Town Hall Recording 6-18-20
Transcript:
Maureen: Welcome and thank you for joining HCM’S call with Doug Johnson and Mike Hengehold. Today is June 18th, on this call Doug and Mike will discuss the recent market moves and positioning and give an assessment of the economic conditions as States continue to normalize activity. They will also give their thoughts on the possibility of a COVID second wave.
Your lines are muted. We ask that you please keep your lines muted and send your questions into our info email box at info@HCMwealthadvisors.com. We will address any questions that come in through our email as best as we can during this call. We're going to try to keep it to around 30 minutes.
With the topics today, it may run a little longer, but we will do our best to keep it at 30 minutes. I will now turn this call over to Mike and Doug, Mike.
Mike: Thanks Maureen. Welcome everybody, welcome to our call, it's been a couple of weeks. We're going to keep with the format we've had. I'm going to start with a quick positive focus, something I just saw recently in a retirement journal.
But some studies have come out recently showing that hobbies in retirement can prevent or significantly reduce the effects of depression in adults over 50. And when people leave work and go home, depression can be an issue. So, think about that if you know people who are really into something, they just seem happier. So, volunteer at your favorite charity, ride bikes, hike, play an instrument, roast coffee beans. Dig out some old hobbies that you used to enjoy years ago before kids and work got in the way. Who knows, you may find some new joy there.
So, getting down to the material for the call. What I'd like to do is start with something that's probably worthy of being part of our introduction in every meeting, in each one of these calls. And that's a restatement of HCM’S prime directive. Now I understand that people who are Star Trek fans that term, prime directive, may have some special meaning. But even if you don't know who captain Kirk is, don't worry. The term prime directive is pretty self-explanatory, and it means sort of that one thing that we pursue above all else. At HCM, our prime directive is helping clients design customized retirement income plans so that they can have sustainable withdraws throughout their lifetimes.
Now by definition, that is a long-term objective and it needs to be treated as such. And I think there's a lot of proof in the wisdom in our process if you think about the imponderables that are consuming shortsighted people today. These include things like, well, obviously that the COVID pandemic, the shuttered economy, who's going to win the election and, you know, how that's going to affect people's pocketbooks. How will social unrest change things, did the oil price collapse that happened a little over a month ago, and how the federal reserve and other global banks are going to respond, and what's that going to mean to everybody?
The reality is when you think about it, we have no control over these things, but these worries consume people, they consume the news flow, and we simply can't predict their outcomes or their consequences. So, we're probably best off to recognize this and move on. But this is the important part that I want to make, I'm sort of setting the stage to make this point, because I want it to go home. So, I'm going to take a brief dramatic pause for emphasis here.
It's important to realize that at HCM we planned for these things five years ago. We just didn't know what we were planning for at the time, but we wanted to be prepared if something happened. And if nothing did happen, then our plans, the reserves that we had in place, things of that nature, would stay there to offer protection when something finally did happen.
So, that's why at HCM, we have safety nets, we have bond ladders, and all these things have five-year terms associated with them, so that our plans span these types of events. So right now, in the conversation it sort of seems like we're planning for today, but we're not that's shortsighted. Right now we're planning for five years from now. This includes the portfolio planning that we're doing, the adjustments we're making. And during the next five years or so, the consequences of everything that's happening today regarding the pandemic, the economy, all the federal reserve action. All that's going to become clear over time and we'll be able to adapt to that through our monitoring process.
And I guess the moral of this story is that those who are trying to react to today's imponderable events, in order to support them today, have waited way too long to prepare. And that's why in the processes that we follow at HCM, we're looking forward. And that's why we have that prime directive now.
With that out of the way, one of the things we've been teaching clients for more than 30 years is that there are essentially three key variables in a well-designed retirement plan. And all of the details from the plan so that there can be a myriad of details, but they all flow from these three main things. They're essentially risk, amount, and time.
So, the first two of those are risk and amount, and those are variables that we have a fair amount of control over. The final one, time, we do have some control over but less so. I just want to address these just briefly and how they fit into the plan. And then we'll get into the meat of the markets and so forth.
So, risk refers essentially to the various potential risks that would have financial implications for people during their retirement years. As we're putting together a retirement income plan and they range from things like health risks, which obviously everybody has some concern about. Risks around family matters, so if people in the family are going to need financial assistance. And of course there's concerns with regard to risks in the market, portfolio risk and so forth. In my experience though, the issues related to health risks, and potential support for children or parents. These are the ones that are most likely to create financial problems because the ones come out of the investment portfolios and so forth are fairly easy to deal with from a planning perspective, because they tend to be cyclical. These other issues tend to come on and people, I guess I would say it's interesting to me that many people tend to worry a lot about the things that are easily managed, like the short term volatility in the portfolios. And pay very little attention to the real threats to their financial independence, which again, come primarily from health and family issues.
