Welcome to the November 2020 Newsletter. This month, we’re covering the election, the coronavirus (COVID-19), the economy, and other news.
Summary
The United States and Europe are in the midst of another surge of COVID-19 cases and hospitalizations. The U.S. seven-day average case count reached new record highs in late October. Please, everyone, maximize your social distancing and wear a face mask. We must reduce the rate of new infections, hospitalizations, and deaths.
The good news: Excellent progress is being made on both the treatment of patients with COVID-19 and the development of safe, effective vaccines.
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 payrolls rose in September by 661,000, and the unemployment rate decreased by 0.5 points to 7.9%. Employment gains were identified in leisure and hospitality, retail trade, health care, and business services.
The August payroll number increased by 118,000 to 1.49 million. The July payroll number was revised up by 27,000 to +1.76 million. The rolling three-month payroll average decreased to 1.3 million this month from 2.7 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 first estimate of the 2020 third-quarter GDP increased by 33.1%. This was the biggest jump in GDP since 1947.
This leap in pent-up consumer demand was the result of recent monetary support by the Federal Reserve and fiscal stimulus by Congress after the major disruptions to the economy in the first and second quarters due to the pandemic.
Inflation
Annual inflation increased in September to 1.4% from August’s adjusted 1.3%, as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, which excludes food and energy, also increased in September to 1.5% from the adjusted 1.4% in August. The Fed’s long-term target remains at 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 | 1.59% |
| 10 Year | 1.70% |
| 30 Year | 1.88% |
This month’s estimated annual inflation numbers are 0.08% higher on average than last month’s.
Stock Market
Commentary
Except for a few U.S. Senate and House races, the election is finally over. If projections hold, the Democrats will maintain the House and take over the White House while the Republicans will hold the Senate. The result: gridlock – which is not a bad thing. With moderate Republicans gaining a few seats in the House, and moderate House Democrats criticizing House leadership for failing to repudiate Democrats being called Socialists, perhaps an optimistic person would conclude some extremist views, on both sides, might be coming to an end. We certainly hope so.
With gridlock, we will not see higher personal income tax rates, higher corporate income tax rates, or a $3 billion fiscal stimulus bill.
We are optimistic about the near-term future. We see real gross domestic product increasing 3% to 4% in 2021 and 2.5% to 3.5% in 2022.
Stock Market Valuations
Over the next one to two years, we expect the U.S. stock market to trade within the area of 20 to 21 times 2022 expected corporate earnings. This is due to predictions for 1) gridlock in Washington, 2) a safe and effective vaccine availability in 2021, and 3) a low interest rate environment.
Therefore, we expect the S&P 500 Index to have the potential to trade into the 3700 range. The S&P 500 Index closed on November 6 at 3509.
Recommended Action for Your Stock Portfolio
- Be a patient, long-term investor who waits for the great years doesn’t sell when the stock market is down.
- Depending on your risk tolerance, maintain 30% to 100% of your portfolio holdings in the U.S. stock market.
- A diversified portfolio should approximate the stock market with 70% in large-cap stocks, 20% in mid-cap stocks, and 10% in small-cap stocks.
- A stock portfolio should be diversified worldwide. Most U.S. investors should maintain 10% to 25% in international stocks spread across large-cap international, mid and small-cap international, and emerging markets.
- Never buy a loaded mutual fund, a fund with a high expense ratio, or a fund with 12b-1 fees.
- Currently, a good U.S. large-cap growth fund is the T. Rowe Price Blue Chip fund, TRBCX.
- If an investor seeks advice, always consult with a Registered Investment Advisor and not just a stockbroker. A Registered Investment Advisor is a fiduciary, someone who is compelled to always put the client’s interests first, not their own interests.
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
COVID-19 Deaths Compared to Spanish Flu Deaths
As of October 31, 2020
The worldwide number of deaths from COVID-19 (2 million) is likely undercounted due to the lack of resources in many developing countries to accurately count these deaths.
Vaccine Distribution
When one or more COVID-19 vaccinations become available, the distribution of the vaccines will have a priority schedule something like this:
- Category One will include hospital employees and patients, nursing home workers and residents, first responders (police officers, firefighters, EMTs, etc.), and other medical workers.
