Bulls vs. Bears

Many people are trying to rationalize the disconnect between the stock market and the economy. Why is the unemployment rate at 14.7% and last week the futures market was up over 1% every morning? The trading sentiment indicators are reaching a euphoric level and the economic data is flashing recession. The short answer to this question is there has never been so much stimulus money being pumped into the economy. There is even more talk about another $2 trillion in stimulus money coming.

I’d like to share another observation that hasn’t gained as much press. I’ve realized that many large investors have become very bearish while younger investors have never been so bullish. Younger investors have opened a record number of brokerage accounts in the last three months.

The more experienced investors that I follow have all turned negative in one way or another. Jamie Dimon, Mohamed El-Erian, Carl Icahn, and Larry Fink are all warning about lasting economic damage. All of them were incredibly bullish for the last few decades. They have a front row seat to the real-time economic data and understand the longer term implications of how the business landscaped has permanently changed.

The younger and more bullish investors care less about fundamentals and short-term valuations. They much prefer price momentum and high volatility. I wrote last week that Elon Musk warned his stock price was too high and now Tesla stock is 4% higher than when he gave the warning. Younger investors shrugged off the warning because they are attracted to the daily volatility and positive price momentum and the high level of short interest in Tesla’s stock. There is a strong correlation that the more negative headlines about Tesla, the higher the price goes. The same could be said about the stock market. The more negative the headlines for the economy, the higher the wall of worry that stocks climb.

Maybe the younger and more aggressive investors have it right and the short-term fundamentals don’t matter as long as the long-term fundamentals improve when the pandemic ends?

This week I was on a conference call with Mohamed El-Erian. He is the chief economic adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-chief investment officer (2007–2014). He is a columnist for Bloomberg and a contributing editor to the Financial Times. His opinion is similar to the other views of the business leaders that have become more negative on the economy. Here is what he had to say.

He said we are all out of our comfort zones. Actually way out of it. Things are not going to go back to the way things were before. We are all worried about health risks and have experienced some mental anguish. There are many difficult decisions ahead. We have to reopen the economy, but are likely to see a second wave of the virus. Companies are going to become risk-adverse and they will change their supply chains. He expects companies will become less productive and there will be more of a domestic bias. The demand side of the equation is the major question market. I would add that this is where the more aggressive investors might have it wrong. Will people emerge from quarantine more frugal or ready to spend?

Mohamed believes that the more aggressive investors are also not taking into account that when the pandemic ends we will be left with more debt in the system. Governments, households, and companies will adapt to the changing landscape with higher debt levels. The more aggressive investors believe that they are in a win-win situation. They are betting that the Fed will bail them out or the politicians will mail out more checks. The Fed is your best friend and will even buy stocks if markets go down. Mohamed went on to say that if the Fed is willing to buy a high yield junk bond ETF then they would buy stocks as well. He was shocked by this decision because they are picking winners and losers and taking on default risk. This will lead to a misallocation of resources because people will only buy what the Fed is supporting, which is exactly what is happening. The flows into the High Yield ETF (HYG) have never been higher. This would not have happened if the Fed didn’t release a statement that they could buy High Yield. The Fed hasn’t bought yet, but the ETF symbol HYG is now in record monthly inflows. I have to hand it to the Fed that this bluff helped to stabilize the corporate bond market.

Mohamed finished the call saying that the long-term outlook for employment will depend on the path of the coronavirus and how fast consumers open their wallets when the economy reopens. Your goal should be to survive with your health and mental well-being and stay in the game financially.

It will be interesting to see how this all plays out over the next few years. Will the bulls be right in their early call for a sharp economic recovery or will the business leaders be right with their call for many stops and starts in the months and years ahead. I’d guess that if you are older and closer to or in retirement you will agree with Mohamed and if you are younger you will agree more with the bulls. 🙂

Expect “ups and downs”

As bad as the economic data has been, the news was even worse for Tesla shareholders. Elon Musk tweeted on Friday, “Tesla stock price is too high imo”. Tesla’s stock immediately fell -10% on this tweet. IMO it should have fallen 30% or more. For those that don’t write in internet slang, IMO means “in my opinion”.

PepsiCo CEO Ramon Laguarta summed it best on a call with investors when he said expect “ups and downs.” He went on to say we don’t think it’s going to be a straight line once people go back to moving around…with potential second waves in some particular markets.

IMO no matter when governments stay-at-home orders are relaxed business will not get back to normal. The source of the economic shock is not 100% the governments fault, it’s the pandemic. Over the last six weeks, 30 million Americans have filed for unemployment benefits. GDP growth showed the economy contracted 4.8% quarter over quarter. Companies and consumers are all preparing for a recession. U.S. banks have seen a sharp increase in both loans and deposits as people are taking out debt while they still can still show income. JPM and Wells Fargo put a stop to this practice as they are no longer offering home equity lines in fear that job losses will lead to in increase in defaults. The economic news couldn’t get much worse with almost 25% of the population now out of work. The conundrum we find ourselves in is the massive discrepancy between the horrible economic data and the rebound in the stock market. This begs the question, why would anyone want to own stocks in the worst economy since the Great Depression?

IMO the reason that you can still own stocks is that the Federal Reserve and Treasury are printing money at a level never seen in U.S. history. Below is a chart of the speed at which the Fed has printing money compared to the last 3 quantitative easing. The recent stock market recovery mirrors the rapid response of the Fed printing money. The Fed balance sheet ballooned by 50% to more than $6 trillion and economists believe that it will increased to over $10 trillion.

The unemployment benefits were most beneficial. For anyone who showed income in 2019 and lost their job or had their income substantially impacted by the coronavirus, they can collect unemployment plus an extra $600 a week for 13 weeks. If you own a business, the government will help pay your payroll for 60 days with no questions asked. There are moral arguments against accepting this money if you don’t need it. I believe that if the government is offering you free money then you should take it. Without people receiving extra money, the economy would never recover. Many people are actually making more money on unemployment as this chart below shows.