I'm not suggesting these things don't matter, because they do, meaning the market issues. But again, they can be managed pretty easily. It's much harder when you're dealing with those bigger issues, again, family and so forth.
When we're talking about amounts, and that risk amount and time component, we're talking about the amount that people save or spend. That's very easy to adjust in the planning process. When we talk about time, you know, the timeline begins the day you're born and ends the day you die. So, there's a certain amount of inflexibility because we certainly don't know the end point of the plan. There is a lot of control people have, it's just not the same level as with the other variables. Certainly, we can eat our vegetables, exercise, we can choose when we retire. Those are all things that have a bearing on the planning.
So when it's all said and done, the objective of the prime directive, is to make sure when we consider those three big variables and all the details that spill out of them, is to make sure that we're maintaining a plan that have the odds of a successful retirement income very high.
I think that’s really what I wanted to cover there. So, I think Doug now has a little bit to touch base on regarding the markets and so forth. So, Doug.
Doug: Sure, so it's been a few weeks since our last call, but the markets have kind of continued to defy logic in the eyes of some and move higher.
So, you know, off the heels of a period of 12 days where we had 10 updated out of 12 days. And of those two down days, I think it was a 12-basis point and a 25-basis point move down respectively. So, a very aggressive move to the upside, which kind of put the market in an extremely overbought condition.
Last week on Thursday, you saw a very volatile down day, which basically eliminated a lot of that overbought condition. We saw the major index is down anywhere from 5.5% - 7%. There was a few headlines surrounding what caused that, one the increase in COVID cases that we've seen raising the possibility of a second wave and we'll touch on that in a little bit.
But there was also some concern around the question and answer portion of the feds press conference, more specifically, some pretty direct questions to chair Powell regarding, you know, is the fed concerned about asset levels and, what are they doing to kind of respond to the idea that they're creating an environment that's fostering some level of economic inequality. Powell kind of danced around the question, didn't really answer it, but then the following day you saw a pretty big sell off. But sure enough, three days later, you had a market that rallied about 5% - 6%. And over the past few days we've seen things settled down quite a bit.
The theme that we've touched on several times during these calls remains in play. And I think maybe more than ever, which is kind of a noticeable diversion between the state of the market and the state of the economy. So, this morning, Jeremy Grantham, who was a legend in the value investing field, had a quote on CNBC and I'm going to read it word for word, because I think it kind of encapsulates this pretty well.
So, he said “It is a rally without precedent, the fastest in this time ever. And the only one in history that takes place against the backdrop of undeniable economic problems.” To highlight this, you've got the P ratio of the U S market in the top 10% of history in terms of being overvalued, while you have the U S economy in the worst 10%, or even perhaps the worst 1%, conditions that we've seen.
So, I think a lot of people are scratching their head and saying, what continues to drive this? And we think it's pretty straight forward. You know, the central bank's willingness to provide liquidity almost every turn. And it's not just the fed it's the ECB, it's the bank of Japan, the bank of England. The additions of purchase programs for almost the entire capital structure outside of equities. It's really emboldened investors to believe that risk in the market has kind of been eliminated.
You're getting a lot of comparisons to the 2000 tech bubble. Look no further than a story out of a Hertz rental car company. So not to go into too much detail on this, but Hertz filed for chapter 11 bankruptcy several weeks ago. Which basically means that they've met, they've divvied up and decided what what's going where, and essentially the equity remaining is worth nothing. It's still trading as a ticker and you know, if you bought it for $1 and sold it for $3, great, you can still make money. But when this all stops, it will be worth absolutely nothing. So, there've been kind of a retail day trading euphoria surrounding this particular ticker and people started to take notice of it, particularly some wall street bank.
They attempted to do the first bankruptcy equity raise in the history of the market. To try to literally lore unsuspecting investors to buy a worthless asset, to then pass on to their creditors. Essentially the SEC stepped in and said, this is predatory we can't let this happen. But the fact that it was even floated as an idea, and almost went through, kind of shows you the level of fraud that we're seeing in some parts of the market.
So, I don't know the history will be kind on what the fed is doing five to 10 years down the road, and I think it's up for debate. Many are concerned that they're creating kind of an asset bubble of massive proportions, but for now they've reiterated their commitment to continue and inject themselves into the market discussion.