- Category Two will include the population that is 65 and older, and those with an underlying medical condition (asthma, diabetes, cancer, COPD, heart disease, etc.).
- Category Three will include the rest of the population.
- Everyone receiving the vaccine will receive an ID card.
Vaccine Development
As a reminder:
- Phase 1 trials are designed to determine appropriate dosages in healthy volunteers while monitoring side effects.
- Phase 2 trials use more volunteers, now with the disease or condition, to confirm the dosage and document side effects.
- Phase 3 trials use tens of thousands of volunteers. Half receive the drug or vaccine, and half receive a placebo. The safety and effectiveness of the drug are measured throughout the trial.
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 enrolled more than 42,000 participants since July in their vaccine trial (20% more than last month). More than 35,000 have received their second and final dose (49% more than last month). Some Phase 3 data will be made available to an FDA-authorized Data Monitoring Committee this month. If the vaccine is deemed safe and effective, Pfizer will apply for Emergency Use Authorization by the end of November. Plans include the production of 1 billion doses during 2021. The negative of the Pfizer vaccine is that it must be stored at -80 degrees Celsius.
Moderna, along with the U.S. National Institute of Allergy and Infectious Diseases, has developed a potential two-shot vaccine dose. Phase 3 trials began in July. On October 22, 2020, Moderna completed the enrollment of 30,000 volunteers in the U.S., with 26,650 having received their second vaccination. Assuming their vaccine candidate is shown to be safe and effective, Moderna will apply to the FDA for an Emergency Use Authorization, likely in late December. The Moderna vaccine must be stored at -20 degrees Celsius.
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. The company announced on September 23 that they are launching a 60,000-person global study based on the success of their Phase 1 and 2 clinical trials. 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. The recruitment of volunteers was briefly halted in mid-October due to a vaccine recipient developing an “unexplained illness.” The FDA and an independent review board permitted trials to resume on October 23. The J&J vaccine must be stored at 0 degrees Celsius.
U.S.-based Novavax began Phase 3 testing on September 24 in the United Kingdom. The trial will enroll 10,000 individuals between 18 and 84 over the next 6 weeks. The advantage of testing in the UK is the current high infection rate that currently exists in that country. Testing of an additional 20,000 volunteers will start soon. The Novavax potential vaccine requires two injections 21 days apart. The Phase 3 test will require 50% of the individuals to receive a placebo.
Merck has recently started clinical trial testing of three potential vaccines. The first vaccine candidate started Phase 1 & 2 testing in August 2020. The second potential vaccine started Phase 1 testing in October 2020, and the third potential vaccine began Phase 2 and 3 testings, also in October 2020.
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. Phase 3 Trials began in May in the U.K. On October 26, AstraZeneca announced their vaccine candidate “has produced a similar immune response in older and younger adults.” The AstraZeneca vaccine must be stored at 0 degrees Celsius.
These efforts are outstanding and are likely to produce multiple safe, effective vaccines by year-end or January 2021, with millions of doses available in early 2021.
Virus Casualties
The chart below dated November 1, shows a dramatic upward trend in new cases.
The November 1 chart below showing “Daily Deaths” displays a slight increase, even with new cases rising significantly in the above chart. This is due to improvements in therapeutic treatments in hospitals for COVID-19. Great job doctors and researchers!
How much do states spend per person?
Every state provides the same basic services, but some do it at a much lower cost, which allows them to have lower taxes. The 41 states with an income tax spent 55% more per resident in 2018 than the nine states without an income tax. The states that spent the least per resident in 2018 were:
| Florida | $3,696 |
| Texas | $4,024 |
| New Hampshire | $4,530 |
| North Carolina | $4,800 |
The highest-spending states per resident were:
| Delaware | $11,235 |
| Hawaii | $10,699 |
| New Mexico | $9,777 |
| Oregon | $9,714 |
| Connecticut | $9,282 |
| Vermont | $9,089 |
| Rhode Island | $8,752 |
| New York | $8,384 |
| Massachusetts | $8,300 |
| Wisconsin | $8,300 |
| California | $6,834 |
| Illinois | $5,720 |
Too many elected officials would rather have taxpayers submit to a tax increase than do the hard work of eliminating unnecessary spending. Former Indiana Governor Mitch Daniels, now President of Purdue University said, “You’re not going to find many places (in a state budget) where you just take a cleaver and hack off a big piece of fat. Just like a cow, a state government’s cost structure is marbled throughout the whole enterprise.”
