So, What’s the Good News?

 Image by Daniel Barreto for United Nations Global Call Out To Creatives

May 10, 2020

Dear Friends,

If this note seems a bit stylistically unpolished, it’s because the thoughts have been pieced together from parts of 4 or 5 separate newsletters we’ve begun and abandoned over the past two weeks.  News, events, observations and assessments of the virus and possible solutions have been changing very rapidly, daily.  As of today, Sunday, May 10th, this is how it seems to us.

In a time of uncertainty, spanning the spectrum of our daily activities, health, work and finances, no consensus has emerged about how the country and, indeed, the world, can regain a measure of familiar routine.  We know what has to be re-assembled: work, school, family, social and civil life, the network of local and global commerce, finances and planning and investments for the future. How do we get from here to there? As of now, no map and navigator has been identified.

Contrary to much of what has been available via the media and scholarly publications, there are elements to this experience that are common to many past events and transitions.  However, while the categories are common to previous times, the solutions may not be.  Most disconcerting is that to many, the solutions seem unclear or even impossible.

One dynamic that we expect to be reliable, as it has been in the past, is the restoration of economies and financial markets.  There have been catastrophic upheavals induced in the financial markets from events that were significant outliers: unexpected and seemingly all encompassing.  These so-called “Black Swan” events challenge our sense of continuity.

Many financial advisors serving clients today have experienced several of these.  Some of us have experienced even more. In each case, the decline in the indexes was brief and as the economy overcame the issue or event that concerned investors, the markets responded to the increase in economic activity thereby producing an increase in company profits. The market reflected that increase in activity through improving company share prices. 

The improvement in economic activity is experienced through the increase in standards of living.  Today, literally billions of people are living at higher standards than in earlier times. This is the driving force behind economies and markets.  It is not going to stop or disappear though it may be temporarily affected by the appearance of the coronavirus-19.  Many people around the world have suffered and died during this pandemic and there is a massive worldwide economic cost. The disruption of life as it was before is incalculable at this time.  There will be controversy and criticism of how the major countries responded to the threat of this virus. However, it is clear that a massive global effort is underway to implement anti-viral remedies and eventually a vaccine to minimize future impact. Already some discoveries and applications are showing themselves to be effective to some degree. 

In order to appreciate how we will emerge from this, we need an understanding of the state of the economy before we can appreciate how the recovery will take place. Several aspects of this have embedded clues within them as to how long it will take to resume a semblance of familiar life, among them are:

• Inflation:

First, the economic destruction was not the result of an economic cause.  After 11+ years of global and U.S. economic growth, a ‘slowdown’ was already occurring.  Some of it was the natural fatigue of staying close to growth limits.  Unemployment was at its lowest level for the past 50 years: typically, this is one of the main causes of a slowing economy and it is usually accompanied by rising inflation.  The economy can’t operate at this high rate of employment without a competition for labor emerging and increasing capital expenditures, which in tandem can allow for an increase in productivity at a diminishing rate of return.  This is often the spark that ignites inflation.  Up to the recent shutdown of the economy, inflation had not yet been triggered in any meaningful way.

Of course part of the reason was that the Federal Reserve Board, which has the responsibility for modulating inflation and employment has been using many indirect and creative methods to keep interest rates low and inflation low since the 2007-09 “Great Recession.”  Tight controls of immigration contributed to the diminished labor supply and added additional inflationary pressure. But that pressure hadn’t reached inflationary ignition point yet. 

• China:

In addition, there was an accommodation with China about trade that needed to be rebalanced.  The potential for a slowdown in both economies became evident and resulted in quick agreements being made, effectively setting the issue aside for the future as both countries had other domestic issues that needed attention. 

None of this meant that a recession was imminent.  Yes, slower growth, but not necessarily a contraction.  Low interest rates, low inflation and a somewhat smoother trade environment would have probably allowed an increase in Gross Domestic Product (GDP) going into the new year, which the financial markets recognized by expanding P/E multiples.  If corporate earnings were just maintained, this would naturally increase share values.

In fact, this is what was occurring into February 2020.  The threat of a global contagion was not part of this picture.  As it became clear that we were facing a very serious spread of a new, potent virus, some of the very developments that have supported the global economy (travel, trade, manufacturing) became the vectors that spread the virus quickly.  In retrospect it is clear that most of the world was unprepared for this.  As the threat was assessed, drastic measures had to be taken to reduce the rate of infection, or as the phrase became known, “flatten the curve.”

We, the planet, are now in phase four of the unwelcomed, dangerous and unfortunately deadly experience.  Phase one was denial and blame.  It was short lived as the infection spread around the world very quickly.  Phase two was acceptance, followed by mobilization, reaction and response.  We, America, were not prepared for phase three.  It was a long agonizing and makeshift process that ultimately brought the entire country to a standstill, both figuratively and literally.  The markets no longer knew how to price companies in this situation and consequently the equity markets declined swiftly and very significantly.  All these phases have been accompanied by great fear. 