Moreover, the government dropped an extra $1,200 checks in the bank accounts of most Americans. With the increase of the supply of money, will this cause inflation?

IMO there is no inflation. The problem the economy is facing is deflation. Between the collapse in incomes, 20% drop in GDP, and 50% drop in energy, the biggest threat is deflation. I do expect inflation for food. There has been a shortage of meat due to the disruption in the food supply chain. With 30 million people out of work and companies slashing paychecks, deflation is starting to take hold. Companies are now in survive mode and they are going to continue to cut overhead and salaries. The only way out of this mess is for consumers to spend at the level of Christmas this summer. Hopefully, there is pent up demand and people are feeling flush as they have built up their savings over the last few months. Unfortunately, the consumer is likely to tighten their belts and hold off on going on a spending spree until there is a vaccine.

I’m not at all worried about inflation, but it could become a problem if the economy begins to overheat in a stronger economic recovery in 2021. I would welcome this problem and any inflationary pressure attached to it. I don’t believe that it will be this easy, but I’m hopeful that the economy will stage a rebound once we beat this virus. We all want life to get back to normal as quickly as possible and there has been positive developments in speeding up the manufacturing of the vaccine. Pharmaceutical companies are ambitiously targeting 100 million vaccines by the end of the year. In the meantime, expect “ups and downs” until there is a vaccine.

Free oil for life!

On Tuesday, the price of a barrel of oil fell to -$37! If you did a double take, yes there is a negative sign in front of the $37. You would actually be paid $37 to take delivery of the May contract for oil! Imagine if the gas station would pay you to fill your tank. At first glance this looks like the investment opportunity of a lifetime. If you could buy oil and store it for a month or two, then sell it when things normalize, you could maybe double or triple your money.

I did look closely into how I could profit from the opportunity. The difficulty is that there was nothing that I could buy that didn’t come without a great deal of risk. The oil ETF (USO) which is the largest and most liquid oil ETF was trading at a 35% premium! This premium signifies that the investments held inside of the ETF were valued at 35% higher than what they were worth. I would lose -35% if the NAV of the ETF went back to what the contracts were actually worth. This is exactly what happened over the next few trading days. The only way to profit is if I could buy oil and take delivery of it. Unfortunately, buying an oil tanker was never in my business plans, but it would have been the easiest money that you could ever make. Even if you owned an oil tanker it was already full of oil because the world is flooding in it.

This didn’t stop other people from trying to buy this oil ETF. Another advisor shared a story with me about one of their clients that called them and demanded to buy the oil ETF. The advisor told the client not to buy, but the client persisted because all his friends were buying. This client had the advisor allocate 25% of his account into it. The advisor followed the clients wishes and that oil ETF immediately went down around -40% from the time they bought. The good news for the client was the ETF was down as much as -65%. The advisor joked with me that his clients wife will probably not be at the next annual investment meeting.

The inexperienced investors who rushed in first probably lost more this week than they ever did trading pot stocks and crypto currencies. I’m sure there is someone out there that hit the trifecta of losing -65% in oil, pot, and crypto.

Many of the new online trading companies monitor what other investors are buying on the platform. On the Robinhood app, 100,000 investor accounts opened positions in the oil ETF and it moved into the top 30 before the -65% crash. Now 196,034 accounts own this position. The lower the price goes, the more Robinhood accounts will open a position. To put this into perspective, Apple is held in 348,820 accounts. Another firm Interactive Brokers had to write down -$88 million in losses because they couldn’t collect the margin calls from their clients accounts fast enough. Not only did inexperienced investors buy this ETF, they did it with borrowed money. This was one of the reasons why the price of oil fell as fast as it did. It was due to all the margin calls. I’m sure there were some tough dinner conversations this week about brokerage accounts blowing up.

The actual price of oil is really closer to $26 a barrel and not the $17 that you see quoted in the news. The contract price for oil delivered for September 2020 is at $26. If you believe oil is going to be higher than $26 in September, then you can buy all the contracts you want. It seems like a good bet, but so did oil for delivery back back in January 2020 for the May 2020 contract and that fell from $40 to -$37.  With this trade, you will either be spectacularly right or spectacularly wrong. This is the perfect investment for someone who wants to gamble.

The most careless retail investors are back in this market. They don’t care about fundamentals or economics. Many also don’t even research the symbol before they buy.  More than a few retail investors bought Zoom Technologies (Zoom), instead of the correct company Zoom Video Communications (ticker symbol: ZM). ZM is the video conferencing company that has benefited the most from the new abnormal stay at home economy. But it was ZOOM stock that increased 700% in a month before the SEC stopped trading in it. These investors were buying the wrong stock and the dumbest ones who made the mistake first profited 700%!

You have to  wonder where they get all of their money to continue to speculate. I’m sure many stimulus checks got lost in the oil ETF. The good news is that over the last few weeks markets have stabilized and trading volume is dropping. This means that most of the short-term selling pressure is over for now. It also could mean many larger institutions don’t want to buy at these high prices. But markets tend to rise on low volume and fall on heavy volume. I’ll continue to monitor this trend. I’ll also look into buying an oil tanker. 🙂

The Phone Is Not Ringing Off the Hook

I wanted to share an article from the Wall Street Journal yesterday that I thought was very interesting. Jason Zweig interviewed Charlie Munger of Berkshire Hathaway. Charlie is Warren Buffett’s right hand man and in my opinion is one the greatest investors who has every lived. Charlie Munger’s hero is Benjamin Franklin and many people joke that Charlie is a reincarnation of Benjamin Franklin. Charlie even wrote a classic investment book titled Poor Charlie’s Almanack: The Wit and Wisdom of Charles T. Munger.

