Welcome to the October 2020 Newsletter. This month, we’re covering the coronavirus (COVID-19), its effect on Americans’ well-being and the economy, and other news.
Summary
The Secretary of the Treasury, Steve Mnuchin, and House Speaker Nancy Pelosi continue to make some progress on a final fiscal stimulus bill, but time is running out. The House typically is in recess for the month of October. How the economy performs over the next six to nine months is dependent on a bill being passed.
Excellent progress is happening on both the treatment of patients with COVID-19 and the development of a safe, effective vaccine.
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 August by 1.4 million, and the unemployment rate decreased by 1.8 points to 8.6%. The employment news last month improved significantly! As per the chart below, it is going to take some time to get back to only 4% unemployment.
The July payroll number decreased by 29,000 to 1.76 million. The June payroll number was revised down by 10,000 to +4.78 million. The rolling three-month payroll average decreased to 2.7 million this month from 3.1 million last month.
The Fed is predicting unemployment to drop to 5.0 from 6.2% in 2021.
Gross Domestic Product (GDP)
The Bureau of Economic Analysis said the third and final estimate of the 2020 second-quarter GDP decreased by -31.4%. This was a slight 0.3% improvement over the second estimate last month.
The pandemic has significantly changed the U.S. and worldwide GDP outlook for the calendar year 2020.
| United States | Worldwide | |
| Original 2020 GDP Projections as of Dec 2019 | 1.3% | 1.3% |
| Original 2020 GDP Projections as of Dec 2019 | -8.2% | -3.1% |
The Atlanta Fed expects the 3rd quarter GDP to rebound to a +32% compared to the second quarter! The Fed is currently predicting 2021 GPD to grow by 3.6 to 4.7%.
Inflation
Annual inflation increased in August to 1.4% from July’s adjusted 1.1% as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, which excludes food and energy, also increased in August to 1.6% from the adjusted 1.4% in July. The Fed’s long-term target remains at 2%.
The Fed is predicting the PCE index for 2021 to increase by 1.6 to 1.9% and the core PCE index to increase by 1.6 to 1.8%.
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 | 1.50% |
| 10 Year | 1.63% |
| 30 Year | 1.78% |
After multiple months of higher inflation numbers above, this month’s numbers are 0.14% lower on average.
Stock Market
Commentary
The stock market entered a new bull market on March 24, 2020 as the bear market set its low on March 23, 2020. Since then, the market has had a strong and steady rise through August. September had a 10% pullback, which is a typical correction found in all bull markets.
This stock bull market will not go up in a straight line from here, but we are optimistic the rest of 2020 and 2021 will see positive growth.
Stock Market Valuations
Over the next one to two years, we expect the market to trade up to the area of 20 to 21 times 2022 corporate earnings of $175. This will put the S&P 500 Index well over 3600. The S&P 500 Index closed on September 30 at 3363.
According to Vanguard, the long-term outlook for average stock market returns over the next 10 years are as follows for U.S. investors:
- 4% to 6% for U.S. stocks
- 7% to 9% for international stocks
U.S. stock returns will be limited in the future due to their relatively high market valuations today. The prediction that international stocks will outpace U.S. stocks over the long-term is another reason to maintain a highly diversified portfolio.
Investors have moved past the earnings prospects of the calendar year 2020 as they set their sights on improving earnings in 2021 and 2022. The market has performed well due to this forward-looking mindset, which has made it possible for the S&P 500 Index to push forward into record-high ground. Investor willingness to place a price/earnings ratio of 20 and even 21 on normalized 2021 S&P 500 operating earnings could push the index into the 3,600s or higher going forward.
Recommended Action for Your Stock Portfolio
We have had a remarkable stock market recovery since the extreme lows of the market on March 23 due to the pandemic. Specifically, we had a great August in the stock market and a bad September. This is how the market behaves – up and down, but mostly up. We are looking forward to a favorable, though not straight up, remaining 2020 and the twelve months of 2021.
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
| United States | Worldwide | |
| COVID-19 | 211,000 | 2 million |
| Spanish Flu | 675,000 | 20 to 50 million |
Vaccine Development
Below is a brief summary of vaccine development for four U.S. companies and one U.K. company.
Pfizer and their German partner, BioNTech SE, have enrolled more than 35,000 participants in their vaccine trial. More than 24,000 have received their second and final dose. The company’s target is to enroll 42,000 total. The companies have said they expect phase 3 data to be available by late October with an application to the FDA to be submitted in early November for an Emergency Use Authorization. Some scientists are asking for a month’s delay to the end of November so the data can be studied. 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 testing is underway only in the U.S., with a 30,000-person trail that could yield interim results later in the fall. Moderna has not released any new information since last month. The Moderna vaccine must be stored at -20 degrees Celsius.
