The Beginning of Unemployment
The market takes the stairs up and the elevator down then the fed steps in.
This weekend’s read is slightly shorter than usual. With the ongoing rains these past few weeks in San Diego, coupled with the heavy rains we faced on Thursday and Friday, I found my home office flooded, turned into an indoor swimming pool. Although my daughters, ages 2 and 4, were delighted by the idea of having an indoor water park, we have been working with insurance and the water mitigation companies to fix this issue. Now, I feel fortunate enough to have a spare room in which I can continue to work. This event served as a reminder that with COVID-19 and stay-at-home protocols, things can go awry.
Since March 23rd, the S&P 500 is up 27% at a time when unemployment grew by 17 million in the month of March. A good example of how the stock market and the economy are not the same thing. Over time the stock market will follow economic data. It’s kind of like walking a dog. You may be walking in a straight line while Fido may be roving all over the place. In the end though, you will both still be moving in the same general direction.
When we look at liquidity and credit, the government has stepped in and started to buy all risk assets. Literally all assets, including junk bonds. This is preventing the market’s ability to go up and down and function properly. Essentially, right now markets go up and then the government steps in and transfers all the downside risk. Ultimately, the Fed is manipulating the markets at a fundamental level. Which makes evaluating companies or price discovery non-existent. Our investments are predominantly index based because we believe the markets are efficient and therefore there is accurate pricing on companies. We will continue to monitor index funds to make sure they operate efficiently.
Bankruptcy and Bailouts
Corporations get money in two ways: equity ownership and debt borrowing. Most companies that are well managed can weather a 3-6-month interruption to business. However, a complete stop in business drains those reserves at a quicker rate. Unfortunately, many companies will be facing bankruptcy. In bankruptcy, equity goes to zero and the debt holders become the new owners of the company’s assets. They restructure some of their debt into equity and potentially with new leadership the company is able to operate again. Typically, bankruptcies hurt senior executives and board members steering the ship since their compensation is highly concentrated with stock options of the company. A majority of companies are well managed and have good corporate governance and with the government programs will survive. But there are a few corporations that were mismanaged before the crises that will need to consider bankruptcy and they should, since the government can’t be the golden parachute for greed and mismanagement.
12 Trillion dollars
Yes - we are on track for the Fed to own/borrow 12 trillion dollars of risk assets to help save our economy. To say that is a lot of money, would be an understatement. There are about 330 million US citizens which equates to approx $36,000 per US citizen. And even then, this is not enough stimulus by the looks of unemployment. One of the $350 billion-dollar programs, the Paycheck Protection Plan, which was meant to save jobs and reduce the expanding unemployment rate, was oversubscribed by some estimates in the 1.3 trillion-dollar range. With the growing amount of uncertainty that number seems to keep growing. All this to say, keep an eye out for CARES Act 2. We are watching the amount of capital the Fed and Treasury are borrowing and their impact on the bond market.
Unemployment
You can’t hide from unemployment: it’s a tsunami and it’s growing at a faster rate than ever in history and it will affect everything. 1/3 of apartment renters in the United States didn’t pay rent in April, farmers are throwing away 6-10 thousand gallons of milk a day as demand shrinks. Even the post office will run out of money soon! The reality is still the same. Until people can start working again the economy can’t be productive, we will still be in this period of extreme uncertainty. We continue to be defensive with a weighting in quality credit.
Spill over into another mortgage crises
Potentially, the stimulus plan has measures in place to support ‘mortgage forbearance’. Typically, what happens is lenders agree not to foreclose on a property and the homeowner agrees to become current with their loan at some point in the future. The stimulus plan mandates 90 days no eviction policy but for mortgages they have up to a year. Why would they do this? Well, the volume of forbearance on mortgages has grown to 2 million since March 27th and it is estimated that there will be 2 million or more late payments on mortgages in the month of April. I am not too worried about banks as they have more cash on hand than in 2008 and have an open line of credit with the Fed. But Fannie Mae, Ginnie Mae and Freddie Mac guarantee $7.5 trillion in loans. Do balance sheets even matter anymore?
A Few Planning Opportunities
We are looking at how this changing situation affects taxes, investments and planning among other things. Though it is not a complete list, it should give you an idea of what we are evaluating for our clients
Taxes:
2019 Taxes have an extended filing date July 15th. Potentially to fund more deferred retirement plans
No RMD in 2020, could reduce the tax bill or better yet be the perfect time to look at a Roth conversion
Cash flow:
401(k) loans increased up to $100k and payments may be deferred for one year. Potential help cash flow and taxable income
401(k)/IRA withdrawal up to 100k can be made from qualifying retirement plans and taxes can be spread over 3 years. Again, helping with cash flow.
Giving and Estate Planning:
Charitable deductions on taxes for individuals who do not itemize up to $300 of deductions. If you do itemize, 100% of cash donations are deductible in 2020. The number used to be 60%.
With markets down you can lump-sum fund a 529 plan for a grandchild and take advantage of market growth tax free for a child/grandchild.
If you are above estate tax exemption amounts and own closely held stock or family business. With values down you can get the future growth out of your estate.
We have started to review financial plans and would like to reiterate that everyone will be impacted and have a planning opportunity. We believe these opportunities will be here for at least the next quarter.
If you are not having these conversations with your advisor already, we welcome the opportunity to help. Please contact us at info@clientfirstcap.com and we will be happy for the opportunity to offer our services.