There is so much noise right now on what’s happening or what’s going to happen next. At 96 years old, Charlie’s wisdom is a blessing and he cuts through the headlines and gives us insight into what they are thinking inside of Berkshire Hathaway. Charlies investment advice is to play the long game and not be aggressive. The goal is to ride out the storm and come out on the other side stronger financially.  Charlies says that everyone is frozen now.  Even though there might be buying opportunities, Charlie doesn’t have the faintest idea whether the stock market is going to go lower than the old lows or whether it’s not. The coronavirus shutdown is “something we have to live through,” letting the chips fall where they may, he said. “What else can you do?”

Below is the very timely interview in full.

Charlie Munger: ‘The Phone Is Not Ringing Off the Hook’

The Berkshire Hathaway vice chairman has always preached the value of being prepared to pounce when there are bargains to be had. Has that time come?

By  Jason Zweig
April 17, 2020 10:00 am ET

If the coronavirus lockdown has frozen your investing plans, you’re in good company. Charlie Munger is watching and waiting, too.

Mr. Munger, vice chairman of Berkshire Hathaway Inc. and Warren Buffett’s longtime business partner, likes to say that one of the keys to great investing results is “sitting on your ass.” That means doing nothing the vast majority of the time, but buying with “aggression” when bargains abound.

I spoke this week by phone with Mr. Munger, who turned 96 years old on Jan. 1. He sounded as sharp and vigorous as ever, and as usual he drew bright lines between what he’s fairly certain of and what he thinks belongs in the “too-hard pile”—where he and Mr. Buffett consign questions they don’t know how to answer. Overall, Mr. Munger made it clear that he regards this as a time for caution rather than action.

In 2008-09, the years of the last financial crisis, Berkshire spent tens of billions of dollars investing in (among others) General Electric Co. and Goldman Sachs Group Inc. and buying Burlington Northern Santa Fe Corp. outright.

‘Everybody’s just frozen.’

— Berkshire Hathaway Vice Chairman Charlie Munger

Will Berkshire step up now to buy businesses on the same scale?

“Well, I would say basically we’re like the captain of a ship when the worst typhoon that’s ever happened comes,” Mr. Munger told me. “We just want to get through the typhoon, and we’d rather come out of it with a whole lot of liquidity. We’re not playing, ‘Oh goody, goody, everything’s going to hell, let’s plunge 100% of the reserves [into buying businesses].’”

He added, “Warren wants to keep Berkshire safe for people who have 90% of their net worth invested in it. We’re always going to be on the safe side. That doesn’t mean we couldn’t do something pretty aggressive or seize some opportunity. But basically we will be fairly conservative. And we’ll emerge on the other side very strong.”

Surely hordes of corporate executives must be calling Berkshire begging for capital?

“No, they aren’t,” said Mr. Munger. “The typical reaction is that people are frozen. Take the airlines. They don’t know what the hell’s doing. They’re all negotiating with the government, but they’re not calling Warren. They’re frozen. They’ve never seen anything like it. Their playbook does not have this as a possibility.”

He repeated for emphasis, “Everybody’s just frozen. And the phone is not ringing off the hook. Everybody’s just frozen in the position they’re in.”

With Berkshire’s vast holdings in railroads, real estate, utilities, insurance and other industries, Mr. Buffett and Mr. Munger may have more and better data on U.S. economic activity than anyone else, with the possible exception of the Federal Reserve. But Mr. Munger wouldn’t even hazard a guess as to how long the downturn might last or how bad it could get.

“Nobody in America’s ever seen anything else like this,” said Mr. Munger. “This thing is different. Everybody talks as if they know what’s going to happen, and nobody knows what’s going to happen.”

Is another Great Depression possible?

“Of course we’re having a recession,” said Mr. Munger. “The only question is how big it’s going to be and how long it’s going to last. I think we do know that this will pass. But how much damage, and how much recession, and how long it will last, nobody knows.”

He added, “I don’t think we’ll have a long-lasting Great Depression. I think government will be so active that we won’t have one like that. But we may have a different kind of a mess. All this money-printing may start bothering us.”

Can the government reduce its role in the economy once the virus is under control?

“I don’t think we know exactly what the macroeconomic consequences are going to be,” said Mr. Munger. “I do think, sooner or later, we’ll have an economy back, which will be a moderate economy. It’s quite possible that never again—not again in a long time—will we have a level of employment again like we just lost. We may never get that back for all practical purposes. I don’t know.”

Berkshire won’t escape unscathed. “This will cause us to shutter some businesses,” Mr. Munger said. “We have a few bad businesses that…we could be tolerant of as members of the family. Somebody else would have already shut them down. We’ve got a few businesses, small ones, we won’t reopen when this is over.”

Mr. Munger told me: “I don’t have the faintest idea whether the stock market is going to go lower than the old lows or whether it’s not.” The coronavirus shutdown is “something we have to live through,” letting the chips fall where they may, he said. “What else can you do?”

Investors can take a few small steps to restore a sense of control—by harvesting tax losses, for instance—but, for now, sitting still alongside Mr. Munger seems the wisest course.

Did the Fed cross the line?

Last Saturday, I wrote that the investment returns for small cap American businesses would eventually register off the charts, but I didn’t expect it to happen in the next 4 days! For my more aggressive-moderate risk taking clients, I did buy small caps, but not enough given the size of the move. If I had known the Federal Reserve was going to bail out all unsecured debt and junk bond investors, I would have moved 100% of all client assets into small caps. The Federal Reserve is now backstopping most fixed income investments and even buying stocks is on their radar.

This recent move by the Fed got an adverse reaction from Wall Street, except of course for those investors that just got bailed out. Today, the Wall Street Journal editorial board wrote an opinion piece titled, The Fed’s Main Street Mistake, that challenged this recent move by the Fed. (For those interested in reading this opinion, I added it to the bottom of this email.) The editorial board believes that the central bank is favoring Wall Street over small business owners.

