The First Domino
“In just two months the unemployment rate has gone from the lowest rate in 50 years to the highest rate in almost 90 years.” Gus Faucher, Chief Economist at PNC Financial The global health pandemic has exposed fundamental weaknesses in world financial markets and economies. As the stock market (S&P 500) has recovered with a slight gain year-to-date, it may have lured smaller investors into a false sense of security that the worst is behind us. However, for those tracking the S&P 500, according to Bloomberg’s Dave Wilson, “there’s a distinction to be made between the S&P 500 index’s five biggest companies and all the rest. Amazon, Apple, Facebook, Alphabet, and Microsoft’s combined values have increased 266% from the start of 2015, whereas the remaining 495 rose just 25%.” In 2020 they closed Disneyland and it is uncertain if there will be a Super Bowl. According to Chairman Jerome Powell, “A prolonged recession and weak recovery could also discourage business investment and expansion, further limiting the resurgence of jobs as well as the growth of capital stock and the pace of technological advancement. The result could be an extended period of low productivity growth and stagnant incomes.” The textbook definition of a recession is “two consecutive quarters of economic decline”, however, in differentiating the textbook definition to the real-world scenario, we urge our readers to consider the following: In 2020 they closed Disneyland and it is uncertain if there will be a Super Bowl. This week we learned from testimony given by Jerome Powell, “Among people who were working in February, almost 40 percent of those in households making less than $40,000 a year had lost a job in March. This reversal of economic fortune has caused a level of pain that is hard to capture in words, as lives are upended amid great uncertainty about the future.” There exists a common misconception that the economy and financial markets are strongly correlated. With 1 in 5 Americans claiming unemployment benefits, not factoring in illegal workers, those not declaring income and those business owners not eligible, we have a large portion of Americans with lower household income, where income is a function of household spending. As consumption makes up 68% of U.S. GDP, similarly business spending, known as investment spending, makes up an additional 20% of U.S. GDP. The risks remain significant: with less income paid to households, households consume less, leading to less corporate revenue, leading to layoff, creating a snowball effect of further decreases in household income. With government stimulus measures in place, Q2 GDP is -32.9%, the sharpest decline since modern tracking began in 1947, with the next worst drop of 10% coming in 1958. The questions investors should be asking is, what happens to the economy should government stimulus measures stop. The depth of economic devastation our nation is experiencing is not an act of God, it's a failure of Presidential leadership As part of the stimulus plan expired July 31st, many Americans face the risk of losing the supplemental $600 of unemployment benefits. As Senate Democrats and Republicans negotiate for a solution satisfying both sides, we believe it is unlikely we will see a solution this week. Furthermore, we believe Senate Democrats may prolong negotiations, undermining the current administration, as Americans feel further financial discomfort. Presidential Candidate Joe Biden was swift in commenting on historical GDP numbers: "The depth of economic devastation our nation is experiencing is not an act of God, it's a failure of Presidential leadership. Had President Trump taken immediate & decisive action, 10’s of thousands of lives & millions of jobs would never have been lost". We expect Democrats in the coming months to leverage a full-scale attack on the Presidency, with the use of conventional and social media. President Trump recently remarked “if Americans wanted their 401(k) and stocks to disintegrate and disappear, they should vote for Joe Biden”. In the immediate term we could see an initial shock to the market, however, recent data suggests the markets may be pricing in a Biden Presidency, and the question investors should be asking is, how will business activity and consumption spending fare in a low interest rate, low tax environment? At Samra Wealth Management we expect heightened volatility over the summer months, with the U.S. Covid-19 related death toll surpassing 150,000 and increased travel restrictions against the U.S., it has become evident that there is a resurgence of the coronavirus based on data provided by the Department of Health & Human Services, showing hospital inpatient hospital beds in Southern States, occupied by Covid-19 patients at over 20%. It could be suggested that there exists a correlation between conservative state leadership, prioritizing constitutional rights and religious beliefs over science and human rights, with the growing spread of the virus. Furthermore, we expect market volatility to be exacerbated in Q3 from a number of factors as we approach flu season, research pointing to a heightened hurricane season, and the number of smaller investors moving markets as institutional investors remain on the sidelines. We further believe clients of large wire houses such as Merrill Lynch, Morgan Stanley and UBS, in search of higher yields, stand to experience higher losses, as Merrill Lynch recently reported: “US equities are not cheap but we are still bullish because there is no alternative (record 77% of S&P 500 stocks pay higher dividends than Treasuries)”. Mike Wilson, Chief Investment Officer at Morgan Stanley believes the worst is likely behind us, as markets have likely priced-in fears of a recession, recommending investors look towards equities. While Mark Haefele, Chief Investment Officer of UBS believes “fiscal stimulus, pent-up consumer demand, and negative real interest rates should provide further upside for stocks in the months ahead.” Sentiments we do not share, as we stated in our June issue of The Samra Report: Where’s Warren, Mr. Buffett has amassed a war-chest of $137B in cash. Investors should ask themselves why would the ‘Oracle of Omaha’ be sitting on $137B in cash, could it be that Mr. Buffett believes the worst is yet to come? With Q2 GDP coming in at negative 32.9%, we would argue the first domino may have already fallen, and investors would be wise to meet with their financial advisors sooner, as opposed to later... 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 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 Centers for Disease Control and Prevention. 2020. COVID-19 Data Dashboard – Patient Impact & Hospital Capacity. [online] Available at: <https://www.cdc.gov/nhsn/covid19/report-patient-impact.html> [Accessed 30 July 2020]. Haefele, M., 2020. Narrow Market Rally Can Broaden Out In Second Half, UBS’S Haefele Says. [online] Bloomberg.com. Available at: <https://www.bloomberg.com/news/videos/2020-07-23/narrow-market-rally-can-broaden-out-in-second-half-ubs-video> [Accessed 30 July 2020]. Oaklye, D., 2020. Hunt For Yield Pushes More Investors Into Riskier Assets. [online] Ft.com. Available at: <https://www.ft.com/content/9ab40034-a4db-11e6-8898-79a99e2a4de6> [Accessed 30 July 2020]. Powell, J., 2020. Speech By Chair Powell On Current Economic Issues. [online] Board of Governors of the Federal Reserve System. Available at: <https://www.federalreserve.gov/newsevents/speech/powell20200513a.htm> [Accessed 30 July 2020]. Samra, I., 2020. The Samra Report: Where's Warren. [online] Samrawealthmanagement.com. Available at: <https://www.samrawealthmanagement.com/post/where-s-warren> [Accessed 30 July 2020]. Schwartz, K., 2020. I’M A U.S. Citizen. Where In The World Can I Go?. [online] Nytimes.com. Available at: <https://www.nytimes.com/2020/07/07/travel/american-travelers-restrictions-coronavirus.html> [Accessed 30 July 2020]. Woodard, J., Young, J. and Devery, J., 2020. The RIC Report: Where To Go When Yields Are Low. [online] ml.com. Available at: <https://olui2.fs.ml.com/MDWSODUtility/PdfLoader.aspx?src=%2Fnet%2Futil%2FGetPdfFile%3Fdockey%3D6208-12160077-1%26segment%3DDIRECT> [Accessed 30 July 2020].