Insights

We are sending you a very brief summary of the recently passed Coronavirus Stimulus 2.0 along with a link to a well-done article in Business Week about how COVID-19 may be changing our lives going forward.

Six months after the expiration of the CARES Act, the Senate finally engaged in a serious process to extend badly needed benefits with a compromise bill that Congress overwhelmingly passed last week and was just signed by President Trump.  The $900 billion, 5,593-page legislation contains some well reported items as well omits some popular items from the House’s $2 trillion dollar bill that died in the Senate months ago.  Some highlights:

Emergency Payments

• $600 non-taxable recovery rebate check (stimulus payment) which starts to phase out at $75,000 of taxable income for single filers and $150,000 for joint filers.  A family with 2 children under 17 would receive $2,400 if under the income limit.
• $300 per week supplemental emergency unemployment was extended until March 14^th as well as “regular” unemployment benefits that would have expired.

Business Support

• PPP loan recipients can write off expenses paid by the loan.  In general, when a loan is forgiven it becomes taxable income.  The IRS issued guidelines which prohibited businesses from deducting expenses against forgiven loans.  Congress overruled the IRS and these loans will be treated as non-taxable grants for businesses qualifying for forgiveness.
• New PPP program allows a second round of loan applications for businesses that had a least a 25% decline in any quarter in 2020 relative to 2019.  The list of allowable expenses for proceeds from the PPP loan was also expanded.
• PPP loans, EIDLs (Economic Injury Disaster Loans) contain many other provisions and updates for those affected.

Personal Tax Changes

• Medical expense deduction was permanently reduced to 7.5% of adjusted gross income from 10%.
• Lifetime Learning Credit was expanded by increasing the incomes before the phaseout kicks in.  The Tuition and Related Expenses deduction was eliminated but more families are likely to benefit from the overall changes.
• Charitable deductions for those who do not itemize will be allowed to deduct $600 ($300 for each spouse) if filing a joint return in 2021.  For 2020, the limit is $300 per return under the original CARES Act.
• Those with unspent funds in the flex spending accounts (FSA) will be allowed extend the grace period to 12 months provided the employer adopts the change.  COVID-19 affected both planned medical expenses as well as childcare expenses.  If this affects you, reach out to your employer ASAP to encourage the change.

There is so much more in this bill and we will be able to help those who may benefit from any of these changes.

What is not contained this legislation:

• No waiver of RMDs for 2021 so we will proceed to work with those affected to update the timing and amounts of your distributions.
• No further student loan relief which expires on January 31, 2021.  For those individuals and family members carrying student loans, January is an important time to review your loan status.

The stimulus bill touches on so many areas that will end up having some impact on many of you.  Fortunately, none of this is particularly urgent before the end of the year.  We are here to help and answer any questions as they come up in the new year as well as provide guidance for better decision making if you or your family is affected in any way by the legislation.

Perhaps even more important at this point, we have included a well-done article from Bloomberg Businessweek entitled  “Ten Ways Covid-19 Has Changed the World Economy Forever” about what keeps us up at night.  We have an extremely bifurcated economy that is still suffering.  Substantial government spending with extraordinary increases in debt combined with aggressive Federal Reserve monetary policy are keeping the economy from collapsing.  Those with assets are doing well, but how and when will it end?  All asset prices are at high levels and may remain at elevated levels for some time.  We feel portfolios are well positioned at this point.  Growth should start to pick up substantially when the virus is under control which should help support stock prices.  However, the system is fragile and any number of events could derail the markets, including increasing interest rates.  We are prepared to adjust to changing conditions and are relatively optimistic about the near-term.
Ten Ways Covid-19 Has Changed the World Economy Forever

We end the year thankful for the opportunity to work with such great clients and are looking forward to continuing to partner with you to navigate whatever lies ahead.

Disclosures

Although the race has not been called, it certainly looks like Vice-President Biden will be called the winner by this evening or tomorrow morning.  These results will not be official and legal wrangling may continue over the next week.  The election result will not change.  The Senate is highly likely to stay in Republican hands.  The most probable outcome is a split government.

The market reacted favorably this week.  We have held the opinion that a Biden presidency would not be detrimental to the stock market and that seems to be playing out.  However, as the political situation becomes clearer, there may be some adjustments to make to the portfolios. Our basic outlook has not changed but there is more uncertainty about the size and timing of a necessary stimulus package.  Here are the key points:

1. Chairman Powell said this week the Federal Reserve has capacity and intention to provide financial stability through the purchase of assets.  Interest rates will stay low for the foreseeable future.  This lends support to the stock market but does create problems for retirees looking for income.  It requires more risk to get adequate returns on investments.
2. There is a significant amount of individual and corporate liquidity meaning there is a lot of cash on the sidelines.  Hopefully, stimulus will be directed to and get to the people and businesses that need it most.  We will address this need in future communications.  It would not be a good thing to have massive bankruptcies and homelessness in the middle of this pandemic.
3. Shutdowns or not, COVID-19 continues to change our behavior and spending patterns.  We are in for a long winter and the economy needs help to get through it.
4. Unemployment remains high.  Segments of the economy are recovering and there are hopeful signs in the manufacturing sector.
5. Trade wars are likely going to be a continuing drag but there is some hope this situation will improve.
6. There was no “blue wave” in this election and therefore no public mandate for passing major progressive legislation, including particularly large new taxes.
7. Taxes will need to go up.  This would be true under any administration when you are spending $1.80 for every $1.00 collected in taxes.  But with a split government, the probability of any major changes went down considerably.
8. The dollar may very well continue to weaken making international investments more attractive.