Tim Seymour, who in my opinion is one of the best financial journalists, said that the Fed is going off the rails on a crazy train. While they pick winners and losers, people have to wonder, “Where’s my bailout?” He was even wearing a t-shirt, “Where’s my bailout” on CNBC when he gave these comments. Tim has been the biggest advocate for capitalism and one of the loudest cheerleaders for the bull market over the last 5 years.

The investment community consensus is that this was a tragic move for our economy and markets. This move created a moral hazard for investors to take more risk because they know the system is rigged and they will get bailed out if there is any trouble. The Fed did not reward prudent and responsible investing and instead favored investors who were reaching for higher returns. The counterargument is that those risky investors who got bailed out didn’t deserve recent losses because a pandemic was out of their control.

My impression from the recent Fed move is that things are much worse in the economy than anyone is expecting. If the Fed is willing to stick its neck out this far then their internal economic models must be showing a severe economic contraction. The debate on this recent program will be felt for years to come. A more effective program would be to help those small businesses that need aid immediately. The Paycheck Protection Program (PPP), which offers companies forgivable loans didn’t go nearly far enough. It’s a flawed program and needs to help small business owners with expenses other than payroll and rent.  The grant money given to these companies needs to be much higher, but so does the verification required that substantial income was lost. The government needs to keep these small business out of debt. I believe that the failure to help these local businesses will stall any economic recovery.

I’m not going to fight the Fed and I’ll make investments alongside the change of rules. It’s a very interesting debate to follow and I have my opinion, but I only care about how this change by the Fed is going to impact your investments going forward. I now feel much more comfortable owning fixed income since the Fed is backstopping everything.  The biggest questions going forward for financial markets will be if the Fed is bailing out even the highest risk investors and printing another $6-$8 trillion, what will happen to the value of the dollar, is the government moving us towards socialism, and will this ultimately create inflation? It is clear that the Fed will do anything in its power to keep interest rates low and they want investors to own riskier assets This move is really not much different than what the Fed was doing before the pandemic. The Fed’s was cutting interest rates into a booming economy. I’ll continue to invest alongside the Fed, but I look forward to the time when small businesses get the help that they so desperately need now.

Registering off the Charts

As we all expected, the overload of negative headlines is registering off the charts. I’m going to keep all of my thoughts to business and investments. I completely understand that families are suffering from job losses or family members are sick or loved ones are dying. Nurses and doctors are saving lives. To be honest, it’s hard to write about investments, but that’s how I relieve my stress and it’s in my DNA.

The Federal Reserve and Congress is helping to build a bridge and supporting the economy until we all escape our houses and return to work. The scientists have done an extraordinary job creating antibody tests, developing therapeutics, and fast tracking a vaccine. Testing kits are ramping up, but the magic bullet won’t be until there is vaccine and then life will return to the new normal. The most positive news in all this mess is that the large U.S. banks are much better capitalized and they should be able to ride out this storm. The stock market volatility will continue because there is so much uncertainty. There are signs that investors have mostly written off 2020 and are becoming more focused on 2021 earnings. It will be interesting to see how stock prices react when companies begin to report earnings. The longer we all remain locked down, the longer the recovery will take. We are at war with an invisible enemy and going forward the most important question will be when the stay at home order ends. I expect this debate to heat up later this month.

I’m not going to predict what the stock market will do next week or next month. I have no idea and I don’t think any economist alive can predict what will come next. I don’t think anyone foresaw that the impact on small businesses would be so severe. Small business have been by far hit the hardest. I know firsthand from speaking with many of you who work at these very businesses.

When the time is right, the best opportunities will be investing in the very small businesses that are getting hit the hardest. I’m beginning to take a closer look at small cap companies. This will be a departure from my focus on large cap investments over the last 3 years. The highest quality blue chip companies have had the highest returns over the last 3 years. I believe that Vanguard Small Cap ETF will outperform most Large Cap ETF’s off the bottom. The hardest hit small cap companies that have the lowest debt will likely offer the greatest investment opportunity. I am being very patient and waiting until I see the bottom before investing in this area. I expect the negative news will continue to register off the charts. My hope is the future returns for the small cap American businesses will eventually have their turn to register off the charts when our economy gets back on its feet.

Stay Healthy!

The CARES Act

This week the US Government and Federal Reserve took dramatic steps to stabilize the economy. The Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 was signed into law on Friday. This is a $2.2 trillion package, including nearly half a trillion dollars in individual rebate checks, another $500B for support of several severely-damaged industries, nearly $400B support including tax credits for wages and payroll tax relief, over $300B of support for state and local governments, and almost $150B for various initiatives to support hospitals and the health care system.

Below is a summary of the CARES Act (Source: https://www.kitces.com/). I wanted to share only the sections from my financial planning resource that might be applicable to your personal situation. If you own a small to mid sized business, I can email you those sections to learn more.

Please feel free to reach out to me if you have any questions on how this CARES Act impacts you. I’m still digesting it and if I don’t know the answer immediately, I can research and get right back to you with the answer. Please feel free to send your questions. Stay well!!!

Cares ACT (source: www.kitces.com) 

Perhaps no single provision in the CARES Act has received more interest from the general public than Section 2201, Recovery Rebates For Individuals. In short, people want to know whether they should be expecting a check from Uncle Sam, and if so, how much the check will be for.

The good news is that according to estimates by the Tax Foundation, over 90% of taxpayers should receive some amount of Recovery Rebate. The bad news is that thanks to the way the law was drafted, there may be a substantial number of people who could really use help right now who won’t qualify, and even for those that do, practical issues with how such payments may be distributed could substantially delay their receipt!

