Maureen: All right, welcome and thank you for joining HCM’S call with Doug Johnson and Mike Hengehold. This is Maureen Everhart. Today is April 29th. Doug and Mike will discuss the market updates and see if there's time for optimism yet. They will also share their thoughts on the states reopening plans, and of course will address client questions that have come in.
Your lines are muted, and we ask that you please keep your lines muted. If you accidentally unmute it, you just need hit *6 to get it muted again. If you have questions, send them into our email box at firstname.lastname@example.org. And we will do our best to keep this call around 30 minutes. With that, I turn this over to Mike and Doug.
Mike: Sounds good. Hello everybody, the first thing I'd like to do as we have in the past is start with a positive focus and positive things that have happened over the last two weeks, I guess, since our last call. Today there was news on the virus front that was good. Gilead, which is a biopharmaceutical company, announced that it has a drug that's showing promise as an antiviral. It's interesting because last week the world health organization put out some disappointing news on this exact same drug, and today they're announcing that it has potential. So that's exciting; it's progress. It's certainly not a magic pill.
In fact, it's not a pill at all. It still requires someone to go into the hospital for intravenous treatment, and they have to be on the medicine for about a week. And it's important to realize it's still in test, it's not something that's come through. But, the market liked this news a lot, so that's progress.
Second, and probably the biggest news of the last two weeks, is that the Bengals took Joe Burrow in the NFL draft. So, Cincinnati is going to the Super Bowl, we can count on that.
Over the course of the last couple of weeks, a number of States have begun the process of reopening to some level of commerce. While this is going to be a gradual process, it is progress. And that's what's important, that we're moving forward and in this endeavor. But things are going to be different, as Mike DeWine, the governor of Ohio, said during his reopening announcements. To sort of summarize it, no mask, no work, no service, no exceptions. So, we're all going to have a different set of behaviors in how we work, how we educate, how we commute, how we entertain. All those things are going to be changes, but we are moving in the right direction.
And finally, as it relates to the investment markets. The markets have shown some life recently. Using the Dow Jones as a proxy, while it's still down roughly 5,000 points from its mid-February highs, it has made up a tad more than half of those losses. That's encouraging because, not the point change so much, we're not too focused on that. But because when those sorts of things are happening, they’re number of internal indicators within the market that are improving. And those are the things that we follow, in implementing a number of our tactical decisions. And so, they are beginning to improve.
Assuming that continues, that means we're getting closer to increasing our equity exposure. And of course, if those trends break, then we'll be holding our current levels for a while longer. So that's my positive spin on things to start. And as I said last time, my job is to deliver the good news.
I bring Doug along for everything else. So, Doug is HCM’S director of portfolio management. And what I'd like to do now is introduce Doug and allow him to make some initial comments. Doug?
Doug: Okay, great. So yeah, it's been two weeks since we held the last call. So we certainly have a lot of information that we can touch on. So I think kind of the three things that I want to focus on today, and one of the highlights of the call would be, you know, are we seeing signs of optimism? And then I want to touch a little bit on the emotional aspect of bear and bull markets. Because I think we're starting to see some of those emotions really come to the front. And then finally, kind of where do we stand? Mike touched on it a little bit. I wanted to go into slightly more detail on kind of where we are right now, and what the plans might be for portfolios going forward.
So, in terms of the signs of optimism. As Mike mentioned, States are beginning to open back up. Which is a good sign. We saw Georgia, being the first this week, and then you've got several States, including Ohio, going to open up next week. It is going to be with some significant restrictions.
I don't need to go into the details of that. But, at the same time, when we're talking about what we want to see, in terms of feeling better about what's going on, one of those, obviously is economic improvement. And the only way you're going to get economic improvement is if you in fact, open the economy back up. So what we're seeing in that respect, is a good start. Mike also mentioned that this morning we saw the announcement of the Gilead drug. I can't pronounce his name, so I'm not even going to try. We just, affectionately call it now, the Gilead drug.