With the political situation still in flux, we will make adjustments if warranted.

Disclosures

“What’s natural is the microbe. All the rest — health, integrity, purity (if you like) — is a product of the human will, of a vigilance that must never falter. The good man, the man who infects hardly anyone, is the man who has the fewest lapses of attention.”  Albert Camus, The Plague

As we head into next week, many are concerned about how the market will respond to a potential Biden win, especially if the Democrats also win a Senate majority.  It is conceivable it will have a positive economic effect, particularly with increased stimulus.  We continue to believe fiscal stimulus and monetary policy have a far greater impact on our economy (and stock market prices) than political rhetoric, even though political discourse dominates the news.  However, we do expect volatility to continue and are ready to adjust if conditions materially change.

Virus—The above quote from Camus is timely.  Those who have read The Plague will also recognize his metaphorical intent as he addresses any contagion that overtakes any society, whether it be a virus or a corrosive ideology.  Our government cannot control the fact that COVID-19 exists.  It also cannot control our psychological response to changes, even without lockdowns.  With no lockdown in Chicago, the city business districts still have drastically lower foot traffic.  Mass transit ridership is down at least 90%.  Even without restrictions, Americans (mostly) have greatly reduced indoor activities related to dining, shopping, weddings, church services, travel, etc.  COVID-19 related intensive care patients as well as last ditch respirator use are beginning to reach capacity limits in some areas with large case spikes.  While therapeutics and recoveries have improved since March, that is concerning as we move into the fall flu season which will see many more deaths.  Collectively, most of us are much more careful to avoid contracting and spreading the virus even in the absence of restrictions.  For perspective, this virus may end up killing more Americans than WW II and people are acting accordingly.  The result of behavioral changes, even when not forced, point to a slow, uneven recovery.

So how will this scenario play out in our economy?  There are factors offsetting the bad news.  Some sectors are not nearly as affected as others. Many corporations and investors who were fortunate enough not to be in sectors most affected by the virus have significant amounts of cash and savings rates increased due to decreased activity due to restrictions or behavior changes. Extraordinarily large stimulus efforts (with more to come) should provide a bridge to safely getting on the other side of the pandemic.  The key in the coming months is to get cash into the hands of those who need it most.

Investing Concerns

1. Stock market values relative to GDP were recently at highs reached only 3 other times:1928, 1999, and 2008.
2. Growth stocks (primarily driven by large tech) relative to value stocks are historically expensive. Historically, value stocks have outperformed growth, yet the last 11-12 years have been one of the best periods for growth stocks.   At this extreme level, it is an entirely reasonable to think value will outperform growth over the next 10 years.
3. Technology stocks now total over 30% of the S&P 500 with just 5 companies comprising over 25% of the index at its peak. Many other asset classes are still significantly below highs reached in February 2020.
4. US stocks versus international stocks are at a price premium based on earnings at a level last seen 40 years ago.

The next 10-12 years will most likely look significantly different than the last 10-12 years.

Economic Record of Current Policy

In 2018, we wrote about expected negative effects from starting a trade war with China.  Manufacturing employment peaked shortly after Trump’s action.  Unfortunately, the trade deficit has not been solved and the action likely contributed to a decline in U.S. exports.

The tax cuts were supposed to pay for themselves by boosting economic growth above 4%.   A good business will borrow money to expand if the expected returns are higher than the cost to borrow money so theoretically, this could be a good idea to boost economic growth. So what happened?  We increased our deficit to 4.3% of GDP before COVID-19, yet growth was not over 3%.  The cuts did not pay for themselves and the deficit was increasing at an accelerated rate before the pandemic.

Economic growth in the last quarter was 33%, fantastic, but still a ways off from recovering losses of over 35% in of the first 6 months of the year.  The math is simple in measuring the recovery by percentage:  If you start at 100% and lose 50%, you then need a 100% increase to get back to where you started.  Less people are working now and continued high unemployment will drag economic growth significantly – for context, there are more unemployed Americans now than at the worst level of the 2008 decline.  The hardest hit sectors of our economy need more help and should absolutely be the focus of additional stimulus efforts.  There are already signs of slowing growth heading into the fourth quarter following the large 3Q rebound.

We feel the following trends will be in place in 2021.  We are positioned accordingly but recognize the situation could change and we will have to make adjustments.

1. We will get a substantial stimulus bill that will help provide a safety net for those most affected economically by COVID-19 job losses and support economic recovery
2. The Federal Reserve will work to keep interest rates low in an attempt to prevent deflation and support economic growth
3. Value stocks will start to outperform growth stocks
4. The dollar will weaken and international stocks will look attractive

It has been a trying year for many.  Unexpected virus and intervention we have not seen in the past to support the securities market, otherwise we could have had a stock market crash and banking crisis exceeding the 1929 crash.