CALCULATING THE AMOUNT OF A TAXPAYER’S RECOVERY REBATE ADVANCE

As a starting point, the CARES Act provides a refundable income tax credit against 2020 income of up to $2,400 (more on this in a bit) for married couples filing a joint return, while all other filers begin with a refundable credit of up to $1,200. The credit amount then increased by up to $500 for each child a taxpayer has under the age of 17.

Thus, a single taxpayer with one child would be eligible for up to a $1,200 + $500 = $1,700 refundable credit, while a single taxpayer with two young children would be eligible for up to a $1,200 +$500 + $500 = $2,200 credit. A married couple, on the other hand, with one child and who file a joint return, would be eligible for up to a $2,400 + $500 = $2,900 credit, while the same couple with four children would be eligible for up to a $2,400 + $500 + $500 + $500 + $500 = $4,400 credit.

If you’ve read the last two paragraphs closely, you probably noticed a lot of “up to”s in there. And there’s a reason for that. As a taxpayer’s income begins to exceed their applicable threshold, their potential Recovery Rebate Payment (their credit) begins to phase out. More specifically, for every $100 a taxpayer’s income exceeds their credit, their potential Recovery Rebate will be reduced by $5.

The applicable AGI threshold amounts are as follows:

Married Joint: $150,000
Head of Household: $112,500
All Other Filers: $75,000
Example #1: Mickey and Jackie are married and file a joint return. They have 4 children, ages 10, 13, 15, and 17, and have $176,000 of Adjusted Gross Income (AGI).

As such, they are eligible to receive a maximum Recovery Rebate of $2,400 + $500 + $500 + $500 = $3,900! (Note: Recall that the potential Recovery Rebate is only increased by $500 for each child under 17, so only three of the couple’s children qualify.

But while $3,900 is the maximum potential Recovery Rebate the couple to which the couple could be entitled, they have income in excess of their $150,000 threshold amount. More specifically, they are $26,000 over their threshold amount, so their recovery rebate must be reduced by $26,000 x 5% = $1,300.

As such, the ultimate Recovery Rebate check that Mickey and Jackie will receive will be $3,900 – $1,300 = $2,600!

RECOVERY REBATES WILL BE DISPERSED BASED ON 2018/2019 INCOME BUT ARE ACTUALLY FOR 2020
One of the more confusing aspects of the Recovery Rebate is that it has a bit of a ‘split personality’, in that the initial amount paid will be based on either a taxpayer’s 2018 or 2019 income tax return (whichever is the latest return that the IRS has on file), while it will ultimately be ‘trued up’ if a taxpayer is owed money based on their actual 2020 income.

Coronavirus-Related Distributions

Mirroring similar relief that has been provided to individuals in Federally declared disaster areas in the past (for things like hurricanes, wildfires, and floods), the CARES Act creates Coronavirus-Related Distributions. Coronavirus-Related Distributions are distributions of up to $100,000, made from IRAs, employer-sponsored retirement plans, or a combination both, which are made in 2020 by an individual who has been impacted by the Coronavirus because they:

Have been diagnosed with COVID-19;
Have a spouse or dependent who has been diagnosed with COVID-19;
Experience adverse financial consequences as a result of being quarantined, furloughed, being laid off, or having work hours reduced because of the disease;
Are unable to work because they lack childcare as a result of the disease;
Own a business that has closed or operate under reduced hours because of the disease; or
Meet some other reason that the IRS decides to say is OK.
Given the laundry list of potential individuals who may qualify for relief under this provision, it seems rather clear that Congressional intent was to make this provision broadly available. The IRS will likely operate in kind, and take a liberal view of who has been impacted by the Coronavirus enough to qualify for a Coronavirus-Related Distribution.

There are a number of potential tax benefits associated with Coronavirus-Related Distributions. More specifically, these include:

Exempt From the 10% Penalty – Individuals under the age of 59 ½ may access retirement funds without the normal penalty that would otherwise apply.
Not Subject to Mandatory Withholding Requirements – Typically, eligible rollover distributions from employer-sponsored retirement plans are subject to mandatory Federal withholding of at least 20%. Coronavirus-Related Distributions, however, are exempt from this requirement. Plans can rely on a participant’s self-certification that they meet the requirements of a Coronavirus-Related Distribution when processing a distribution without mandatory withholding.
Eligible to be Repaid Over 3 Years– Beginning on the day after an individual receives a Coronavirus-Related Distribution, they have up to three years to roll all or any portion of the distribution back into a retirement account. Furthermore, such repayment can be made via a single rollover, or multiple partial rollovers made during the three-year period. Finally, if distributions are rolled using this option, an amended return can (and should) be filed to claim a refund of any tax paid attributable to the rolled over amount.
Income May Be Spread Over 3 Years – By default, the income from a Coronavirus-Related Distribution is split evenly over 2020, 2021, and 2022. A taxpayer can, however, elect to include all of the income from a Coronavirus-Related Distribution in their 2020 income.
(Nerd Note: Although, in general, spreading the income of a retirement account distribution over three years is likely to result in a better tax outcome than including all the income in just a single tax year, that may not be the case now. Notably, if an individual is experiencing significant financial difficulty, and to meet expenses they take a Coronavirus-Related Distribution, it likely indicates lower-than-normal income, at least temporarily, for 2020. If higher income is expected in future years as life returns to ‘normal’, it may be best to include all the income on 2020’s return. Plus, as an added bonus, if some or all of the distribution is later rolled over within the 3-year repayment window, it’s only one tax return to amend!)

