As August closes at a record high for the S&P 500, we remain bearish heading into the final stretch of the third quarter. With the Federal Reserve signaling a pivot towards a more accommodative stance, “Chair Jerome Powell unveiled a new approach to setting U.S. Monetary Policy, letting inflation and employment run higher,” a shift that will likely keep interest rates lower for longer. This proactive stance should have investors concerned, however, may be beneficial to those with a higher appetite for risk.
2020 has shown a disconnect of epic proportion when comparing Unemployment (U-6) to the stock market (S&P 500). A stark comparison depicted below, as the S&P 500 seamlessly advances above 3000, while Unemployment U-6 peaks early in Q2, above 14%. At Samra Wealth Management, it is our opinion that politicians and Wall St. professionals appear to lack in common sense and good judgement. In our May issue of The Samra Report we shared the following excerpt:
In an interview at the Economic Club of Washington, D.C., Federal Reserve Chair Jerome Powell stated that he does not see a recession. A statement echoed by Treasury Secretary Steven Mnuchin, who “sees the stock market riding a wave of demand once the outbreak is contained”. We believe the term forced recession has been used to help alleviate the pain of losses and reassure investors that a recovery will be swift. Investors would be wise to understand that a forced recession is still a recession, regardless of how we arrived here.
In our November 2019 issue of The Samra Report: “Winter is Coming” we stated: “consumption spending makes up 68% of the United States GDP equation, insinuating a reduction in wages translates to a reduction in economic output. Although economic data does little to support our view, we remind investors that economic data did little to predict the last financial crisis.” Fast-Forward to H2 2020, the disparity between valuations and economic data become even more concerning: The stock market continues on an upward trajectory while Americans are being laid-off at the fastest rate since the great financial crisis, yet, delinquencies on residential loans are nearing 2007 lows. Digging deeper into the data, you will find single-family residential mortgage and credit card loans experienced an uptick up until Q1 2020, indicating government stimulus measures are working. However, continue to peel back the layers, and you will learn 32% of Americans had outstanding housing payments at the beginning of August 2020. At first glance, this may not appear troubling until you factor in:
Most residential mortgages are packaged and securitized, creating investment products.
“In the second quarter of 2005, credit card delinquencies hit an all-time high – even though house prices had boomed.” According to Michael Lewis in his book The Big Short, signaling a fundamental weakness in the strength of our economy.
Readers should at this point be asking themselves two questions: (1) Does the current economic and financial climate echo similarities to that prior to the Great Financial Crisis. (2) What portion of your fixed income portfolio Is backed by residential mortgages.
The impact of unemployment has temporarily been bridged by government stimulus measures, specifically the treasuries ability to print money. In the near-term a low interest rate environment signals a thriving residential real estate market; however, the longer-term effects of low or negative yields will impact the strength of the US Dollar, while access to “cheap” capital creates upwards pressure on inflation. Investors should similarly ask themselves two additional questions: (1) How sensitive is your portfolio to interest rates; (2) how to hedge foreign currency risk in your portfolio.
Although not the most volatile year in terms of market history, 2020 has been a year filled with volatility. The disparity between the S&P 495 vs the 5 largest companies in the S&P 500 shows cause for concern. According to Charles Schwab’s Chief Global Investment Strategist, Jeffrey Kleintop:
Take market value out of the equation and U.S. stocks are faltering after years of global dominance. A version of the S&P 500 Index that gives equal weight to each stock dropped 2.9% this year through Friday, according to data compiled by Bloomberg. At the same time, an equally weighted MSCI index of non-U.S. shares fell just 2.3%. The S&P 500 gauge led the last seven years, except for 2017. “The outperformance by the biggest U.S. stocks is hiding a change in leadership by the average stock.
At Samra Wealth Management, our risk-off philosophy is risk-on, and we recommend investors talk to their financial advisor about considering how the below strategies may provide some downside protection against possible loss and volatility:
Positions in Leveraged Gold
Positions mirroring the S&P 500 VIX Short-Term Futures Index
Selling Put options on High-Quality equities, following the Samra Wealth Management Sector Rotational Strategy on the areas of Technology, Healthcare, Industrials, Financials and specific consumer related holdings.*
Purchasing Put Options for downside insurance.**
Disclosure: All views/opinions expressed herein are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. All economic and performance data is historical and not indicative of future results. The information contained here does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities.
*, ** The strategy discussed above is for illustrative and educational purposes only and should not be construed as an endorsement, recommendation or solicitation to buy or sell any particular security. Options involve risk and are not suitable for all investors. Certain complex options strategies carry additional risk. Please read the options disclosure document titles Characteristics and Risks of Standardized Options by clicking on this hyperlink text https://www.theocc.com/about/publications/character-risks.jspbefore considering any options transactions.
Covered calls provide downside protection only to the extent of the premium received and limit upside potential to the strike price plus premium received.
The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. Indexes are unmanaged and do not incur management fees, costs, or expenses. It is not possible to invest directly in an index.
References
Adamczyk, A., 2020. 32% Of Americans Had Outstanding Housing Payments At The Beginning Of August. [online] CNBC. Available at: <https://www.cnbc.com/2020/08/06/32-percent-of-americans-had-outstanding-housing-payments-at-beginning-of-august.html> [Accessed 31 August 2020].
Fred.stlouisfed.org. 2020. Unemployment Rate Vs S&P 500. [online] Available at: <https://fred.stlouisfed.org/series/UNRATE#0> [Accessed 31 August 2020].
Lewis, M., 2020. The Big Short. [online] Real-economics.blogspot.com. Available at: <https://real-economics.blogspot.com/2011/06/michael-lewis-big-short-obamas-mistake.html> [Accessed 31 August 2020].
Samra, I., 2020. The Samra Report: What If It Returns.... [online] Samra Wealth Management. Available at: <https://www.samrawealthmanagement.com/post/what-if-it-returns> [Accessed 30 August 2020].
Samra, I., 2020. The Samra Report: Winter Is Coming. [online] Samra Wealth Management. Available at: <https://www.samrawealthmanagement.com/post/winter-is-coming> [Accessed 30 August 2020].
Torres, C., 2020. Fed Paves Way For Low-Rate Era With Inflation Able To Run Higher. [online] Bloomberg.com. Available at: <https://www.bloomberg.com/news/articles/2020-08-27/powell-says-fed-to-seek-inflation-that-averages-2-over-time> [Accessed 31 August 2020].
Wenger, J. and Edwards, K., 2020. The Historic Economic Effects Of COVID-19. [online] Rand.org. Available at: <https://www.rand.org/blog/2020/05/is-the-unemployment-rate-now-higher-than-it-was-in.html> [Accessed 31 August 2020].
Wilson, D., 2020. U.S. Stocks Lose Worldwide Dominance When Counted Equally. [online] Bloomberg Radio's Dave Wilson. Available at: <https://theonedave.tumblr.com/post/628078974792351744/us-stocks-lose-worldwide-dominance-when-counted> [Accessed 31 August 2020].