Welcome to the December 2020 Newsletter. This month, we’re discussing the coronavirus (COVID-19), the economy, and other news.
Summary
For investors to place the 2020 pandemic in the rear-view mirror, vaccine discovery remains the priority. The development of multiple safe and effective vaccines, which provide immunity from COVID-19, has been the focus of the pharma and biotech sectors since March. Based on current projections, U.S. pharmaceutical companies expect to globally produce up to 50 million doses in 2020, and up to 1.3 billion doses by the end of 2021.
The U.S. economy has displayed a high level of resilience during the worst pandemic in a century. Given the resurgence of COVID-19 during the late autumn and early winter seasons, it would make sense for Congress to pass additional stimulus relief measures to help bridge the next few months until the vaccines are available.
Employees should continue to make their weekly, biweekly, or monthly contributions to their employer’s retirement plan and personal and spousal IRAs. At this time, additional money can be added to an investor’s stock market allocation, but only on a dollar-cost-average basis. All portfolios remain fully invested.
The Economy
Employment
U.S. nonfarm payroll employment rose in October by 638,000, and the unemployment rate decreased by 1 point to 6.9%. Employment gains were identified in leisure and hospitality, professional and business services, retail trade, and construction. Government employment declined. This was the sixth consecutive month the unemployment rate declined.
The September payroll number increased by 11,000 to 672,000. The August payroll number was revised up by 4,000 to 1.493 million. The rolling three-month payroll average decreased to +934,000 this month from +1.3 million last month. We are still adding jobs, but at a slower rate than earlier this year.
Gross Domestic Product (GDP)
The Bureau of Economic Analysis said the second estimate of the 2020 third-quarter GDP increased by 33.1%.
This leap in pent-up consumer demand was the result of nonresidential fixed investment, residential investment, and an increase in exports.
Inflation
Annual inflation decreased in October to 1.2% from September’s adjusted 1.4%, as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, which excludes food and energy, also decreased in October to 1.4% from the adjusted 1.6% in September. The Fed’s long-term target remains at 2%. It’s unlikely the Federal Reserve will allow interest rates to measurably increase until inflation reaches, and for a period of time, maintains 2%.
Long-term inflation expectations can be determined by calculating the differences between Treasury bond yields & TIPS real yields of the same maturities. Results are:
| Bond Maturities | Annual Inflation Expectations |
| 5 Year | 1.68% |
| 10 Year | 1.77% |
| 30 Year | 1.93% |
This month’s annual inflation expectations are 0.07% higher on average than last month’s.
Stock Market
Commentary
We expect investors to remain focused on the corporate earnings recovery in 2021 and 2022. Interest rates should stay low indefinitely, and COVID vaccines are on the way. Investors prefer federal gridlock over any one party controlling the House, Senate, and White House. If the Republicans can capture at least one of the two senate runoff races in Georgia on January 5, gridlock will remain.
We are optimistic about the near-term economic and stock market future. We see real gross domestic product increasing 3 to 4% in 2021 and 2.5 to 3.5% in 2022.
Stock Market Valuations
We believe 2021 earnings for the S&P 500 Index companies will be at least $165, expanding to at least $180 in 2022. With a low-interest-rate environment, a PE ratio of 21 provides the S&P 500 Index the ability to trade into the 3800 range.
Mike Wilson, Chief Investment Officer for Morgan Stanley, has raised his “base case projection” for the S&P 500 Index for December 2021 from 3350 to 3900. Mike favors the financial, health care, materials, and industrial sectors.
The S&P 500 Index closed on November 30 at 3621.
Recommended Action for Your Stock Portfolio
Many investors have switched from buying individual stocks or mutual funds to exchange-traded funds (ETFs). Two of our recent ETF favorites are:
- RSP is Invesco’s Equal Weighted S&P 500 Index ETF. This fund owns the largest 500 U.S. stocks equally. The typical S&P 500 Index fund (such as SPY) is “market capitalization” weighted. This currently results in over 20% of an investor’s money being invested in only the seven largest stocks. Thus, RSP is more diversified than SPY. The annual expense ratio of RSP is only 0.20%, so it is also inexpensive.