Enhancements To Loans From Employer-Sponsored Retirement Plans

Many employer-sponsored retirement plans, such as 401(k)s and 403(b)s, offer participants the option of taking a loan of a portion of their retirement assets. For individuals who have been impacted by the coronavirus (using the same definition as outlined above for Coronavirus-Related Distributions), the CARES act enhances the ‘regular’ plan loan rules in the following three ways:

Maximum Loan Amount is Increased to $100,000 – In general, the maximum amount that may be borrowed from an employer plan is $50,000. The CARES Act doubles this amount for affected individuals.
100% of the Vested Balance May Be Used – In general, once an individual has a vested plan balance that exceeds $20,000, they are only eligible to take a loan of up to 50% of that amount (up to the normal maximum of $50,000). The CARES Act amends this rule for affected individuals, allowing them to take a loan equal to their vested plan balance, dollar-for-dollar, up to the $100,000 maximum amount.
Delay of Payments – Any payments that would otherwise be owed on the plan loan from the date of enactment through the end of 2020 may be delayed for up to one year.
Required Minimum Distributions Are Waived In 2020
Section 2203 of the CARES Act amends IRC Section 401(a)(9) to suspend Required Minimum Distributions (RMDs) during 2020. The relief provided by this provision is broad and applies to Traditional IRAs, SEP IRAs, and SIMPLE IRAs, as well as 401(k), 403(b) and Governmental 457(b) plans. Furthermore, the relief applies to both retirement account owners, themselves, as well as to beneficiaries taking stretch distributions.

In one somewhat surprising twist, the CARES Act not only eliminates RMDs for 2020 but any RMD that otherwise needed to be taken in 2020. More specifically, individuals who turned 70 ½ in 2019, but did not take their first RMD in 2019 (and thus, would have normally been required to take such a distribution by April 1st, 2020,  as well as a second RMD for 2020 by the end of 2020) do not have to take either their 2019 RMD or their 2020 RMD! Thus, these procrastinators get to escape two RMDs instead of just one!

Relief For Student Loan Borrowers

The CARES Act includes several provisions aimed at providing relief to student loan borrowers, including the following:

Student Loan Payments Deferred Until September 30, 2020 – Section 3513 suspends required payments on Federal student loans though September 30, 2020. During this time, no interest will accrue on this debt. Unfortunately, though, while required payments are suspended, voluntary payments are not prohibited. And by default, payments will continue unless individuals take proactive measures to contact their loan provider and pause payments.

Also notable is that this period of time will continue to count towards any loan forgiveness programs. As such, any student borrower who intends to qualify for a program that will ultimately forgive the entirety of their Federal student debt (such as via the Public Service Loan Forgiveness program) should immediately pause payments. Because whereas other borrowers who continue to pay Federal student loans during this time may simply be paying down what is effectively 0% debt (at least temporarily), those borrowers who will ultimately have their outstanding student debt forgiven (upon completion of whatever requirements are necessary for their particular loan forgiveness program) are paying down a debt that would otherwise be wiped clean anyway!

Finally, all involuntary debt collections are also suspended through September 30, 2020. This not only includes wage garnishment or the reduction of other Federal benefits, but the reduction of any tax refund (for student loan purposes). As such, borrowers of student debt who are delinquent on payments and would normally be subject to a reduction of their tax refund have an incentive to file their tax returns early enough so that the refund is processed before this relief expires.

Employers Can Exclude Student Loan Repayments From Compensation – Section 2206 provides employers a (very) limited window of time in which they can take advantage of a special rule to aid employees paying down student debt. In general, amounts paid by an employer to an employee which are used to pay student debt (or payments made by an employer directly to the loan provider) are considered compensation to the employee, and are subject to income tax.

Under Section 2206, however, employers have from the date of enactment of the law, through the end of the year, to provide employees with up to $5,250 for purposes of student debt payments, and exclude those amounts from their income. This amount, however, is coordinated with the ‘regular’ $5,250 limit that employers can provide employees tax-free for current education. As such, total maximum tax-free education assistance an employer can provide an employee in 2020 is $5,250.

Pell Grant and Subsidized Federal Student Loan Relief For Students Leaving School – Both Pell Grants and Subsidized Federal Student loans are subject to various limits. Section 3506 of the CARES Act excludes from a student’s period of enrollment any semester that a student does not complete due to a qualifying emergency. Section 3507 does the same with respect to the Federal Pell Grant duration limit.

Curiously, both provisions are contingent upon the Secretary of Education being “is able to administer such policy in a manner that limits complexity and the burden on the student.” Upon first glance, these provisions would appear to create far more “burden” for the Secretary of Education than they do on the student!

Finally, if a student withdraws from school during the middle of a semester (or equivalent) because of qualifying emergency, Section 3508(b) eliminates the amount of a student’s Pell Grant that would normally have to be returned, while 3508(c) cancels any direct loan that was taken to pay for the semester.

For the many who have already lost their jobs, and for the countless more who will likely find themselves subject to the same fate in the coming weeks, there is, thankfully, some (relatively) good news. Unemployment compensation benefits have been significantly expanded by the CARES Act. These enhancements include:

Pandemic Unemployment Assistance – Self-employed individuals (who are generally ineligible for unemployment compensation benefits), and other individuals who are ineligible for ‘regular’ unemployment, extended unemployment or pandemic unemployment insurance, or run out of such insurance, will be eligible for up to 39 weeks of benefits via this provision.

Uncle Sam Will Cover Unemployment for the First Week of Unemployment – In general, individuals are ineligible to receive unemployment benefits the first week that they are unemployed. It essentially amounts to an elimination period that’s meant to encourage people to try and get another job quickly so as to avoid the week without income. Of course, at present time, finding work quickly is difficult, if not impossible. And in recognition of this fact, the CARES Act offers to pay to states to provide unemployment compensation benefits immediately, without the ‘normal’ one week waiting period.

‘Regular’ Unemployment Compensation is ‘Bumped’ by $600 per Week – Section 2104 of the CARES Act provides states with the ability to increase their unemployment benefits by up to $600 per week with Federally funded dollars, for up to four months. This has the ability to dramatically increase the amount of money an individual is entitled to temporarily entitled to receive via unemployment compensation benefits, as the average weekly unemployment benefit nationwide is under $400! Thus, the many individuals will see their unemployment checks increase by 150% or more thanks to this part of the CARES Act.