So, where does that leave us? One of the things that many have been surprised by is the willingness for them to create this type of market environment. Seemingly one where the definition of the market, that's in the chairman's words, ‘properly functioning’, is one that goes up and vice versa.
So, this backstop that’s been created both in a sense, physical and some psychological, has moved this rally past critical levels from a technical standpoint. You have market internals right now that would tell you that the health of the rally is one that has a higher probability of being sustainable going forward regardless of what the economy is saying.
So, when we look at these two scenarios there's still a number of things that can provide headwinds going forward. You know, things that Mike alluded to second wave, social unrest, political uncertainty, disappoint economic news, China relations election, etc. But right now, in this new normal, in a backwards type of way, bad news can actually be good news. If it means the fed is going to be more aggressive in their policies for longer. And I know that sounds very odd and unusual, but this is the market environment we're currently in.
So, taking all of that into consideration, we've taken another step to adding back some risk to portfolios. Moving approximately 5% from the defensive side to the equity side. This remains in line with our stated goal of getting portfolios back to client’s target equity allocation, but we're still trying to do this in a measured way. We ultimately believe this approach remains appropriate based on the data we have right now. But we also know that there are strong cases to be made on both sides of the equation. So, the situation remains extremely fluid. We're dealing with this kind of on a day by day basis.
So, Mike, you mentioned earlier that the rise in this kind of COVID second wave, so to speak. Can you go on and talk a little bit about what you're seeing there, if you're concerned or how that might affect things going forward?
Mike: Yeah well, I do have one question for you though. When you talk about sort of bringing portfolios back to their neutral targets, we've taken a couple of steps there. What might the future, I realize it hinges a little bit on how things unfold, but what might that look like if we stay on the path, we're on?
Doug: Sure. So, I think it would look similar to what you would see in maybe a dollar cost averaging situation. Where you're going at time intervals to add additional risk to the portfolio. Now, if we saw some kind of significant downside flush that we thought was maybe a little bit overdone, we might accelerate that process.
Or if things really start to run away and get overbought again, we might take a step back and say, okay, we're going to sit tight on this. Or even maybe rebalance portfolios to their current models. So you know, that I think is the best way to think about this right now.
Mike: Okay. Thank you.
So, getting back to question of where we stand with the COVID-19 situation. We have seen infection rates spike. Obviously, this has been in the news and no secret to anybody. Most notably in some of the Southern States, we've seen it in Texas, Florida, Arizona. Some of the state officials there are starting to rethink their opening strategies.
Probably the biggest news recently has been in Beijing, China. They're experiencing a new surge and they've taken some pretty draconian steps sort of back into where we were a couple of months ago to help suppress the outbreak. They're closing schools, canceling airline flights, doing lockdowns in particular areas.
So, the question I think that we all think about when we see this is how will this be treated here? If we see another more broad resurgence. And the attitude around the virus seems to change somewhat. Now that we have more data, and the medical community has a better idea on how to handle COVID cases. The fatality rate seems to be much lower than was originally feared. And government officials are saying that they would be reluctant to go into another shutdown situation, even if new cases exploded. However the reality is if we did have that surge in new cases, I suspect that people would sort of take it into their own hands and sort of quickly revert back into a quarantine type mentality on their own if things got particularly bad.
If that happened of course, it could certainly, or would certainly put a dent in the trajectory of the economic recovery, and potentially put another ripple in the markets. This is one of those risks that we plan for when we keep these sorts of protective measures always in place in the back of the portfolios.
If that does happen though, we would likely see more stimulus. So, we sort of have a roadmap now. If you think back to the 2008 - 2009 crisis, we saw what the government did in terms of stimulus. And most recently, obviously, we saw them step up to the plate. I suspect that we would see that again with additional stimulus. There's certainly already political discussion about around four, and that would probably be accelerated.
As Doug was alluding to before in a perverse way, that could actually be good for the markets over the short run. And I think we have no doubt from market history that there's going to be a price to be paid for all of this stimulus money that has gone into the markets.
However, that may have to wait until the economy needs to stand on its own. Because these central banks around the world regularly declare themselves as being ready, willing, and able to keep up the infusion of this stimulus money, as long as these threats exist, as a result of the covert crisis.
So, while there is likely, they have reckoning, it may well be reasonably far out into the future. Speaking, Doug, did you have something about reopening you wanted to mention?
Doug: Sure.
