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Key takeaways:
- Reduced likelihood of another shutdown
- Liquidity from central banks is propping up the markets
- Growth continues to decrease as inflation ticks up
- Proactively plan around taxes
Normally we wash our cars at a car wash place down the street from our house. But with the heat and Covid-19, I thought it would be a great idea to try washing our cars at home with my two girls. Everything started fine, but I soon was testing my patience as one daughter was using the water hose at the same time the other was opening the windows. Obviously, it was my fault by not laying out a plan, or having a process; none of us were on the same page. All said, everything turned out fine and now we have clean cars without cheerios all over the back seats. Speaking of the importance of process, over the last couple of weeks, I have been talking about our investment process and how we come up with our investment recommendation. I know given all the uncertainty around the markets it can be stressful. This week we are talking about a lower likelihood of another shutdown, GDP coupled with unemployment and the importance of having a strong financial plan.
COVID-19 topped 150,000 deaths by Wednesday, with growth rates continuing to increase in California, Florida and Texas. The loss is horrible and now almost everyone knows of a family that has had COVID. Doctors are now learning more around the long-term effects of COVID. With many states not meeting CDC guidelines around reopening and an uptick in travel, COVID will be here for a substantially longer timeframe than originally anticipated. While many of us are taking various precautions while we wait for a vaccine, the critical facts for avoiding infection remain the same: distance and exposure time. One of the positive side effects of social distancing in the Southern Hemisphere, which currently is in peak flu season, is a sizable drop in flu cases, with estimates of a reduction in cases of 70-90%. A similar trend in the US could mean less strain on our hospitals during fall and winter, implying that a second wave of COVID-19 could be manageable with current infrastructure and medical supply chains. This is good news since it will reduce the probability of another complete shutdown.
The Worst Drop in GDP Since the Great Depression Coupled with Increasing Job Losses
This week the Bureau of Economic Analysis came out with a 32% drop in GDP from last quarter. This figure was in all the major headlines. However, keep in mind the 32% stated in the report is an annualized number, meaning that the actual drop in GDP from last quarter was 9.5%. That said, a 9.5% drop in quarter over quarter GDP is still the worst drop we have seen since the Great Depression, which was 12.9% over a whole year. For context, quarter over quarter decline during the 2008 Financial Crisis was 3.8% (measured over 5 quarters).
We also saw new figures come out around job losses with jobless claims rising to 1.43 million. Weekly jobless claims still remain on top of the pyramid as important data to watch in relation to investment risk. Four months into COVID, unemployment claims continue to grow and my sentiment is that a good percentage of these jobs will not come back. Current total unemployment claims are at 34.5 million and we believe this number will grow as this was the last week of PPP loan benefits.
Direction Within Investments
I believe currently the markets are not a reflection of the current economy, but rather a reflection of how much the central banks can create liquidity. We are looking for the second- and third-degree effect of high unemployment and unlimited printing of money which I believe will result in slowing growth alongside increasing inflation. In this current market environment, our risk mitigation strategy has worked well.
Congress is working on the GOP version of CARES Act 2.0 called the HEALS Act, which recently failed to pass in the Senate. The reality is that after bi-partisan compromise, we will likely have another $2 trillion dollars entering the money supply. Essentially, the Fed has been asking Congress to print more money which in turn will be used to prop up the markets. Another injection of large liquidity into the market furthers our view around increasing inflation.
Based on our outlook around market dynamics, we are reducing risk in our portfolios while staying in the same risk tolerance by overweighting investments in large US companies and government bonds. Specifically, with our view that inflation will increase, we have over-weighted utilities and treasury inflation protection securities. We have also added non market driven assets such as gold and commodities into our portfolio mix, 2-6% of the overall portfolio depending on risk tolerance band.
Keep in mind even the most conservative risk tolerance still has a fair amount of volatility given all the moving pieces in the economy. Some of these include the exhaustion of PPP funds and resulting impact to struggling businesses and employment, eviction moratoriums ending, and loan forbearance programs facing a series of hard stops. On top of that, we have job losses re-accelerating and enhanced unemployment benefits expiring this week. There is enough there to create a lot of uncertainty.
Proactive Planning
Covid-19 and the changing employment landscape has significantly impacted finances, both short and long term, for many families. Some individuals, particularly those in high risk age groups, are now considering early retirement while others will likely need to work longer than anticipated given loss of income. Family dynamics are also changing for many with adult children moving back into the home or grandparents moving in with children. These life changing decisions make it important to have a strong, well thought out family plan in place.
One of the bigger expenses in retirement is taxes. It is my view that there is a high probability of increased taxes in the future as both the federal and state governments seek to reduce deficits brought on by Covid-19. Given current tax rates, which are anticipated to be lower than future tax rates, we are encouraging individuals and families to proactively plan around taxes.
Here are 5 ways you can plan today:
- Roth conversions – Future tax rates may go up
- Harvest some gains – Long-term capital gains rate may realign with ordinary income
- Boost your giving to beneficiaries today – Annual gifting amounts may be capped in the future
- Take advantage of the low interest rate environment and do complex estate planning – Low interest rates and high exemption amounts make this an ideal time to do complex estate planning
- Make family loans – Inter-family loans are at historically low interest rates.
I anticipate having conversations around these strategies as we enter into October. Again, if you like this newsletter, please share it with someone who can also benefit from our thought pieces. These newsletters contain original content on our views and address topics asked for by our clients. If you have any questions or suggestions, please let us know.
Related: Investments Will Always Look to Fundamentals to Guide the Path of the Market