Unemployment Compensation is Extended by 13 Weeks– In the event that people are nearing – and ultimately reach – the maximum amount of weeks of unemployment compensation provided under state law, Section 2107 of the CARES Act will allow them to receive such benefits for an additional quarter.

What was my most popular post?

I have written this weekly blog for over 5 years. There are now well over 200 weekly posts written over this time. I’ve had a few posts that have been picked up nationally.

I enjoy writing posts about stock market and financial planning topics.  I’ve learned that my posts about financial planning are read more often. In fact, all of my posts over the last year that are not stock market related are in the top 10. The current event posts have a 1 week shelf life because markets these days climb a way of worry and the 24/7 news cycle always finds something new to focus on. The financial planning related posts stay more current and a few of those posts that have been viewed more often than the home page of my website!

The #1 most viewed post was titled – 2018 taxes – Are you going to pay more or less in taxes? This post being #1 makes sense because nobody wants to pay more in taxes. The #2 post that I wrote years ago, still continues to be viewed even more than most of my new posts. The title of this post is, How has the banking system changed over the last decade? This post made a good case why banks were undervalued because they had rebuilt their balance sheets, had tightened lending standards, had diversified their revenue streams, and were buying back stock.

I realize that if I wrote more about financial planning than current events, my website traffic would increase significantly. If I was mentoring a financial advisor starting out in the business, I would advise them to never write about current events and especially politics.  I try to stay away from writing about politics, but it remains the major risk to markets.

I’m always curious to know whether my weekly readers of this post want me to write more or less about stock market events.  I’ve asked many of you for feedback. I’ve learned that you want updates on my current investment views and would like to be kept informed on current events that might influence your investments while keeping you updated on my portfolio positioning. I recognize anything I write about politics will strike a nerve. As I’ve gotten to know you well, I’d estimate half of you will vote for President Trump, and for the other half, the election can’t come sooner. Going forward, I plan on continuing to mix it up between financial planning and wealth management topics.

I’ll be on vacation next week for the kids February break, but I will still be checking emails and monitoring markets. There is just too much volatility and unfolding events happening in China to completely step away.  Plus, a good vacation for me is reading up on companies and spending time with the family. 🙂

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***Alert – Technology Bubble

A few weeks ago, I wrote a post how a new mega trend had emerged for sustainable investing. What I should have done immediately after I wrote that post, was go out and buy Tesla stock. In full disclosure, I had owned it for my more aggressive clients. I sold it when the value for the business began to make no sense. I gave a very generous assumption that Tesla could generate $3B in free-cash flow by 2023-2024 and this put the enterprise valuation around $100B. I exited around this level. Tesla stock continued to go all the way up to a $150B value. I failed to recognize that investors of Tesla were not valuing the business the same way I was. They were riding the momentum like Bitcoin or their favorite crypto-currency. Tesla became bitcoin on wheels.

This gave me a flashback to the pot stock Tilray that was bid up to an unbelievable $30 billion valuation. The company only had a few million in sales.  I wrote a post a few years ago on how insane the rally was in pot stocks. Since that time most of these pot stocks are all down -80%. I’m not predicting that Tesla will drop -80%, but it’s not worth $150B.  The size of the company at one point last week was almost as large as Toyota in market capitalization! Toyota sells around 10 million cars a year and Tesla sells 500k a year. Volkswagen Group owns Audi, Bentley, Bugatti, Lamborghini, and Porsche and their market cap is $100B. Tesla at $150B is a tough comparison.

A Tesla bull would make their case by quoting Wayne Gretzky, “Skate to where the puck is going, not where it has been.” Tesla is leading the way in electric vehicles and they are changing the automotive landscape. Even though Tesla became overvalued and highly speculative, I believe it is capitalism working at its best. Capital should be given to the company that is skating to where the puck is going and taken away from where the puck has been. Case in point is Ford stock that dropped -10% when they reported earnings this week. The market cap of Ford is now $33 billion compared to $150 billion for Tesla. After Tesla made a historic move to $960, it fell $100 in the final hour of trading, and then dropped another $150 the next day. From the high price of the stock, the total loss was -30% in only a few hours of trading. But this won’t stop this crowd. If they can lose 90% in marijuana stocks with no earnings and buy worthless cryptocurrencies, it will take much more to shake them out of a growing company like Tesla. Tesla is the future of electric vehicles. But I’d warn this crowd that the beauty of capitalism is that it is self-destructive. Toyota, Ford, GM, Volkswagon, and all the new competitors will allocate more capital into electric vehicles. There will be so much money allocated that combustion engines will be the losers. The prices for all these electric vehicles will fall fast as new efficiencies are realized. Tesla has the first-mover advantage and they build the most desirable electric vehicle with the best technology. These investors can value Tesla in a wide range between $75B-$175B because it’s possible that Tesla is the big winner and will sell millions of electric vehicles in the next few years. After this period, Tesla will need to stay a few steps ahead of the competition.  However, all of the CEO’s of the major automotive’s are going all-in on electric vehicles now that that they realize that they are getting disrupted by Tesla.

I would like to retract what I wrote a few weeks ago that a new mega trend had emerged in sustainable investing. The mega trend is not sustainable investing. The mega trend is that there is now a legion of investors buying technology stocks and they do not value companies. This is the same crowd that traded cryptocurrencies and got wiped out. They picked up the pieces and bought marijuana stocks thereafter because they were all going to go up 100%+. They believed everyone was suddenly going to start smoking pot. As soon as the same crowd blew themselves up, they have moved onto U.S. technology stocks. They believe everyone will go out and buy more Tesla’s than Toyota’s in the next 5 years. The thinking now goes that all the major technology companies deserve valuations over $1 trillion. If they are worth $1 trillion, why shouldn’t a few of them be worth $2 trillion? It’s safe to say that investors buying these technology stocks don’t spend much time valuing the business. They look for a stock that has positive catalysts, strong momentum, and then they load up if the algorithms/computers start buying. The story over the last year has been technology stocks and sustainable investing.  You have the choice to either dance while the music is playing or sit it out. It has become the worst market environment for value investors.

