What is the process for rerisking? Are we there yet? What does that look like?

So, as the market continues to move higher. I'm sure there's a lot of people out there that are kind of asking themselves like, what else do we need to see in order to start adding risk back into the portfolio? I think for us, the biggest challenge right now is trying to strike a balance between the extreme destruction that we've seen on the economic side, coupled with historically expensive valuations. And then marrying that, or looking at that, against the what I would say is kind of the positive of the technical side of things. At the same time, respecting both disciplines.

When we talk about market internals, and I've kind of used this term before. But you know, when we look at internals, it's not just the price of the index. It's other things underneath the surface that are showing the health of the advantage, or the health of the index. Similar to going to get a physical. You can walk into the door of the doctor's office and look completely healthy, but then they run a bunch of tests on you and say, wow, your cholesterol is sky high, or you have heart diseases, or there's something wrong that you wouldn't see unless you really kind of looked for it.

So those internals have slowly but surely been improving here over the past few weeks. And we've gotten to the point where we've seen participation from the cyclical sectors. We've seen participation from some of the small caps, and that has put us, the levels and a lot of these internals, either right up against the line or that have moved over the line. That would indicate, okay, the market is now healthy enough for us to kind of start to put risk back to work.

I think as the economy begins to open back up, you get the economic narrative that’s being portrayed, and is going to kind of take hold, so to speak. And that may continue to put a bid under the more economically sensitive stocks in a big way over these next few days. That's only going to further increase those breadth indicators that we had talked about.

So, where we stand right now is, if we can maintain these levels on a closing basis for a few days. One of the most important ones that we see now, is that the market approached it's 200 day moving average. Which yesterday, we popped above that briefly, but then we closed underneath it. Today, we traded a little bit below it. I mean, the number's right around 3,000, and then we get to this explosion above it. So, a close above that level is a good sign. If it can hold it for a day or two, that's a really good sign. And, you know, it would probably give us enough evidence at that point to say, okay, we can begin this process despite all of the problems that we're seeing on the fundamental side.

Now, what I will say to this is that, you know, we haven't changed our opinion at all on what the fundamental aspects look like going forward. We still think that there's tremendous challenges there and it puts us in a very awkward position here, trying to, again, balance these two things. But we want to make sure that we're not, you know, kind of putting ourselves in our own echo chamber and not considering the other side of the argument, so to speak.

The other thing I'd want to iterate is that if we do end up doing this, and it increasingly looking like that could be the case, it's going to be in a more measured way than you would normally see it. We've touched on this before where at the bottom of the cycle, you can be very aggressive in the way you re risk, both in the amount that that you use and the asset classes that you use.

I don't think that's the scenario here. We would have to do this in a much more calculated way, and we would have to do it, quite frankly, with very tight stops on the trade. Normally we don't want to try to trade in and out of things, but if we pull the trigger on this and it happens to be the day that the market begins to roll over again. We want to be ready and willing to go ahead and pull those positions back out. And, you know, move back to our original max defensive positioning.

So, with all that said though, we want to say that we're, we're not predicting necessarily that this whole thing is over. I think central banks have done a tremendous job convincing investors that they're simply not going to allow a significant sell off. You know, almost under any circumstances. The question is, can they do that indefinitely?

A lot of people have kind of looked at the system and said, well, you know, you guys have talked about the fed for a while, you kind of knew that they were going to have this response. We expected that they would have theis response, but I think this is one of those things where you hear about miracles being performed. But until you see them with your own eyes it's really hard to, I don’t know, I'd say accept the fact that this is actually possible.

And right now we're witnessing with our own eyes, the fact that they have put a tremendous amount of stimulus in the market. Not only the fed, but central banks around the world. And they've come with a very consistent message that if anything falters or slips here, that they're at the ready to come with even more ammunition than they've already come with.

Now what that will look like, Will it even happen? I don't know. But the fact that they've made that pledge, and for the most part followed through with it to some extent. I think has given maybe, I don't want to say a false sense of confidence, but the ability for a lot of people to be a little bit more aggressive than they normally would be.

So I mean there's certainly questions around that, will there be an eventual pushback of all the stimulus that we're seeing? You've got PPE loans that are set to run out in June, and then you've got unemployment benefits, they're set to run out in July. If we're still kind of in this dire situation, you know, 40 million people are still out of work, and Congress comes back and says, we need another $3 trillion. We need another $5 trillion. As we creep closer to election time, what will be the political will to continue to add money to the deficit in order to kind of keep this going. So that will be something that's interesting.