But it's been in the news now twice, as a possible treatment. I think it's important to remember it's not a vaccine and it's not something you'll just be able to kind of, you know, take as a pill and be immune to the virus. But it is an effective or is believed to be an effective treatment.
And why that would be important is because if the normal treatment would take 10 days to discharge somebody from the hospital, and we can cut it down to five, it allows hospitals to clear out more quickly, beds to not be at maximum capacity. So, you know, good signs on that front.
And then lastly, we've seen market internals continue to improve a little bit. Percentage of stocks above their 50-day moving average continues to climb. And that's just kind of one example, of seeing a little bit broader participation. Up to, you know, last week, it was why the rally was being carried by the big five stocks, your Google, Microsoft, Apple, Amazon, and Facebook.
But now we're starting to see some small cap participation, some sectors of the market that had been kind of lagging. So, all that is pointing to small signs of optimism, in an environment that's had a lot of pessimism quite frankly.
So moving on, emotions of a bear market or a bull market. So we're seeing a lot of articles that have come out right now that when I read them, and these are in major publications too, your Bloombergs, your MarketWatches. These aren’t, you know, fringe kind of conspiracy theory websites. These are, you know, these are major publications.
I'm reading articles and I'm seeing headlines that as I read them, my jaw almost drops because I'm thinking, could these types of articles be written, with a straight face, in an environment where we don't see stocks ripping up, the way they have. For example, the one that I saw in MarketWatch the other day, and I may butcher the title a little bit, but it said something like, ‘why it's not abnormal to have the stock market go up when 26 million people have lost their job.’ And at first I'm thinking, okay, this is going to be a satire piece, but it was a very, very serious kind of deconstruction on how this could be possible. And as I'm reading through it, I'm reminding myself that, you know, a lot of times in these extreme market conditions you get an emotion of rationalization. Where we start to allow the market movements that we've seen to kind of drive our narratives, so to speak. So, you've heard us lament several times about the economy, how things are struggling, how demand destruction, all the unemployment.
The GDP print this morning was, you know, negative 4.8. Which nobody seemed to care about because of the Gilead announcement was right on top of it. But the economic situation in this case has not necessarily gotten a whole lot better right now. But the market has continued to grind higher almost in the face of that, largely on the back of a lot of the Fed policy that we've seen. But you're starting to see this, we call it FOMO, this fear of missing out, where people almost feel like they have to jump back in the market because it's going up, and they're going to miss something. Or you start to see articles that talk about how, evaluations don't matter, earnings don't matter. Or we're in some kind of new environment where everything that you've believed no longer exists, because the market dictates that it doesn't.
Now, in 2000 you had the tech bubble and earnings don't matter, you know, eventually they did. In 2007 you had real estate prices never go down, eventually they did. Now I think you're getting a combination of a lot of different things. One of them is something we've touched on several times being, you know, the idea that the Fed is going to be able to do anything and everything that they can to prevent a catastrophe.
Ironically, at the Fed meeting today, they used some extremely dire language. Talking about how the economic backdrop is as bad as they've seen it, at the same time, they did nothing but reassure investors that they're going to do everything that they possibly can to make sure that asset prices remain, you know, at elevated levels regardless of the optics. There's even one point that the chairman, Powell, made the comment that now's not the time to be concerned about the debt. Which some have seen as somewhat tone deaf, but now you're starting to see the, you know, the rationalizations of very unusual things. That in normal market conditions would never fly, are starting to become mainstream thoughts. So, from our perspective, it's a little concerning to see that. Usually when things like this happen, they play out over longer timeframes. And the fact that this has been condensed, both down and up, over a 70-day period is only going to make those emotions a little bit more extreme. So, part of the battle that we're facing right now is looking at all of these things and trying not to let those emotions, because, you know, even as advisors we feel those as well. But trying not to let those kind of cloud our judgment, and make us lose sight of the things that we're trying to pay attention to.
And then lastly, you know, where do we stand right now? So, our main concern is, and remains, the fallout from what is quite frankly, a severe economic destruction. I think the GDP print confirmed that today, considering that this was a first quarter print and you really only had about two weeks of pure quarantine conditions in the United States. You still had a negative 5% print. So, what's going to happen next quarter? We've already had a month; I think that'll be something that people are paying attention to.
