Markets - Ignorance Is Bliss
The economy is not providing sensational data to say the least, but the market is boasting a helpful rebound from its' recent lows. As we wade through the plethora of information related to the impact of COVID-19 on the economy, one thing is clear: the market is ignoring the current reality in hopes of a better, not so distant, future. Though it may feel like the objective of this email is to inundate you with charts and graphs, the real goal is to provide you with a picture of the current economic condition in a way that's easy to understand and visualize.
COVID-19 Daily Cases
As you can see in the table below, daily new Covid-19 cases are sustaining a downward trend, which is certainly positive news. I've heard it said before that the market will gain some upward momentum when there is less bad news, not necessarily good news, and we watched that unfold last week.
Source: https://www.worldometers.info/coronavirus/country/us/
Stimulus Inspires
Many of you have experienced the benefits of the CARES Act stimulus firsthand. In my last email, I provided a brief overview of the provisions that I felt were relevant to physicians and dentists, and thankfully, the Payroll Protection Program, Federal Loan assistance, and more have been a beacon of hope during this time of uncertainty. Without the CARES Act, the Penn Wharton Business Model hypothesizes that U.S. GDP would have fallen at an annualized rate of 37 percent in 2020 Q2, with the unemployment rate reaching 12 percent by 2020 Q3. PWBM estimates that the CARES Act will dampen the short-term decline in GDP to a 30 percent annualized rate in 2020 Q2, with the unemployment rate reaching 11 percent by 2020 Q3. However much the interventions have helped, the U.S. has provided more fiscal stimulus as a percentage of GDP than has any other country.
Source: Goldman Sachs Global Investment Research
Though it is helpful now, the money is not free and without consequence. Stimulus raises the debt burden of the country and increases the risk of inflation. There's suddenly more money in circulation, but not more goods and services, which debases the U.S. dollar and lowers purchasing power. The more you print, the more you devalue the dollar. The Fed can fight inflation and possibly unwind the quantitative easing at some point by selling their bonds in the treasury market, effectively pulling money out of the economy. However, in doing so, interest rates would likely rise and stocks normally struggle. The Fed's ability to buy and sell bonds as a way of controlling the money supply can act as a hedge against the risk of inflation, but it will not relieve the debt burden. It is worth noting that the United States was once the largest creditor in the world, meaning it lended the most to the world and borrowed the least from it, but it now it is the largest debtor in the world and has been since 1985. The question is whether the increase in national debt is sustainable with over a third held by foreign governments and roughly 17% dedicated to funding the Social Security Trust Fund, Disability Insurance Trust Fund, Military Retirement, and Medicare.
Now For The Bad News
The chart below shows the number of days that economic activity was impacted by restrictions in the first quarter. The U.S., along with many other countries, implemented restrictions for 11 to 18 days of the 91 day quarter, whereas China experienced restrictions on economic activity for most of the 1st quarter.
Even a few days of restriction are expected to lower the U.S. GDP to an annualized quarterly growth rate of 1%. Notably, the number of days with restricted economic activity will be far greater in the second quarter, which can be seen in consumer behavior across the board.
Eight of thirteen major categories decreased. Clothing led the way with a 50.5% drop, furniture a 26.8% drop, and restaurants and bars were down 26.5%. As you would expect, the decrease in spending is a global problem and the cuts in the budget are very similar from one country to the next.
This significant change in behavior has led to a dismal outlook for many small business owners. As you can see in the table below, a majority (nearly 35% of surveyed owners) say they can only hold on for 1 to 2 months if the current quarantine continues.
The lack of reserves to withstand these conditions is a prevalent issue for a majority of households in the United States as well. Though the top 1% has continued to increase their wealth since the 2008 financial crisis, many income earners never recovered. Individuals and families with incomes in the 60th percentile or lower have little to no savings. This, coupled with the increase in unemployment for these income groups, will put significant pressure on lenders as U.S. households struggle to make payments.
The Weekly Economic Index published by the New York Fed is an informative signal of real economic activity, tracking a series of data points such as same-store retail sales, an index of consumer sentiment, initial unemployment insurance (UI) claims, an index of temporary and contract employment, a measure of steel production, a measure of fuel sales, and a measure of electricity consumption. All measurements are consolidated to represent 52-week percentage changes, which also eliminates most seasonality in the data. As you can see below, this has dropped to -9.4%, which is lower than was previously seen during the 2008 financial crisis.
Unfortunately, this brings us to the recently released projections for the 2nd quarter of this year. Needless to say, the consensus by the forecasting experts is supported by the apparent changes in economic activity due to COVID-19.
Volatility
Some people are pretty good at ignoring the fluctuations in their accounts. For some, this is testing how much volatility they can stomach. We expect significant volatility will continue as the markets react to earnings reports, GDP estimates, and other news released in the coming weeks. I would encourage you during these times to keep your perspective zoomed out rather than zoomed in on the information above. Though the data is contending with gains at the moment, a look at history shows the pain of a contraction is short-lived when compared with periods of expansion. As Nick Murray once said, "The long-term determinant of real-life, long-term investment outcomes is not investment performance, it's investor behavior." As we zoom out to remember the big picture, we can clearly see that tolerating a bear market is worth the wait.
The last image illustrates the results of a study conducted by Dalbar, an independent research firm. During the twenty year period between 1999 - 2018, the average equity fund investor performed well below the Annualized Return of the S&P 500. Why? Because the average equity investor only owned their portfolio holdings for three years. As Nobel Laureate and famous economist Eugene Fama once said, "Money is like soap, the more you handle it, the less you will have." Part of my role is to provide ongoing education, which in many instances is a clear perspective during times of volatility, to provide accountability and keep emotional investing schemes at bay, and to keep investment strategies aligned with your best interest and the financial planning objectives we've set. As we wade through an unprecedented time together, our team is here to provide guidance and reassurance. With daily cases receding, we can see light at the end of the tunnel. We expect the rollercoaster of volatility will continue and you may lose sight of that light for a moment, but know it's near and be patient.