Johnson & Johnson has developed a potential vaccine that uses a weakened form of the common cold virus. 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 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. The Novavax potential vaccine requires two injections 21 days apart. The Phase 3 test will require 50% of the individuals to receive a placebo.
AstraZeneca (a British & 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. The company has not released any new information since September 3. 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, with millions of doses available in early 2021.
Virus Casualties
Last month the new cases showed a clear downward trend. But the newest data on the right is showing a slight upward national trend.
The chart below shows a slight decrease, even with new cases rising in the above chart. This is due to improvements in therapeutic treatments in hospital cases for COVID-19.
Who are the corporate bad boys this month?
Answer: Boeing and the FAA. The information below is from the House Committee on Transportation & Infrastructure’s report published on September 16, 2020 regarding the 737 Max aircraft.
The Boeing 737 MAX is the 4th generation of the 737 aircraft, which was first certified in 1967. The 737 MAX was first certified in May 2017. On October 29, 2018, Lion Air flight 610 crashed in the Java sea minutes after departing Jakarta, Indonesia. On March 10, 2019, in strikingly similar circumstances, Ethiopian Airlines Flight 302 crashed six minutes after takeoff from Addis Ababa, Ethiopia. These crashes were the horrific culmination of a series of faulty technical assumptions by Boeing’s engineers, a lack of transparency on the part of Boeing’s management, and grossly insufficient oversight by the FAA. The five primary causes of the crashes are identified below.
1) Production Pressures at Boeing
There was tremendous financial pressure on Boeing and the 737 MAX Program to compete with Airbus’ new A320neo aircraft. Among other things, this pressure resulted in extensive efforts to cut costs, maintain the 737 MAX program schedule, and avoid slowing the 737 MAX production line.
2) Faulty Design and Performance Assumptions by Boeing
Boeing made fundamentally faulty assumptions about critical technologies on the 737 MAX, most notably with MCAS. Based on these faulty assumptions, Boeing permitted MCAS – software designed to automatically push the airplane’s nose down in certain conditions – to activate on input from a single angle of attack (AOA) sensor. Boeing also expected pilots, who were largely unaware that MCAS even existed, to mitigate any potential malfunction. Boeing also failed to classify MCAS as a “safety-critical system.”
3) Culture of Concealment at Boeing
In several critical instances, Boeing withheld crucial information from the FAA, its customers, and 737 MAX pilots. This included concealing the very existence of MCAS from 737 MAX pilots and failing to disclose that the AOA Disagree alert was inoperable on the vast majority of the 737 MAX fleet, despite having been certified as a standard aircraft feature. The AOA Disagree alert is intended to notify the flight crew if the aircraft’s two AOA sensor readings disagree, an event that would occur if one sensor is malfunctioning or providing faulty AOA data.
Further, Boeing concealed internal test data it had that revealed it took a Boeing test pilot more than 10 seconds to diagnose and respond to uncommanded MCAS activation. The FAA standard is a maximum of 4 seconds for a pilot to diagnose and respond to an unexpected flight condition.
4) Conflicted Representation Between the FAA and Boeing
The Committee found the FAA’s current oversight structure at Boeing has created an inherent conflict of interest that has jeopardized the safety of the flying public. Several instances have been documented where Boeing Authorized Representatives (ARs) – Boeing employees who are granted special permission to represent the interests of the FAA and to act on the agency’s behalf – failed to disclose important information to the FAA that could have enhanced the safety of the 737 MAX aircraft.
5) Boeing’s Influence over the FAA’s Oversight Structure
Multiple career FAA officials gave documented examples where FAA senior management overruled a determination of FAA technical experts at the behest of Boeing. An internal study of the FAA found, “Many FAA technical and safety employees believe the agency’s senior leadership are overly concerned with achieving the business-oriented outcomes of the industry stakeholders and are not held accountable for safety-related decisions.”
Bond Market
The Federal Open Market Committee (FOMC) voted to keep the federal funds rate at the 0 to 0.25% target range at the September 15 – 16 meeting. The FOMC also pledged to “maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent.”
U.S. Treasury
Congress and the U.S. Treasury continue to negotiate another round of fiscal stimulus for the economy. The Senate has increased their willingness for fiscal stimulus from $0.5 trillion to $1.6 trillion. The House has dropped its request from $3 trillion to $2.2 trillion. Congress did manage to pass a “continuing resolution” to keep the federal government open past October 1. The President signed the bill on September 30.
Recommended Action for Your Bond Portfolio
The Fed’s zero-interest-rate policy has caused money market accounts to dramatically lower their interest rates. Therefore, our bond recommendations have changed, as we no longer recommend holding excess cash. 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.