Where We Stand
The novel coronavirus has upended our lives to such an extent that it feels as though we have crammed a decade’s worth of life into the last few months. The pandemic has caused widespread economic instability and fostered conditions leading to social unrest. All levels of government have responded with orders to slow the spread and mitigate the harm caused by mass joblessness. The securities’ markets have gyrated wildly, as investors reallocate their capital to preserve assets and grow where new opportunities arise. Given these developments, it makes sense to review what has happened and look forward.
The virus has infected over 2.4 million Americans and taken approximately 125,000 lives. The epicenter of the disease has moved south and west, as states with low levels of infections earlier in the year are experiencing rising infections, hospitalizations and fatalities. Projections for the rest of the year are less dire than those advanced by the infectious disease specialists early on but are more severe than the overly optimistic scenarios presented by the administration.
The prognosis for new treatments and vaccines appears promising. Doctors have learned about much more effective treatments as they begin to understand the virus’ impact on the human body. Gilead Sciences’ Remdesivir has been shown to lessen the duration of the illness, but this pharmaceutical is not a cure. In early June, Regeneron Pharmaceuticals started clinical trials to see whether its antiviral antibody treatment is effective in both treating and preventing the disease.
Vaccine development is in overdrive, as many of the world’s largest pharmaceutical companies have candidates starting widespread Phase III (final phase of testing) as early as this summer. The executives of these companies are temperamentally cautious, yet some have already issued confident predictions. AstraZeneca’s CEO, Pascal Soriot, was recently quoted as saying that the company could deliver a vaccine by October, if all goes well in its clinical trials in August and September of this year.
There are a few aspects of this vaccine development process that allow for optimism. While novel, the SARS-CoV-2 is very similar to SARS-CoV-1 and MERS (Middle East Respiratory Syndrome), which first appeared in 2003 and 2012, respectively. Therefore, virologists already have a significant understanding of how these viruses operate. Different companies are also taking different approaches to developing the vaccine, with many using cutting edge molecular biology not available with earlier vaccine development efforts. Clinical trials are also slated to enroll 30,000 subjects each, which is a large sample size at the outset. Finally, the pharmaceutical companies, government and foundations are working in parallel on scaling the production of their medicines, so they should have sufficient supplies to inoculate large segments of the population. Following is a chart of where the most promising efforts stand out of the 130 + teams throughout the world working on treatments and vaccines:
The killing of George Floyd at the hands of Derek Chauvin and other Minneapolis police officers shined a spotlight on social problems within the United States. The peaceful protests indicate a strong desire for change, since the inequality of opportunity based on the circumstances of one’s birth continues. We are not here to offer any proposals, other than noting that the risk of continued social unrest is high and hoping cooler and more compassionate heads prevail.
Much of the economy was shut down in April and early May, with shelter in place orders by state and local governments. Unemployment skyrocketed, with weekly claims still averaging about 1.5 million new filers every week. Continuing claims for unemployment are about 20 million, which is an all-time high. This level of unemployment has had a devastating impact on economic activity, which declined 5% in the first quarter of the year and is expected to contract another 30% in the second quarter.
Reopenings started in Georgia in early May, and the rest of the sunbelt followed soon after. Connecticut was the last state to begin the opening process on May 20, and New York’s staged opening is a long process, with economic activity slowly re-emerging in NY City. While the Northeast is coming back to life, increasing infections in areas such as Texas, Florida and Arizona are slowing the movement of people and growth of the economy. Forecasters expect a strong recovery, with 20% growth in the 3rd Quarter, followed by an additional 5% growth in the 4th Quarter. Even if this rebound happens, the economy will still be about 5% smaller than it was at the close of 2019.
Government Response – Rates and Bonds
The government’s initial fiscal response was aggressive, with programs such as the CARES Act and the Paycheck Protection Program providing roughly $3 trillion of stimulus. For context, the US economy produces $20 trillion of goods and services every year, so the government has covered about 15% of the total economy.
The Federal Reserve (Fed) also lowered interest rates, backstopped banks and purchased bonds directly and indirectly through Exchange Traded Funds. This year, the Fed’s balance sheet has ballooned from $4 Trillion to over $7 Trillion. It should be noted that this balance sheet averaged below $1 Trillion for decades before the 2008 Financial Crisis. Jay Powell, the Chair of the Fed, has promised to keep rates close to 0% until 2022. This signal suggests that bond yields for all but the riskiest securities will be minimal for years to come. Given this development, returns for balanced accounts that contain bonds will be lower for the foreseeable future.
The stock market reached a low on March 23rd, when the S&P 500 fell 31% from the beginning of the year.Since then, the market has rebounded +39% and is now only down about 4% year-to-date. It should be noted that financial markets have no “conscience,” since much of the rebound occurred during periods of extreme social unrest. Markets are mechanistic, and they rise and fall based solely on investors’ aggregate buying and selling decisions over time.
The market has most likely recovered for two reasons. The first rationale is that investors expect the severe economic damage from the pandemic will repair itself quickly. This line of reasoning also assumes that little long-term damage has been done to employment or patterns of consumption. The second rationale for the rebound in stocks is that the Fed’s unprecedented easy monetary policy forces stock prices higher, since there are no alternatives to risky assets, such as equities.
In conclusion, we are optimistic regarding the prognosis for improved medical treatments and a vaccine. This development would limit the worst economic outcomes. The markets will most likely muddle through with heightened volatility, depending on news flows. We are also uncertain of long-term trends, given the novelty of the monetary policies put in place.