For example, after the economic downturn in 2001, Washington state lawmakers and the governor worked together using priority-based budgeting to trim waste. Their efforts eliminated $2 billion of annual spending without resorting to tax increases or eliminating critical services.
On the other hand, Kansas spent $33 million on advertising in 2019. Why? Did they also need to spend $44 million on cellphones? What critical functions couldn’t be completed without spending $23 million on dues and subscriptions or $419 million on “other fees”?
State legislators have a responsibility to make the most effective use of taxpayer money. The U.S. Congress, likewise, should understand that bailing out extravagant state and local government spending will only ensure more of this reckless behavior in the future.
Who is the corporate bad boy this month?
Answer: Ernst & Young (EY), one of the Big Four accounting firms.
Source: Page A1, The Wall Street Journal, October 17-18, 2020.
EY’s audits are meant to give investors confidence in companies’ financial statements. But EY missed red flags or failed to aggressively pursue them at some companies ahead of major scandals. For the most part, it was outsiders who raised questions first about the companies listed below, not EY. Now regulators are scrutinizing EY’s work. Where has EY unfortunately been involved? See below.
1) German payments processor Wirecard AG can’t locate $2 billion in cash. The company has collapsed and has filed for insolvency.
2) China’s Luckin Coffee Inc. fabricated $300 million in sales. Luckin Coffee’s CEO and COO have both been fired, and its stock has been delisted on the Nasdaq exchange. Luckin Coffee still has not released its 2019 financial results.
3) NMC Health PLC and NMC Finablr PLC, two U.K. sister companies, were found to have $5 billion in previously undisclosed debt. The parent company has filed for bankruptcy.
4) And finally, EY was the auditor of WeWork, an office-space company that nearly collapsed after fumbling an initial public offering in 2020. WeWork’s founder and CEO, Adam Neumann, drank Don Julio 1942 tequila and smoked pot in the office. He took a $362 million loan from the company. He used company money to fund pet projects that involved surfing. WeWork leased office space in buildings whose owners included the CEO. Meanwhile, company losses exceeded $1.7 billion on revenue of only $1.8 billion in 2018. In early 2020, WeWork’s bonds, due in 2025, were trading with a 64% discount. EY said WeWork’s ambitious growth strategy and cash burn had been known to investors.
Referring to the litany of missing company cash, hidden corporate debt, and client bankruptcies, an EY spokeswoman said, “Our commitment to audits has never wavered.”
Bond Market
Commentary
Real gross domestic product (GDP) increased at a 33.1% annual rate during the third quarter, following a 31.4% decrease in the second quarter. Prior to the pandemic, real GDP had been increasing at a 2% annual rate. At the end of the third quarter, real GDP was 3.5% below the peak GDP level achieved in the fourth quarter of 2019.
Federal Reserve
At their last meeting, the Federal Open Market Committee (FOMC) members noted, “Over the coming months, the Federal Reserve will increase its holding of Treasury securities and agency mortgage-backed securities at least at the current pace to sustain smooth market functioning.” The Fed plans to purchase U.S. Treasury securities at a pace of $80 billion a month and $40 billion a month of mortgage-backed securities. So far this year, the Fed’s balance sheet has grown from $4.15 billion at the end of January to $7.18 billion in late October.
The Federal Reserve Chair, Jerome Powell, continues to ask Congress for more fiscal stimulus during press conferences as he admits the Fed cannot adequately support the U.S. economy on their own.
U.S. Treasury
A targeted fiscal stimulus bill directing relief toward those most affected by the pandemic would be most helpful at this time. But there remains only a slim possibility that a post-election deal can be reached and passed during the lame-duck session of Congress.
The Congressional Budget Office noted the dramatic damage the pandemic had on the Federal budget this past year: “During April through September, the Federal deficit in 2020 was eight times the deficit in the same period the previous year.”
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 healthy 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.