But, you know, even in that, we still have this similar reluctancy to have a conviction in the idea that the economy is just going to bounce back and go right back to normal. Even with Ohio businesses opening up, the restrictions on that are going to make that almost impossible.
And the real concern is that we feel like the market has a level of optimism right now that is, maybe a little bit too high, and prices are reflecting that. But at the same time, we also have to be respectful of what's going on with those prices. As I mentioned before, we're starting to see the internals of the market improve, in some cases significantly.
So, when we see something like that, we have to be considerate and respectful and say, okay, based on where this is, if it gets to the point where we feel that the market health is back to good levels. You know, we may, and we've discussed, making the decision to possibly re risk portfolios a little bit.
Now what I will say is, it will look a lot different than it would if we had gone through a complete recessionary cycle that has kind of a wash out, and a prolonged period of default. Not to say that can't still happen. But in those environments, you're looking to add more risky asset classes, your high yield bonds, your small cap equities. Things that now present a better risk and return profile coming from the bottom of a cycle. Whereas where we are right now, you can look at several different valuation perspectives and make the arguments that the market is actually more expensive today than it was at the highs in February of this year. So how you handle that, from a buying perspective, I think we would probably take a little bit more cautious approach, and possibly scale in. As opposed to being super aggressive with the way that we do it. But our investment committee has begun that discussion and we're certainly keeping an eye on that as things continue to move forward. We have earnings continuing to come out this week, so that'll give us a little bit better picture of the health and the guidance of corporations. And I think once we can get a little bit more clarity around that it'll give us more information to make that decision.
So, we just want our clients to be aware that, you know, even though we've been very pessimistic, some of you have suggested a doom and gloom approach to it, which I don't necessarily disagree with., we're not burying our head in the sand and completely ignoring everything from a positive perspective.
So, Mike, I'll go ahead and stop there and let you comment.
Mike: Okay. I do have one point that I wanted to make and then we'll get into the questions that have come in. Keeping an eye on the clock, we'll go as far as we can. And as usual, if we don't get to your question, your advisor will reach back out to you with an answer, or Doug or I'll reach out to you.
The point I wanted to make has to do with investment policy statements. So, I just really wanted to take a minute and remind everybody that your investment policy statement is a very important piece of your overall wealth plans design. The policy statement is something that you worked with your advisor on in establishing the relationship with HCM.
And that policy statement directs us, with regard to the implementation of your portfolio plan. It formally tells us how you want your portfolio’s risk budget allocated. And how you want that allocation implemented as part of your portfolio planning process. So, whether you want the tactical adjustments, a lot of these conversations that we're having on these calls involve the tactical portfolios because that's where the adjustments are being made. A lot of clients choose that path. Others choose a strategic path that involves strategic rebalancing that is always resetting the portfolio back to its designated risk budget. During good markets, bad markets, and so forth. So, those things are all important and they're driven by that policy statement.
This issue surfaces, for example, when somebody calls us back. We have a question that kind of goes to this, I don't want to get too far ahead of it. But nevertheless, a couple of weeks people have called and said, you know, sell everything I want to go to cash. Well that's completely outside of what we think would be appropriate, and that would cause sort of a whole rethinking of their risk budget.
But in any event, it may make sense to revisit that investment policy statement with your advisor if all this uncertainty is something that makes you uncomfortable. What I wanted to do next then was get into the questions. I'll give this first one to Doug.
Doug, this individual has a family member who's going to be getting married in the fall and is looking to purchase a home. And the question is, giving the COVID-19 economic uproar, I'm telling this person to wait until the dust settles before signing up for a mortgage. With rates low and so forth, do you anticipate existing house prices going up or going down? What will be the true impact of the shutdown as it reveals itself? Will all of the liquidity offered by the Fed impact buying and selling of homes? Will people have to sell?
So, you get the gist, do you have any thoughts about that?
