Quarterly Reflections - October 2020

The struggle of life is one of our greatest blessings. It makes us patient, sensitive, and Godlike. It teaches us that although the world is full of suffering, it is also full of the overcoming of it. ~ Helen Keller, author, activist, lecturer (1880 – 1968)

On the economy

For now the U.S. recession is behind us, per recent comments by St. Louis Fed President James Bullard. After Gross Domestic Product dropped by 9% in the 2nd quarter, the 3rd quarter GDP will show a steep rise resulting from pent-up demand spending amidst the reopening of America. Technically that does mean we are growing again, if far from an annualized 2% pace. The U.S. and world are entering a period that economist David Rosenberg is calling “growth down”, during which we will move forward with more frugality, a life with less, necessitated by the health crisis.

The employment landscape here remains very messy. Corporations from various industries continue to announce layoffs in the thousands, such as Disney, Regal Cinemas, Allstate Insurance, Shell and Raytheon. As in the last two recessions of this century, 2001 and 2008, savvy firms will pivot to technology to employ fewer workers and wait for demand to fully recover before hiring again. The rapid innovation and adaption to contact-less commerce and communication suggests many jobs may never come back. While our headline unemployment number falls, it’s estimated that at some point in 2020 already 60 million Americans filed for unemployment benefits, although “only” 14 million now are unemployed and looking for work, per the Bureau of Labor Statistics.

Much has been made of coming inflation but it is hard to find the catalyst for increasing prices, especially given unemployment numbers. The affluent are said to be putting money saved from cancelled travel and entertainment to use by buying cars, renovating homes and upgrading their home gym spaces and complementary apparel. They are the exception. Businesses have allowed inventories to dwindle, given weak demand while we live with less. Even when demand does perk up, perhaps with the fast approaching holiday season, factories report plenty of excess capacity ready to absorb orders. Thus inflation on a broad-based scale, given high unemployment and a quarantine-like life for many, does not seem on the horizon.

The globe’s economics remain inseparable from the pandemic and will remain that way pending an end of the crisis. China, which has nearly stopped the coronavirus spread, is back on the path to growth. By the end of 2021 the OECD predicts China’s economy will be 10% larger and the U.S. will be back to 2019’s size. Europe is farther behind the U.S. and is expected to be slower and smaller than its pre-pandemic size for years. The nature of the crisis has meant that service-based economies, like the U.S. and much of Europe, have struggled more to gain control of virus outbreaks and find solid footing for reopening. It is much harder to go back to life as usual here than it is for manufacturing-based economies like those in Asia. This may mean our government will be more indebted and our citizens more financially and emotionally exhausted by the end.

On the markets

The market corrected by nearly 10% during September, exceeding the 8% correction in June. Fears of new pandemic-required lockdowns and the usual Congressional gridlock on a fourth fiscal relief package, which may be left behind in the race to fill Justice Ruth Bader Ginsberg’s Supreme Court seat, was more than enough to rattle investors. On the heels of a strong summer, September’s downturn was widespread beyond stocks. Even gold prices took a hit, as did bonds, based on the Core US Aggregate Bond fund, which was slightly negative. These declines hardly compare to the S&P 500 Index’s 34% drop in March but are a sign of the pile up in troublesome news.

One area of the market that has been slower to recover, although did not drop nearly as much in September, is dividend-paying stocks. This slow trend was true in the 2008 market crash as well, when many firms were forced to trim or cut dividends, crushing their prices. The chart below compares 2008 and 2020, based on the institutional swap market* for S&P 500 future dividends. On the left we see that in 2008 the light blue line projected a steep decline and a long, flat ten-year road to recovery. However, instead of ten years, dividends rebounded in four by 2012. The chart on the right shows the 2020 market and predictions. A similar and potentially earlier recovery could be occurring this time around, indicating that dividend-payers might be undervalued.

It should be noted that this chart takes into account dividends on all paying S&P 500 companies. For passive index investors, this data is applicable. For investors who focus on choosing individual reliable companies with strong balance sheets and durable businesses, this trend towards recovery should come quicker.

Overall, keep these points in mind as we head into an electrifying 4th quarter. Election drama will keep volatility high. Politics are not investment decisions. Low real interest rates will keep asset prices high, despite worries about a rich market and a weak consumer. And more fiscal stimulus for individuals, small business and infrastructure will also keep prices popping, when it comes.

On personal finance

Plenty has been made about the plight of the Millennial generation (born between 1981–1996) and their financial woes, be it hefty student loans, anemic incomes or the unaffordable “starter” home market. The whammy of two steep recessions during their young adulthood does not help. A new Deutsche Bank research paper, co-authored by a young Millennial, extrapolates just how these experiences may play out and influence personal financials for all.

Right away the report stresses the burden of payroll taxes on workers. Here and around the world, an aging population is dependent on employees to fund pensions and healthcare. Estimates are that by 2032, Social Security outlays will exceed payroll tax receipts, problems compounded by 2020’s massive unemployment situation and more broadly by our healthy longer-lived senior population. This does not bode well for anyone subject to payroll taxes or for Social Security Income and Medicare recipients.

Then there are the policies and politics. Politicians generally favor the interests of their older constituents, who are more likely to vote and to make generous campaign donations. Since election math favors the older set, policies generally do as well. Consider how Brexit, a hugely disruptive decision with massive financial consequences, was so starkly divided between the younger population’s Remain vote and the elderly vote to Leave. Young people feel particularly cheated by the economic restraints that Brexit has brought, radically changing career opportunities that they had anticipated.

Yet, over time the momentum that Millennials have galvanized in the last several years are beginning to be heard. Consider the popularity of Bernie Sanders and his platform for its approach to climate policy, free health care and education. Remember the attention Greta Thunberg on climate change and David Hogg on gun control have received. These two alone have rallied millions around the world and are not even old enough to be Millenials.

With respect to financial asset pricing, the authors believe that self-correction is likely. Consider housing. The elderly can afford more luxurious homes, often a major part of their net worth. As this population grows, the number of younger, people who can afford to purchase their homes will shrink. If unaffordable, prices will adjust to meet demand, depreciating wealth. Intergenerational transfers of wealth will help to narrow the gap, not in a merit-based way of course, but there will still be some offset there.

There is no silver bullet and it may be difficult to avoid some abrupt financial dislocations. To ease the transition, researchers suggest policy makers prioritize affordable housing, tackle climate change legislation and rework tax law so the burden of paying for entitlements does not fall solely on wage earners. As it stands, the ideal that each succeeding generation is more successful than the last has been eroding for decades now. This hurts everyone the more the rich and poor gap in advanced economies persists.

Please be safe and stay healthy! It is our true delight to help with your investments and finances and we thank you!

*Swaps are derivative contracts used by institutional traders to manage risk; investors can derive valuable information about expected future values based on swap data.

Disclosure

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