The chart below supports just how narrow the stock market has become over the last 12 months. You have one set of investors that has went conservative buying low risk investments that pay high dividends such as Communications, REITs and Utilities and the other set of investors piling into technology stocks. We are now entering bubble territory for technology stocks and it’s impossible to predict when it will end.

This is the third time in the last three years where the famous quote applies from Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds, where he said, “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.”

This herd of investors are delusional and mad and they do realize it.  They have all the best trading tools at their disposal – cutting-edge software, advanced program trading, and no friction costs because trades are now free. It’s like a flash mob when they all pile into the same stock and drive it up and then it will eventually come crashing down. Wall Street is happy to play along and upgrade the companies and raise price targets to justify the valuations. The higher these stocks go the more money they will make. This is the mega trend! Some would call it a stock market bubble, but the entire stock market is not in a bubble. I believe it’s only the stocks that these crazed investors are buying. It has reached a point that it is now expected that all of the major technology stock prices will move between 5%-20% after every quarterly earnings release. Even the mega-cap tech stocks are trading up or down 10% after reporting earnings. Any of these CEO’s of these companies would be quick to point out that their business do not change all that much in three months. The volatility couldn’t be any higher for technology stocks. I’m no longer surprised if they go up or down 5% in any given week. It’s almost expected. A seasoned value investor would be quick to point out that volatility is always the highest at the very top of the market or at the bottom.

I’m confident that this crowd of investors will continue to speculate in technology companies, but at some point, the gains will slow or the losses will increase, which will cause this herd to move on to another area to make even faster money. It is still early because there has been no losses yet. Bubbles only deflate after investors lose money and this one is showing no signs of slowing. I expect the losses will be quick when the time comes because this herd with all the best trading tools will see it coming and they could all head for the exits at the same time. This is the reason why you have noticed a pickup in my trading activity. I’m not speculating in high priced technology companies and I’ve begun to step out of the way of these crypto-technology stocks. I know I’m early starting to sit out while the music is playing, but I’m maintaining some exposure for now. For my retired clients with lower risk tolerances, I have increased fixed income allocations. I’m about 90% complete with my reallocation and I’m much more comfortable with your investments at this phase of the bull market. Going forward, you should expect much less trading activity from me compared to recent weeks.

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Coronavirus – Expect Volatility

The U.S government has just advised – “Do not travel to China.” On January 30, the WHO determined that the rapidly spreading outbreak constitutes a Public Health Emergency of International Concern. The virus has also become a major concern to the stock market and rightfully so. It’s always the unknown risk that comes as a surprise which has the biggest impact on the market. The ongoing uncertainty weighing on the minds of investors is whether or not the coronavirus will continue to spread outside of China? This will likely act as a fog over the market until this question is answered.  Goldman Sachs warned that U.S. economic growth will be cut by 0.4 percent in the first quarter as the number of tourists from China declines and exports to Asia slows. 

It is estimated that two-thirds of China’s economy is temporarily shut down. As you would expect, with less travel and slower economic activity, the price of oil has plummeted 17% since Jan 6th. Oil has fallen so much that OPEC is likely to call an emergency meeting to cut production. Bloomberg reports that OPEC may move its March meeting up a month so that they can rig the price higher by cutting supply. Other commodity prices have slumped on fear that Chinese demand will drop. Copper prices have fallen 12% because the virus will cause a downturn in construction and manufacturing activity in China. On the other hand, the coronavirus is increases sales of face masks and cleaning products.

This economic slowdown occurring in China has already caused a small correction in U.S. stock prices. It’s estimated that nearly 30% of S&P 500 revenue comes from foreign markets. It’s really anyone’s guess how long the coronavirus will continue to spread or if China can control it. This answer won’t be known for a few weeks because the virus has an incubation period of 10 to 14 days, during which the virus can be contagious, but the patient does not display symptoms. The stock market will be trading in a wider trading range with big moves up and down as new developments and breaking news moves stock prices.

As a reference case, there was a similar outbreak when SARS hit China in 2002 and 2003 and the downturn was limited and global growth rebounded sharply after the spread of the virus slowed. It’s not a perfect comparison because the coronavirus is more contagious and less deadly. Also, since 2002, China’s economy has expanded from 5% to 18% of the global economy. There will be ripple effects felt across industries as suppliers cancel projects and business subsequently slows. I believe that the duration of the travel ban in China will ultimately determine how long stock prices stay down. There are many investors with longer term mindsets already searching for buying opportunities. The best time to make money is when everyone else is panicking.     

Over the last few weeks, I’ve made a few changes to allocations with the goal to lower volatility. My goal is to increase diversification in this election year and rebalance so that I can have some cash to buy at lower prices just in case there is a dip in the market. Even though markets fell the last few weeks, returns are still hovering around unchanged for the year. This sell-off hasn’t been all that bad unless you owned energy or commodity stocks which I have avoided. My focus continues to be increasing income and dividend yields. For my more aggressive clients, I’ve made less changes than my more risk-averse clients. My retired clients will see the most changes as I’ve added more bonds to their portfolios. At the present time, I believe that any economic slowdown will be temporary and I’m more concerned about the health and lives of people in China coping with this virus. Hopefully, the coronavirus is contained soon and we can all go back to worrying about politics again. 🙂 Until then 😷!   

 

Please read our disclosure statement regarding the contents of this post and our website as a whole.