And then the last thing that I'll leave everybody with. Is if we get through this thing, this entire thing, in a three-month timeframe, and I'm not talking about the economic side of it. Because clearly that's going to take more than three months, more or less the market side. So you think, if we can go through a 35% decline and recover all of that in a three month timeframe in the face of some of the worst economic data that we've seen, ever. Certainly, since the great depression. I think we'll truly be entering an environment where the consideration of risk reward will have changed significantly.

And I think it's probably going to change the way that people think about how they manage portfolios, and that's us included. It's kind of unsettling to think about in an environment like that. Where you've kind of just got risk off the table because there's an entity kind of in the abyss that's just ready to jump out and save the day at a moment's notice.

But that's kind of the environment that we're in right now and kind of leaning towards. So, these are all things that we're thinking about right now that are probably more down the road, that they're not in the here and now. But I think that people should certainly be considering those things as we're going through this process. But from a technical standpoint, we have seen significant improvement. And if we can continue these trends and these updates, it will probably result in us adding incremental risk to portfolios, in a very  measured way.

Mike.

Mike: Alrighty, thank you, Doug.

Doug: Sure.

Mike: I'm going to take just a few minutes and mentioned two different planning topics. And then we did get some requests, as Maureen noted, to wrap it up a little early so people could watch the space launch.

Two things I wanted to remind everybody of is that anybody that has qualifying income should probably be planning on making an IRA contribution of some type. Remember that with the extension of filing tax returns from April to July, we got the same extension for making IRA contributions. So, you know, making the right decision there's a little planning involved in that, between taking a deductible traditional style IRA versus a Roth account. Sort of depending on where you are in life and where your future tax rates are likely going. And also, don't forget that if you make too much money to fund a Roth directly, but if you still can't do a deductible account, then you can fund it through a backdoor process, which we can help you with.

And also, don't forget that while there used to be age limits, now with Roth contributions, if you have qualifying income you can continue to make Roth IRA contributions. Really for the rest of your life. And that can be a very handy estate planning strategy as well as managing your own retirement income.

The second thing that I wanted to address is that we've had a handful of clients call who expected to receive stimulus checks but have not received them. Obviously, they're wondering what happened to their money. We did a little bit of digging to come up with what the likely culprits were. The treasury says that the biggest reason people don't get their money is that they don't deserve it. So, remember that there are income cutoffs, between about $99,000- $198,000, depending on your filing status and so forth.

If you have any questions about that, you can give us a call. We can help you work through and see if you should be getting a check. And assuming that you should be getting a check, the IRS says it's possible that you simply were scheduled for later in the year. When this all started, you know, we were sort of all led to believe that these checks would be out in days. The reality is the service scheduled this as a 20-week process. And the ones that are being prioritized at the beginning are people with lower income. So, if you have a higher income, you got moved to the back of the line. And obviously if you're a paper check, that's going to cause things to drag out as well.

Some banks are having trouble processing some of the direct deposits from the IRS. So if they get into a problem and don't know what to do with the money, the money gets returned to the service, which then creates a paper check being sent to your last known address. That would be the one that your tax return was mailed from over the last couple of years. Again, paper checks are going to slow things down.

If someone owes child support, the IRS will keep the stimulus money. If that happens, that individual would get a notice. If a child was claimed as a dependent on your tax return, but is not eligible for stimulus payments, apparently that bogs the system down. And finally, if you weren't required to file a tax return then they don't know where to send the money. And there's a form for you to file for that as well.

So that does it for today. What I wanted to do then of course obviously, is thank everybody for tuning in. Let you know that our next scheduled call is, we're moving the calls from Wednesdays to Thursdays, and our goal has been to ultimately put this on a monthly rotation and then keep it there forever. And have it just be a regular feature that we do.

So, since we're sort of in the middle of the news flow, our next call will either be Thursday, June 18th or 25th. We'll send a note out, a reminder, and let you know when that's going to be, the same time just Thursday afternoon instead of Wednesday.

And as always, if you have questions between calls feel free to give us a buzz. We'd be happy to do whatever we can to help out. That does it for today, everybody. Thank you very much. Bye. Bye.

 

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