No Problem vs. Problem
The market has been both volatile and divergent this year. The pandemic has caused extreme volatility. The expectation of which companies will thrive during the pandemic has caused extreme divergence. The average year-to-date return of the Health Care and Information Technology sectors is positive, while the average return of the other 9 sectors is negative. Of the 45 or so stocks which have a year-to-date return over 20%, more than half are in these 2 sectors. The market has decided the stay at home and work at home companies are the winners, and all others are being left behind. Wall Street is already looking to market products based on this trend – iShares has filed with the SEC to register a Virtual Work and Life Multisector ETF.
We can look a little more closely at a couple of names. Microsoft has been declared pandemic proof and closed the 1st half of the year up about 30%. Charles Schwab has been declared not so and is down about 28% during that same period. The investment case for Microsoft is easily identifiable, as the need to work from home has caused a dramatic shift from on premise Information Technology (IT) to in the cloud IT. As their CEO Satya Nadella said in April, “We have seen two years’ worth of digital transformation in two months.” As one of the Big 3 Public Cloud companies, Microsoft is benefiting from this transition, and its subscription model means steady recurring revenue. The market has rewarded Microsoft with a hefty valuation (Forward P/E of 32).
Schwab is not a beneficiary of the shift to the cloud. Instead, it’s negatively impacted by the Federal Reserve’s interest rate cuts in response to the pandemic. Lower interest rates mean a lower spread between a financial institution’s assets (investments and loans) and liabilities (deposits), making it hard to generate profits. But if we step back, we can see Schwab is still adding client assets – in May, assets grew 14% year over year and now total about $4 trillion. Schwab is still one of the dominant players in the asset custody business, and the merger with TD Ameritrade will add assets and provide opportunities for synergies. But the market doesn’t like the near-term outlook at Schwab, which is reflected in its low valuation (Forward P/E of 16).
The evaluation (and reality) of each company’s performance during the pandemic has brought about two very different valuations. While Microsoft’s P/E was higher than Schwab’s pre-pandemic, the divergence has only increased in the last 4 plus months. But both companies have strong market positions, and while Microsoft has stronger prospects during the pandemic, we expect both to thrive over the long term. This makes both companies good investments going forward.
Taking Stock: The Importance of Having a Financial Plan
While your primary concern during recent months has undoubtedly been to keep yourself and your family safe and healthy, your thoughts have probably turned next to your financial security. The impact of the pandemic on our economy has been devastating, and never has the importance of having a financial plan with well-defined goals been more vital. If you haven’t already worked with a Financial Planner to develop a plan, this could be the perfect time to begin this process. If you have an existing plan and have not reviewed or updated it in the past year, you may want to speak with us to re-evaluate where you stand.
What exactly is a financial plan?
It’s a comprehensive picture of your current financial situation, long-term goals and strategies to achieve those goals. It covers all areas of your financial life including investments, cash-flow, federal and state income taxes, insurance, retirement planning, estate planning and more.
Why is it important to have one?
Having a plan based on your values and long-term goals helps you stay on track for the future. It not only reduces your anxiety by keeping you focused on your long-term goals and not on short-term market performance, but it takes the emotion out of your financial decisions and allows you to sit tight in times of uncertainty. You want to make smart decisions based on your plan and not emotional decisions reacting to market volatility. It’s important to have a strategy in place to ensure you have saved enough to fund your retirement.
Financial planning is important for everyone, from people just starting out and beginning to save to sophisticated investors with substantial assets.
Some of the key elements you might want to think about now:
Emergency fund – depending on your situation, you should have enough funds available in an interest-bearing account to cover a minimum 3 to 6 months of expenses. This buffer has been crucial recently while unemployment has reached record highs. Having this cash on hand enables you to avoid both touching any long-term investments (and selling when the market is down) and taking on credit card debt with high interest payments.
Budget Planning – if your income has increased or declined recently, you may want to revisit your budget and fine tune discretionary spending or savings contributions.
Update long-term cashflow projections – assess how your long-term cashflow picture may have changed, and identify steps you might want to take to adjust accordingly. Should planned goal target dates be updated? Do you have charitable or legacy interests that you might like to add to your plan?
Planning Scenarios – you might wish to consider having us run some updated scenarios/models using current account values to see if your strategy remains on track to achieve your personal financial goals.
Retirement Planning – reviewing beneficiary designations on existing 401(k), 403(b), 457(b), & IRA accounts is vitally important in light of the SECURE Act’s passage last December. While retirement plan distribution options remain unchanged for surviving spouses, other individual beneficiaries (children, grandchildren, nieces, nephews, etc.), with very limited exceptions, must now withdraw the entire account value no later than ten years following the year of death of the account owner. Further, Social Security claiming strategies and options have changed for those individuals born after January 1, 1954. We can assist in the identification and evaluation of these strategies.
Estate Planning – make sure you have all of your important documents up to date, such as your Advance Medical Directive, Power of Attorney and Will. A good rule of thumb is to review these documents at least once every five years and more frequently when family circumstances change, such as births, deaths, marriages and divorces.
The recent crisis has highlighted the importance of financial planning. Knowing where you stand and having a comprehensive strategy in place to attain your long-term financial goals is important to keep you on track and to reduce anxiety. As Benjamin Franklin said, “If you fail to plan, you are planning to fail!”