Welcome to the July 2020 Newsletter. This month, we’re covering the coronavirus (COVID-19), its effect on the economy and Americans’ well-being, and other news. Please read on for more information.
Thankfully, weekly jobless claims continue to drop, albeit more slowly than before. But the coronavirus (COVID-19) is spreading much more rapidly than at the beginning of June. The intensity of this pandemic is playing havoc with many lives, as well as stocks. There are fantastic winners and, unfortunately, too many losers. The safest stock market investment today appears to be the highly diversified, low-cost, and tax-efficient Total U.S. Stock Market Index fund.
We do not expect the stock market to return to the March lows.
Employees should continue to make their weekly, biweekly, or monthly contributions to their employer’s retirement plan or 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
U.S. nonfarm payrolls rose in May by 2.5 million, and the unemployment rate decreased by 1.4 points to 13.3%. This improvement in U.S. employment is the best news since the beginning of the COVID-19 pandemic.
The April payroll number was revised down to -20.7 million. The March payroll number was revised down to -1.4 million from +230,000. The rolling three-month payroll average improved to -6.5 million this month from -7.0 million last month.
The Federal Open Market Committee (FOMC) predicts that year-end unemployment will range from 9% to 10%.
Initial jobless claims continue to drop, but now the weekly decreases are slowing.
Gross Domestic Product (GDP)
The Bureau of Economic Analysis said the third estimate of the 2020 first-quarter GDP was unchanged at -5.0%. The decline in the first-quarter GDP reflected the response to the spread of COVID-19 as governments issued “stay-at-home” orders in March.
The Atlanta Fed is now forecasting that second-quarter GDP will contract at a -39.5% annual rate. The New York Fed projects that second-quarter GDP will contract at an annual rate of -16.3%. The FOMC predicts overall 2020 GDP will range from -7.6% to -5.5% at year-end.
Annual inflation dropped in May to 0.5% from April’s adjusted 0.6%, as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, which excludes food and energy, remained the same at 1.0%.
These numbers have become dangerously close to deflation, or negative inflation. Deflation is the reduction in the general level of prices in an economy, and it’s very hard to fight. Deflation was one of the significant problems of the Great Depression. The extreme dangers of deflation are why the Federal Reserve’s official target of inflation is 2%, not zero.
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|
Thankfully, the inflation numbers above are 0.2% higher on average compared to last month’s numbers. Higher long-term inflation expectations this month are a good thing, as we must avoid our worst potential economic enemy: deflation.
The real-time economic data indicates the severe economic contraction brought on by the COVID-19 pandemic is bottoming out. If we’re able to contain the spread of the virus and avoid additional major outbreaks, we should see fewer deaths and a stronger economy in the third quarter. We’re also optimistic that additional fiscal stimulus will pass in Congress, providing more support to millions of unemployed workers.
Stock Market Valuations
Trying to predict a fair stock market valuation of the S&P 500 in 2020 is almost impossible. This month, we will show our first attempt at predicting market valuations for 2021.
We estimate the S&P 500 earnings at $160 to $165 in 2021. With near-zero interest rates, we feel safe to assume a PE ratio of 20 times. This means the S&P 500 Index should have a target range of 3,200 to 3,300. On July 1, the S&P 500 Index closed at 3,116.
Recommended Action for Your Stock Portfolio
Hopefully no one sold during the panic selling in March. If so, just hold on. This will be a difficult year, but even with added volatility, we might squeak out a small gain for nearly everyone by year end. We are looking forward to a favorable 2021 and 2022.
In the short term, you should only buy on a dollar-cost basis. Keep your stock portfolio diversified and low cost.
Here is the latest information on a COVID-19 vaccine development. To be approved by the FDA, each vaccine candidate will have to pass three phases of human testing.
Phase Three testing typically involves 30,000 or more subjects, with two-thirds receiving the vaccine and one-third receiving a placebo. In Phase Three, pharmaceutical companies are trying to prove their vaccine is safe and effective. Plans for Phase Three testing in the U.S. are currently listed below:
- Moderna Inc. will begin in July.
- Pfizer Inc. and partner BioNTech SE will begin in July.
- Oxford University and partner AstraZeneca PLC will begin in August.
- Johnson & Johnson will begin in September.
Most vaccine candidates have historically not made it through all three phases of trials. But keep your fingers crossed that one or more of the above candidates prove to be safe, effective, inexpensive, and readily available in the first quarter of 2021.
We had a downward trend in daily new cases through the first week of June, but since then, it’s been a disaster.
The “Daily Deaths” chart below shows a downward trend so far. But if there is going to be an uptrend due to the higher amount of new daily cases above, it will take two to three weeks for additional deaths to show up.