However, at great human, material and financial cost we have arrived at the event horizon of phase four: recovery and rebuilding.  While in the earlier phases attention was almost exclusively on slowing down the contagion, a new problem was building and coming at us very quickly. However, we were not paying attention to it: what do we need to do, exactly, to restart the economy? We are only beginning phase four and we have no proven plan or pattern to follow. No economy has ever been shut down like this before. Fear has started to subside and anger and frustration are beginning to emerge.

This is now a ‘known unknown’: we are slowly experimenting with how to do this, as evidenced by a range of decisions from state to state and country to country.  The financial markets still do not fully know how to accurately value a company.  Most companies are currently unable to provide analysts with guidance past the first quarter.

In addition it isn’t clear that even in the best case this recovery will be smooth.  We do not think it will be.  We have to be prepared for unexpected conditions.  For example, the rehiring of millions of people likely will be considerably more difficult than laying them off, with or without the relief measures taken by Congress. Some people have said that the experience of so abruptly losing a job and having no income will result in a relatively easy time rehiring existing employees that are eager to begin earning a living again.  We don’t think it’s that simple.

First, significant numbers of workers are filing for unemployment.  The figures seem to be that between 20 and 30 million may file before the “lock-down” is fully lifted.  Those who file, particularly from regular full time jobs qualify for an extra $600.00 a week through July.  Do you think that a person who was barely getting by on their regular paycheck is going to be eager to turn down an extra $2,400.00 a month through July?  Stories are already surfacing of laid off employees choosing the stay on unemployment longer, rather than give up the extra funds.  Employers that applied and received the “Paycheck” loans that Congress made available MUST pay those funds out to an equivalent number of employees for 8 weeks as they agreed on the application.  If they don’t, they have to payback those funds to the government.  The terms of the loan are favorable, but having the loans forgiven and made a grant is much more inviting.  If the employees go back to work, they lose the extra $600.00 a week along with the base unemployment check.  Both of these cannot happen simultaneously  And there is the problem.

Further, if a person was not thrilled with their job, right now there are hundreds of thousands of businesses they can approach for a different job.  They are in great demand.  This will not be a case of the laid off employee simply picking back up exactly where they left off and this may be true for the employer as well.

So, what is the good news?  There is GOOD news.  The markets loath surprises.  What we just described above about re-opening the economy should not come as a surprise.  We all knew it was coming and could be discounted by the markets to some degree.  The recent increase in the value of the markets is an expression of this. Even companies that show a terrible, but better than expected set of numbers will be rewarded by eager investors.  Those that have disappointing numbers will be hurt, perhaps to the point of going out of business, for example, Niemen Marcus. There will be mergers of weaker companies with stronger companies that can strategically help each other.  New products and services will be invented and discovered.  If they genuinely have a benefit, they will be able to prove themselves in the marketplace.  Remember, there was a time, really, when there was no smart phone, video streaming, cloud anything or personal, desktop computers. 

The future is open-ended and that space will be filled with many imaginative possibilities.  If…

And here is the final caution.  The virus and the way we have dealt with it, has been like an earthquake.  It has shaken the very foundation of our economy. We apologize for mixing metaphors, but we have spoken for a long time about the “ballast” that the U.S. economy has.  It is massive, has depth and hidden resources, not the least of which is a base of knowledge, skill and creativity that has taken on major challenges and found solutions.  At this time our economy is the largest, most productive, stable and dynamic there is.  It may not be so forever, but it is now.  If the economy is quickly restored and if this reboot is done well, we can accelerate out of this inertia and confusion.  Perhaps it will take a year to see the momentum build, perhaps longer.

Let’s agree that 2020 is a lost year and devote whatever it takes to clear the debris field from the earthquake and reestablish the base of our economy and culture on a more secure, enlightened, just and open basis.  A dilemma that we as a country are now facing is that the Federal Reserve and congress have provided tremendous support to our economy. The dilemma is that this support may have the effect of continuing to prop up what should be allowed to find its own more sustainable growth trajectory. Until it does, the market will likely be more susceptible to ups and downs. Given this mixed scenario, our best assessment, based on the current situation, is that more reliable growth in the economy will emerge in 2021. 

Impact of the above on your investment strategy:

In the course of this coming year we see this as an appropriate time to jointly review your financial plans, your goals and investments. The goal of a regular review is to adjust wherever is necessary to help increase the probability of your success over the long term.

As always, we welcome and thank you for our collaboration.

Here’s to your continued good health and good wealth.

Jerry! Bernard, Kim, Eileen and Colleen