- Our second recommendation acknowledges the economy is likely to dramatically improve in 2021. We have placed part of our money with IYT, the iShares Transportation ETF. It includes airlines, trucking companies, railroads, and overnight delivery companies. IYT’s annual expense ratio is 0.42%.
In the short term, you should only buy on a dollar-cost average basis. Keep your stock portfolio highly diversified and low cost.
COVID-19
Vaccine Process
Below is a brief summary of vaccine development for five U.S. companies and one U.K. company.
Pfizer and their German partner, BioNTech SE, have achieved over 95.3% efficacy with their vaccine candidate. Over 43,500 volunteers have enrolled in the study, and 38,955 have received a second (and final) dose of the vaccine candidate. So far, no serious safety concerns have been observed. In late November, Pfizer applied for Emergency Use Authorization from the FDA. The FDA has assigned a panel of experts to review the trial data and to meet on December 10 to vote on whether the panel recommends the vaccine for distribution. The FDA will vote soon after this review. The companies are expected to produce globally 50 million vaccine doses in 2020 and up to 1.3 billion in 2021.
Moderna’s two-shot vaccine, which began Phase 3 trials in July, has shown to be 94.1% effective in preventing COVID-19. In their study of 30,000 volunteers — with half receiving the vaccine and half receiving a placebo — 196 volunteers developed COVID-19. Of those, 185 had received the placebo and only 11 had received the vaccine. That means of those who received the vaccine, 174 cases of COVID-19 were prevented. The vaccine also showed signs of being safe. On December 1, Moderna asked the FDA for Emergency Use Authorization. The FDA assigned a panel of experts to review the trial data and to meet on December 17 to vote on whether the panel recommends the vaccine for distribution. The FDA will then take a few days to make their decision.
If and when approved, the distribution of the above two vaccines will begin immediately.
Johnson & Johnson has developed two potential vaccines that use a weakened form of the common cold virus. One candidate is a single dose, and the other is a two-dose candidate. common cold virus. One candidate has a single-dose regiment, and the other is a two-dose candidate. J&J’s two Phase 3 trials are separate, but they’ll be run at the same time.
First, the company launched a 60,000-person global Phase 3 trial in September based on the single-dose regiment. J&J will carry out the study at nearly 180 locations in the U.S. and eight other countries where transmission rates have been high. No data has been published yet.
J&J also announced in mid-November they have initiated a 30,000-participant worldwide study on their two-dose vaccine. No other details have been released.
U.S.-based Novavax began Phase 3 testing on September 24 in the United Kingdom. The trial enrolled 15,000 individuals between 18 and 84. Interim data is predicted to be available during the first quarter of 2021. A Phase 3 trial is expected to begin in the coming weeks in the U.S. and Mexico at over 100 trial sites.
Merck has recently started clinical trial testing of three potential vaccines:
- Vaccine candidate V591 began Phase 1 testing on August 24.
- Vaccine candidate V590 began Phase 1 testing on November 2.
- Vaccine candidate MK-4482 began Phase 2/3 patient dosing on October 19. It will be several months for results to be published for this trial.
AstraZeneca (a British and Swedish company) and Oxford University are developing a potential vaccine for COVID-19. A Phase 3 trial enrolling 30,000 subjects in the U.S. began in August. During the week of November 22, AstraZeneca announced their vaccine candidate had shown to be 90% effective for those 2,800 volunteers who received only a half dose by mistake in their first of two shots. They received a full dose in the second shot. As 2,800 subjects are not nearly enough to apply for FDA Emergency Use Approval, AstraZeneca will be continuing their Phase 3 testing in the U.S. and the United Kingdom for several more months.
Virus Statistics
As of December 1, the chart below shows the dramatic increase in new cases rising from mid-October to mid-November. Fortunately, we see a small drop off at the end of November. Hopefully, we will not see another increase after family gatherings over Thanksgiving.
Below we see the Daily Death chart due to COVID also shows a slight decline in late November. Thank you, nurses and doctors, for working hard to take care of us.
Where is Elvis when we need him?
In 1953, Jonas Salk announced he had successfully tested a vaccine against the virus that causes polio. The first polio vaccine became available in the United States in 1955. But in 1956, only 0.6% of American teenagers had received the vaccine.