We received an email on June 4 from an investment advisor touting the performance of the Anchor Risk Managed Equity Strategies mutual fund, ATESX. This fund buys both long and short positions in the U.S. stock market. Looking just at performance, this is not a bad fund over the past three years it has been in existence. But a deeper dive on Morningstar.com exposes characteristics of the fund that in our opinion shout, “Quickly run far away from this mutual fund; don’t invest here!”
For example, the annual expense ratio of this fund is 2.30%. This is outrageous! It has a 12b-1 annual fee of 0.25%. We do not invest in funds with a 12b-1 fee. And perhaps worst of all, it has an annual turnover rate of 1,068%. Seldom if ever would we recommend a fund with an annual turnover of 100%; that would mean all the investments in a fund as of January 1 are sold during that same year and something else is purchased. Turnover creates brokerage charges, and clients pay 100% of all the mutual fund’s brokerage charges in addition to the annual expense ratio. Finally, the two advisors of the fund, Mr. Leake and Mr. Waters, have none of their personal money invested in this fund. That says a lot.
If you don’t know how to sort out good mutual funds from bad funds, ask Mark at Lorenz Financial for help.
The Collapse of Leveraged Exchange-Traded Notes
Below are two examples of retail investors who lost nearly everything by investing in securities with higher risk than they ever imagined. These facts come from a June 2 front-page article in The Wall Street Journal.
The first victim, William M., a 67-year old investor, got out of the stock market during the 2008-09 financial crisis. When he got back in, he ignored traditional stocks and bonds and went for a red-hot investment, a leveraged exchange-traded note (ETN) sold by UBS (Union Bank Switzerland). The ETN William chose bet on companies that invested in mortgage real-estate trusts (REITs). It worked out great for a while, but then COVID-19 hit. As corporations scrambled for cash, volatility increased in the overnight borrowing market on which mortgage REITs rely. This caused mortgage investment trust prices to nosedive.
Because William invested in a leveraged ETN, both his profits and losses were greatly amplified. William lost $800,000, his life savings, in a matter of days. This ETN was priced a little above $14 a share in January 2020. UBS liquidated the ETN in March 2020 at $0.201 a share. See the chart below.
A second investor of a UBS exchange-traded note also invested in a mortgage real estate trust and lost $750,000. The investor was quoted saying, “We were just looking for basic income.”
Last year, Citigroup offered the VelocityShares crude oil-leveraged ETN. The pandemic sent crude prices down to $14 from $61 a barrel. Losses were amplified for holders of the VelocityShares ETN. It last traded at $0.16 a share, down from $15.
These investors made four mistakes:
- First, they invested in something they did not understand. We urge clients to never invest in something you cannot easily explain to your spouse or a friend.
- Second, they bought an exchange-traded note (ETN). An ETN is a fee-based, unsecured debt instrument with no guarantees that a bank issues. ETNs track the value of an underlying security such as a basket of commodities, currencies, or real estate. Professional money managers do not buy ETNs, and they are NOT exchanged-traded funds (ETFs). ETFs are excellent ways to invest in the stock market, but you should never buy an ETN!
- Third, not only did they buy an ETN, but they also bought a “leveraged ETN.” Leveraged means the bank borrowed money to be invested, in addition to the money the bank got from investors. The borrowed money amplifies gains and losses. We recommend that you never buy a leveraged security because of the risk of great loss.
- Fourth, they put an oversize amount, sometimes everything they had, into one investment. We always recommend having a diversified investment portfolio instead of putting “all your eggs in one basket.”
For all investors, there is no investment that is both safe and highly profitable. Investing one’s hard-earned money is not for amateurs who fail to solicit at least some basic advice from a fiduciary.
Even today, sharks are in the water and will absolutely separate an investor from his or her money whenever the investor lets their guard down. To combat this, turn to a credible fiduciary for professional and ethical advice.
We’re seeing some improvement in the real-time economic data we monitor, which indicates that economic growth is stabilizing. Although the year-over-year figures remain dismal, the month-over-month figures are showing signs of bottoming out.
We expect the second-quarter real gross domestic product (GDP) figure to be among the worst in U.S. history. Despite this, we remain hopeful that we will see a bounce in economic growth in the third quarter.
The Federal Open Market Committee (FOMC) voted unanimously at their June meeting to maintain the federal funds rate at 0% to +0.25%. The post-meeting announcement noted, “The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term. [It also] poses considerable risks to the economic outlook over the medium term.”
The federal budget deficit was $1.9 trillion through the first eight months of the fiscal year, an increase of $1.2 trillion from the same period a year ago. Receipts were 11% lower, and expenditures were 30% higher.
The Treasury Department announced it will not delay the tax filing deadline again beyond the current deadline of July 15.
Recommended Action for Your Bond Portfolio
Our bond recommendations are limited to the five categories below:
- Short-term U.S. bond funds
- Intermediate-term U.S. bond funds
- Ginnie Mae Bond funds
- TIPS bond funds
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.