Doug: Yeah, so, lots to unpack there, I'll try to keep this answer brief. So, I mean, assuming they're not a cash buyer, meaning they're going to pay a hundred percent cash and they're going to get a mortgage, it seems like, you know, based on the federal reserve's comments today, that rates are not going up. And they're not going up anytime soon. Now, the federal reserve only controls the shortest of rates. And the mortgage market is more tied to longer term treasury rates. So, you know, 10-year treasury rates, I think right now is around 60 basis points or 0.6%.
So, with the concern around mortgage interest rates going up, I don't think that's a concern. On the other side, you would assume that with 30 million people or, send 30 million people after tomorrow morning, out of work. Some people aren’t going to be able to afford to pay their mortgage. Now there's been a lot of announcements around, you know, payment forgiveness and such. But it's hard to envision an environment that you're not going to see people have to liquidate homes just because they can't afford them. I mean, usually in a recession, you see real estate prices dip a little bit. So, from that perspective, you know, in a normal recession, I would assume that the real estate prices would go down. But with so much intervention from the federal reserve, it's really hard to say.
So, the one thought I'll leave you with is this. I think over the past 50 years, people have lost sight of what a house is. And it's gone from a vehicle to where you live sometimes, but it's also an investment you're more worried about if it's going to depreciate in value.
So, my advice would be if you find a house that you love, or your daughter or your son finds one that they love. It's the perfect house for them. They can get cheap financing for it, and it's affordable. I would not play games with that and I would go ahead and buy it. That's going to be my thought for that.
Mike: Okay. Thank you very much.
Mike: Next question.
I am worried that the market still has another big drop coming. You seem to be worried about that too. Why did you only sell some of my stocks? Why don't you sell everything and make me as safe as possible?
So, I'm going to try and tackle this one because the answer is as much planning as it is market. And I guess a couple of things come to mind.
First, I want to be crystal clear, maybe doubly crystal clear and then triply crystal clear. We do not see a big drop coming. We don't believe that we, and we don't think anybody else can see the future, so that has nothing to do with what we're up to here and the comments that we're making. Although I guess it sounds like that from the outside. There are a lot of forces that impact what are going to happen tomorrow and that aren't known to us at this moment.
And we fully acknowledge that. However, what we do attempt to do is manage portfolio risk for our retirement planning clients, when the markets don't seem to make sense for valuation or other reasons. So, this risk management activity, if you want to think of it another way, is just like buying fire insurance on your house.
When you buy fire insurance, you don't go home and pray that the house burns down so you can collect the insurance. However, the insurance makes a lot of sense to protect you from risks that you can't afford to take. And so, that's really what this process is about. It is a risk management process.
So, what is the fire, or the risk, that we're buying insurance to protect you from? Well, when we're managing the portfolios, the risk that we're trying to protect ourselves from is a thing called sequence of returns risk. You can Google that if you like. I'm not going to go into the whole discussion now. But, suffice it to say, that this is like compounding that runs backwards when the market goes down. And it's the retirees, and for that matter, the pre-retirees, worst financial enemy, it can eat into your financial independence quickly.
And if the market declines, get out of hand, it can do a lot of damage. So, we always have some level of protection in place in the portfolios. Because since we don't predict the future, you know, crazy things can happen at any time. And we size those to fit where we are in the business cycle. And that would include our HCM safety net and the bond ladders, you're very familiar with those things.
But we use the tactical adjustments in the portfolios, the things that we're talking about now, that sort of overweight, underweight, exposure. We use those tactical adjustments to beef up the safety nets and the bond ladders. When the uncertain risk periods come around and when they're extremely opaque.
And those would be times like now. It would be like being able to buy extra fire insurance on your house if you saw brush fire in your neighborhood. We can't do that, but we can with the portfolios and so essentially that's what we're doing. It's also very important to remember, I think that the portfolio plan, which goes back to that investment policy statement comments I was making a minute ago.
The portfolio plan is just part of your overall wealth design plan. And it includes things like your income tax and legacy planning, cashflow protection, risk management, and so on. And all those things are interrelated on our end. And that's really important to understand that they're all interrelated and how they support your long term financial independence planning.