Please reach out to us with any comments or concerns.  We will see how this next week plays out and provide an update next Friday.

Disclosures

We are updating you on changes we are making to your investment portfolio.  You have been and will continue to receive notices of any trading via email or direct mail if you have not signed up for electronic delivery.  All records are available online for 10 years so there is no need to retain paper notices.  We recommend electronic delivery for everyone as the best way to protect your personal information, particularly when all information is easily accessible in a secure way online.

Equities:  We are increasing the allocation to stocks due to short-term factors which are supporting a rebound in prices.  The rebound was predominately led by technology stocks, particularly the largest stocks such as Apple, Amazon, Google, Facebook and Microsoft.  They are currently selling near or at all-time highs despite economic conditions.  The rest of the global market has not done nearly as well.  Many asset classes are still selling 20% or so below their highs.  We are seeing short-term opportunities to earn a decent return in these asset classes.  International stocks are looking particularly attractive due to stabilizing economies and the ECB has just announced major financial support which should improve the near-term outlook.

Fixed Income:  With extraordinarily low interest rates, we have also increased exposure to the broader bond market to try and capture some additional return.

Markets are forward looking and below is the sentiment we want to capture with the additional investments.

• We have record levels of joblessness (exceeding levels reached in the Great Depression) but there is a promising trend in people being called back to work as the total number collecting unemployment starts to fall as evidenced by the jobs report this morning.
• Restrictions on economic activity are loosening with a corresponding strong increase in economic activity, albeit from a very low base.
• Deaths due to COVID-19 are trending lower. Other metrics such as ICU patients, hospitalizations and cases in high population density metropolitan areas are decreasing.
• The national saving rate has dramatically increased with all the stimulus, much smaller job losses among higher income professionals and no place to spend money. The translation is there is a lot of cash in our economy for both a spending rebound and supporting investments.
• Interest rates are again at record lows for borrowers, even though credit standards have tightened. This should help the real estate markets and larger consumer purchases.

But we cannot be complacent.  There are still significant risks.

• COVID-19 infections will likely return in the fall We do not know the potential severity or breadth of any future outbreak. It is even within the realm of possibility the virus may mutate to a significantly less virulent form.  We still do not have adequate therapeutics to treat infections.  As for a vaccine, we are all hopeful the extraordinary efforts to develop a vaccine will be effective sooner rather than later.  But we also need to keep in mind this fact.  There are seven coronaviruses that are known to affect humans.  There is not an effective vaccine for any of them.  These are real risks to keep in mind to determine if human behavior – whether voluntary or mandated by guidelines and various levels of government – remains constrained and continues to drag on the economy, or how quickly consumers can return to much closer to normal.
• The trade war with China is real. It does not matter what side you fall on the trade debate there are two underlying facts.  Any conflagration is likely to impact stock markets.
  • China is a formidable competitor and has not followed international law or conventions pertaining to intellectual property. They have aggressively been co-opting (a charitable interpretation) technology to build their domestic capabilities.  With substantial numbers of college graduates, particularly in the technology, science and engineering fields, (a larger number than our own country), they are expanding their economic power to the most profitable knowledge-based industries.  This includes their military capabilities as well.
  • Trade wars have a cost, they reduce economic activity and may not be effective.
• Prior to COVID-19, federal government spending was 35% higher than revenue and intermediate term government bond interest rates due to Federal Reserve actions were trending at or below inflation (where 1.6%-2.4% above inflation would be the norm). With this kind of stimulus, it does not matter what political party is in power.  With nearly full employment, much of this money will find its way into investments.  With stimulus spending, the government is projected to spend about twice the expected revenue in the fiscal year ending October 2020.  Take a moment to think about those numbers.  If you were spending 35% more than you were taking in, how long could you sustain it?  What about 100% more?  One clear consequence is going to be some level of higher tax rates, potentially reversing the positive effects on asset prices from recent tax cuts.

We are in a position to try and make sure your portfolios will provide financial security over a long period of time.  As an example, think back over the last 20 years.  In the year 2000, the S&P 500 reached a new record high.  11 years later, the S&P 500 was selling below that level.  We are now going on 11 years of the S&P 500 rising from the last market crash to new records.  Stocks were priced at the high end of their historical range based on earnings and the overall size of the market to GDP.  Now some stocks are approaching those levels again.  There is virtually no chance we will not eventually see lower price levels in the stock market than we have today.  While we hope to capture more return on this upswing, we will also use our techniques to limit the effects of any large sell-off if and when it occurs.

From the start of the pandemic to the outbreak of social unrest after witnessing cell phones capture the appalling murder of George Floyd, it is also time to reflect on the state of our nation.  For all our strengths, these events underscore underlying weaknesses in our system.  From health care to equal treatment under the law, from economic opportunity to the increasing wealth gap, we need to challenge ourselves as a country to do better.  Today the market seems divorced from all the bad news, but it will not always be the case. There are no guarantees markets will always go up.  Being able to adapt to changing circumstances will make a difference in the long run.

As always, we are available if you have questions.