The New York Commissioner of Health, and her assistant, came up with the idea to ask the greatest entertainer, Elvis Presley, to publicly get the vaccine. Elvis agreed and received his polio vaccine just before he went live on The Ed Sullivan Show in 1956. As the news of Elvis’s vaccine went worldwide, it became “cool” for American teenagers to get vaccinated. Within six months, over 80% of American teenagers had received the polio vaccine.
Who is the corporate bad boy this month?
Answer: The Coca-Cola Company
Source: Page B4, The Wall Street Journal, November 19, 2020
The Tax Court ruled on November 18, 2020 that The Coca-Cola Company assigned too much of its worldwide profits to foreign operations in countries with low tax rates and too little profits to the parent company in the United States. The IRS is seeking $3.3 billion for tax years 2007-2009. The costs to Coke will be much higher if the same rationale applies for tax years 2010 to present.
The Tax Court ruling came about as Coke had assigned most of its worldwide profits to foreign subsidiaries like Brazil, Ireland, and Egypt that have low corporate tax rates. The Judge noted Coca-Cola’s foreign subsidiaries had few trademarks or intellectual property and had little discretion over marketing, strategy, and other decisions controlled by U.S. executives.
Yet he noted, some of the subsidiaries had profits far higher than the U.S. company. “Why are the supply points, those engaged only in routine contract manufacturing, the most profitable food and beverage companies in the world?” he wrote. “And why does their profitability dwarf that of Coca-Cola, which owns the intangibles upon which the company’s profitability depends?”
Coca-Cola had previously warned investors that this case could have a material adverse impact on the current and future profitability of the parent company.
Bond Market
Commentary
Looking ahead to 2021, our initial forecast is for real GDP growth within a range of 3% to 4%. We remain somewhat concerned about economic growth in the near term due to the resurgence of COVID-19 cases nationwide, but the rollout of the vaccines early next year should support an ongoing economic recovery in 2021.
The Association of American Railroads reports October carload commodity categories saw gains in grain, iron, and steel, even though the total combined rail traffic through the first 44 weeks of 2020 was down 9.3% compared to last year. The recent strong rail traffic supports the prospects of an economic recovery in 2021.
Furthermore, recent data from the Chemical Activity Barometer, the Bureau of Labor Statistics, inbound and outbound traffic at the ports of Long Beach and Los Angeles, and the American Trucking Association all show an economy that is firmly in recovery mode.
Federal Reserve
The next Federal Open Market Committee (FOMC) meeting will be on December 15 and 16. No policy changes are expected. The Fed continues to purchase U.S. Treasury securities at a pace of $80 billion a month and $40 billion a month of mortgage-backed securities. This action keeps interest rates low.
Two openings remain on the seven-member Federal Board of Governors. Judy Shelton recently failed to receive Senate confirmation, but this could come up for another vote in December or January. The Senate could also vote on the nomination of Chris Waller. If both fail, President-elect Joe Biden will have the opportunity to nominate two people to the board.
U.S. Treasury
Janet Yellen has been selected as the next U.S. Treasury Secretary by President-elect Biden. She will likely be confirmed by the Senate. As Ms. Yellen and the current Fed Chair, Jay Powell, have worked closely together in the past at the Fed, a smooth transition is expected.
The current federal government stopgap spending authorization is set to expire on December 11. As of this writing, both sides have agreed to the topline spending levels.
Recommended Action for Your Bond Portfolio
The Fed’s zero-interest-rate policy has caused money market accounts to dramatically lower their interest rates. Bank Certificates of Deposits (CDs) and Treasury bills and notes pay less than 1%. Therefore, our bond recommendations have changed, as we no longer recommend holding excess cash. And at this time, we do not recommend CDs, muni bonds, U.S. Treasury securities, high yield bonds, or international bonds.
Below are our four recommended bond categories for an investor’s bond portfolio:
- Short-term U.S. bond funds
- Intermediate-term U.S. bond funds
- Ginnie Mae Bond funds
- TIPS bond funds
**Please note: Everyone should maintain a safe, liquid emergency fund for at least six to nine months of home expenses before investing in a stock or bond portfolio.**
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.