So when we reduce the risk in our advance and defend portfolios, the tactical portfolios, we'd limit those equity reductions to a level that will keep you within the conservative end of your sustainable withdraw asset allocation as it's laid out in your wealth plan. The wealth design plan that's been put together with your advisor.
That way your future retirement income remains intact. I think that's the most critical piece to get here, is that we're managing the portfolio as part of your overall wealth plan to protect your retirement security. And there are limits on how far we will go in reducing equity exposure. Just like there are limits on how far we would go in increasing it. And all that's relative to the investment policy statement, but the process is consistent throughout.
So, I think that does it for that question. So, here's another one. Doug, this is probably appropriate for you.
Hello, Mike and Doug. On a previous call you spoke of demand destruction. It seems to me that there are many nuances to this. Some demand has in fact been destroyed and that it will never come back. Whereas some demand has been delayed, meaning it will come back partially or fully within time. So, I also think it will take years before we have empirical data to know the real impact. Do you agree? And most importantly, what are the implications for investing.
Doug: So, yeah, I think there's been a significant amount of demand destruction. I think it's obvious to say that, you know, when the government mandates that economies basically needed to shut down and you're going to see that. The issue going forward will be, how quickly can the threat of the virus be completely eradicated?
Because, you know, I've seen several kinds of polls that have asked people, in various levels of safety so to speak, would you go to a stadium and watch a live sporting event? And the answers basically came down to only 25% of the respondents said that they would do that regardless of whether or not there was a vaccine or a treatment. Where all the other questions were, maybe if we had a vaccine, some even said, no, I'll never go again.
So I think until we can get some clarity on what the path forward is going to be, you know, around social distancing, around the virus, around any treatments. I don't think it's possible to have demand come back to levels that we saw, you know, at a hundred percent before.
The other thing is, quite frankly, you can still have recessionary conditions, with a large part of the economy still intact. It's simply a supply and demand issue. Most recessions take place because there's an oversupply of something, and then there's not enough demand to meet it.
In this case, it may be a little bit different. But, you know, I think it could take a long time to see things kind of returned to a new normal. Now, how does that relate to investing? You know, again, normally you would see a recessionary period. You would see, you know, companies pulling guidance, and it would have a material effect on what investors are willing to pay for that going forward.
But I think from a psychological standpoint, the Fed has gone a long way to changing that perception. And this may be a little bit extreme, but I think it's getting to that point - just that the data doesn't matter because the central banks will do anything and everything that they can to prop up what they can.
I mean, they can't necessarily prop up the economy, but they can do their best to prop the market up until this goes back to normal and everything's okay. It's an interesting way to look at things. I think it's somewhat dangerous. You've heard the market's a forward-looking vehicle, but you know, at what point are we now saying that the market is looking forward to 2025.
And if that's the case, then it should really never go down because it's only going to see positive things that far out in the future. So I think it is going to affect investing. I think it's going to affect the way that you have to kind of set portfolio analysis up and the way you make decisions.
And I think that we're not quite sure a hundred percent how that's going to look, but we're starting to get a little bit of an idea. And it's certainly going to be a little bit different than it used to be.
Mike: Okay. Well, looking at the clock, I think we're about done. So, I want to thank everybody for participating in our call. And as I do each week, I want to say thanks to those who put themselves at elevated risks so that the rest of us can all enjoy a semi normal life during this quarantine. That obviously includes those working in grocery stores, healthcare workers, first responders.
Even those working in carry out restaurants are meeting a lot of different people all day long. So, our thanks go out to all of them. Our next call is scheduled two weeks from today, Wednesday May 13th. Of course, if news breaks in the interim, we will communicate with you to schedule a quick call or we'll send you a video or emails or something.
So we're not going dark, but in terms of marking something on your calendar, Wednesday May 13th. And as always, if you have any questions between calls or need any help, if there's somebody that you care about who could use a hand, let us know. We'll do whatever we can. As we've been saying all along no strings, we want to help those we can. And that does it for today.
Thanks everybody. Goodbye.