LGT's Profit Sense

We made it to mid-September of a year uniquely defined in just about every facet of life. From a personal well-being standpoint, the COVID-19 pandemic has claimed the lives of over 193,000 individuals in the US in just over 200 days. With hope of a vaccine on the horizon, individuals are keeping a close eye on development and action plans for administration once approved by the Food and Drug Administration (FDA).

Procedures put in place to mitigate the spread of the coronavirus have led to extensive quarantining, loss of jobs and businesses, workplace adaptation, trillions of dollars of federal funding, and a heightened sense of insecurity about public health.

Along with the coronavirus pandemic, American’s have taken a strong stance towards ending social injustice this year, looking specifically at the leadership of our country for guidance and change.

All of these variables are building steam as we head into November – US Presidential election month.

The following is an assessment of the past month, and what to potentially expect in the future as uncertainty about financial and personal health grows.

During the month of August the S&P 500 index turned positive for the year at +6.25%, only 106 trading days after the March 23^rd, 2020 low of -30.4% YTD. The roughly 5-month recovery time is 38 months shorter than the 43-month recovery average of the previous 5 bear markets where the index dropped more than 30%.

Between the March low and the end of August the S&P 500 index closed at new all-time highs seven separate days. Since the day the World Health Organization (WHO) declared the coronavirus a pandemic (March 11^th, 2020) and September 11^th, 2020 the index gained 23%.

Overall the equity recovery seems to be in full stride, but the details provide a bleaker outlook.

An estimated 29% or 145 companies that comprise the S&P 500 index are still down an average of -20% YTD.

Similarly, the tech-heavy NASDAQ index was up just shy of +27% YTD through August, but only five of the 3,300 companies the index tracks drove roughly 40% of the cap-weighted return. What this translates to is a façade of recovery marred by companies struggling to stay afloat.

Thankfully, over the past 30 years the S&P 500 index’s worst 12-month period was between March 1^st, 2008 and February 28^th, 2009 at -43.3% return, and it seems 2020 will not replace this record.

Within the fixed income space investors have seen consistently low treasury yields since the all-time 10-year US treasury low of 0.501% set March 9^th, 2020. While this low yield trend will seemingly continue throughout the rest of the year and through 2021, the 10-year U.S. Treasury note yield last closed above 2% at the end of July 2019 – over one year ago.

Although yields have been low, the Bloomberg Barclays Aggregate Bond index, which calculates 6,000 publicly traded government and corporate bonds with 5-year average maturities, was positive almost +7% through the end of August 2020.

Since the onset of the pandemic, the gap between returns of “risky” assets (US Investment Grade notes, US High-Yield notes, and Global Equities) has tightened and even inverted compared to “risk-averse” assets (US Treasury notes, US Municipal notes, and Gold). The closing of this gap points to investors seeing above-average returns for traditionally safer assets when compared to the returns of riskier assets. With many factors at play, it is clear to see that return-seekers are viewing fixed income as a reliant source in these volatile times.

At the beginning of the year lumber producers cut supplies on the thought that home builders would be stalled for the foreseeable future. This supply cut did not last long, as the price per thousand board feet (PBF) is now $858, up over 110% from the $406/PBF at the end of 2019.

Other thriving commodities are precious metals, specifically silver and gold. For the first time in history the price per ounce (PPO) of gold pushed over $2,000 this year. This increase has partly been due to the weakening US dollar, partly due to low interest rates, and mostly due to the equity market volatility that convinced investors to flee to safety.

But not all commodities have been as fortunate, with oil production being slashed due to demand decreasing significantly throughout the year. In 2019, the world production of crude oil was 101M barrels per day, while 2020 has seen output slashed by an average of 2.4M barrels per day since mid-March. OPEC+ came to an agreement in April with a plan of action for oil output, but the recovery process will be arduous as the demand for oil is stagnant.

As of the Q2 US Gross Domestic Product (GDP) report, the US debt-to-GDP ratio was 137%, or $26.5T of government debt divided by the $19.4T economy. This ratio also highlights the 10% fall of US GDP in Q2 2020. And the borrowing has no end in sight, with the government forecasting $4.5T of total borrowing by the end of FY 2020 (ending September 30^th, 2020).

For comparison, the previous four fiscal years combined total borrowing equated to $3.8T.

U.S. household debt continues to grow

Specifically for mortgage debt, as almost 70% of the $14.27T US household debt represents mortgage loans. Although, with the current low interest rate environment the majority of mortgage applications this year are for refinancing for a better rate.

Like with most sectors and the world as a whole, the road of recovery for the US economy will be lengthy. While the jobless claims data lately has been better than Q2 2020, the positive numbers for the labor market have essentially stalled. The lowest unemployment levels since the beginning of the crisis have been reported over the previous two weeks, but the numbers are still over four times higher than the same time period one year ago. The 4-week average for continuing uninsured claims is near 9.2% or 13.385M, profoundly higher than the 1.7M average pre-pandemic.

Looking ahead for a sign of stability in this economy is somewhat like venturing through a corn maze – there is an end somewhere, it will just take consistent effort to find the path to the end. The 2008 Great Financial Crisis was concentrated to over-leveraged financial institutions, while 2020 has shown that businesses across all industries were over-leveraged before the coronavirus took hold, leading to more than 250 bankruptcy filings of companies with at least $50M in liabilities through the first 7 months of 2020.

The labor market onslaught is predicted to continue, with analysts estimating 33% of the layoffs between March and May will be permanent (i.e. those individuals will not re-enter the labor market). Investment grade companies are projected to borrow $1.6T of bond offerings through the end of 2020, blowing past the $1.3T record set in 2017.

Most analysts are assuming the US economy will not recover to pre-pandemic levels until 2023 at the earliest. And what makes this corn maze of life even more difficult is unknown Center for Disease Control (CDC) guidelines that will help re-open the economy. Some industries, like travel and leisure are relying heavily on these guidelines, as more than 57 cruise ships are currently anchored near U.S. ports without passengers or sailing schedules.

As for next steps, recent polls show that only about half of Americans would be comfortable receiving a vaccine once developed.

In July the CDC estimated that 40% of Americans infected with COVID-19 will remain asymptomatic through their infection period, so mitigating the spread is even more difficult when trying to trace infections.

Whatever the path might be, remaining diligent in personal health and adhering to a comprehensive financial plan can limit sleepless nights and overall negative stress.