So, you know, as we see States continue to open back up and attempt to get back to normal, I think one of the things that's going to come out of this, assuming that we don't get a massive second wave that shuts everything back down. Is you're going to continue to see what I call ‘fun with numbers’ headlines.
So, what these are is, they're going to be headlines that will tout these massive percentage gains, probably records. And they're going to get extrapolated to “confirm” that a V shape recovery is underway. Percentages are pretty easy to increase when they start from zero, and that's what we're seeing with a lot of these month over month numbers. I think if we're being honest, the absolute levels of these numbers remained significantly depressed across the board.
Look no further than the initial claims. We're almost three months into this crisis and we're still seeing 1.5 million people filing initial unemployment claims. To put that in perspective, adding all of the claims data that we've seen over the past three months that comes to, I believe, close to 45 million people total. The average weekly peak that you see during a recession is 500,000 - 600,000.
So, we're really nowhere near the recovery, I think, in the employment figure that a lot are hoping for. The Q2 numbers are expected to be historically bad across the board with earnings and GDP. I think that at this point is already being expected, so, I don't think that'll be a shock to anybody. But, you know, I guess with that said, there are some encouraging signs that things are moving in the right direction. But from our perspective, we still believe this is going to take much longer than people think.
And so far, this has all kind of been overridden by the fiscal and monetary stimulus programs that we've seen. But the question really is, is there going to come a point where the weight of the recessionary economy finally becomes too much for the fed to essentially hold over its head?
This continues to be a concern for us as we go into the summer months. And we see that the PPP loans and extended unemployment benefits set to expire. And I know throughout the market many strategists are concerned about this and have kind of dug their heels in almost in disbelief saying that this can't continue indefinitely. But there's a famous saying that's, ‘don't fight the fed’, and certainly a lot of people have attempted to do that unsuccessfully over the past few months.
So, we're certainly seeing signs of things improving. But I think from a perspective that we're going to see a V shaped recovery in the economy, I’m still of the belief that that's not going to happen, even though we've essentially seen a V shape recovery in the market.
Mike: Okay. So, I think that probably does it for our sort of formal outline. Just a reminder of my initial point, that the planning for now was done several years ago. The planning that we're doing now is for several years from now. And I think that that really fits into the sort of the long-term nature of how we approach this process.
I think though Doug, did you have some questions that came in?
Doug: Yeah. So, one that I saw, which I think is a good one. We're hearing a lot about both, deflation and inflation, kind of what the effects of those would be on market conditions.
I think that we've kind of been in a deflationary environment for a while. Deflation usually comes in the form of excess debt that's unproductive. It kind of puts a boulder around your neck, so to speak, and prevents you from kind of growing your business. And I think as the fed is trying to continue to lower rates, they're doing their best to fight those deflationary forces.
The one that I think is picking up more steam, is the inflation side because you've got the fed basically printing money out of thin air and putting it into the system. But I think the one thing to consider in all this is, if we see any kind of significant unexpected inflation. That's probably the one thing that could really put a damper on what the central banks are trying to do. Because it would essentially cap their ability to create liquidity at such a massive rate. Because if they continue to do that, they would run the risk of hyperinflation, the dollar falling, and that's not a scenario that they would want to see. It would almost be, you know, put them in a bind to where they may have to actually raise rates, instead of continuing to cut them.
And what we've seen is in an environment where the market seemingly depends on these constant temporary emergency measures. A regime of rate rises and tightening financial conditions, would not be conducive to further growth in the equity market.
So, we're not seeing those numbers yet, but it's certainly something to keep in the back of your mind.
Mike: Do you have another, was that it?
Doug: It looks like that's it for now.
Mike: Alrighty folks, just to follow up on what Doug is saying. The notion of the fed giving, is really what seems to be behind. That's sort of the additional variable that's overwhelming the economic difficulties that we're seeing in sort of the real world economy.
Rising interest rates, if they were doing it intentionally, would be one of the ways that they would begin to take back some of this stimulus. The concern would be that if the market delivers that same force, it could have the same essential consequences. And that would probably not be a good thing.
In the meantime, our next call right now is planned for, Thursday, July 16th. Obviously if news breaks, we will be reaching out to you and scheduling a call sooner. In that interim if things stay on course, Doug is it fair to say that we'll likely making another incremental increase to move the portfolios back to neutral?
Doug: Yeah, I would say that. So far that's the plan, right?
Mike: Yeah, so that would be the plan. So as always, if you have any questions between calls, or need any help. Or if there's anybody that you know or care about the could use a hand, let us know we will do whatever we can, otherwise that does it for today. Thanks everybody. Goodbye.