The month of July 2020 will clearly be one to look back on in financial history as an important month. After an avalanche of negative publicity regarding the economy and the prospects for the U.S. to pull out of the pandemic, the economy continued to strengthen and the stock market reflected that strength. It has been absolutely amazing that for all of the negative headlines we have read regarding the economy and the spread of the virus, that the stock market has dramatically improved over four straight months. July was an extremely strong month for all financial assets.
I have a lot I want to discuss in this posting and some of it is quite valuable information. I want to explain why the stock market is not likely to have a major downturn due to negative real rates of return. I also want to rebut the so-called “pundits” that argue that the rise in the stock market is a bias against the working class and mainstream. Obviously, they do not understand, as do I, the Wealth Effect which I will explain later in this posting.
Partner Eddie Wilcox and his wife, Jennifer, walking the beach
Most of the general public has completely missed the implication of Zero-Sum economics. They just do not understand that if one segment of the economy suffers, by the effect of Zero-Sum, some other segment of the market must be strong. That has proven so clearly true in these very difficult times. The most important real-world example I can give you is from the famous comedian, George Carlin, as he described why this country became so fixated on germs. Even though this famous comical dialogue was recorded 20 years ago, it is so very true in today’s economy. I will give you his thoughts.
Before I launch into those fairly interesting subjects, I need to cover the markets for July which were excellent. The Standard & Poor’s Index of 500 Stocks was up a sterling 5.6%, during the month of July. Year-to-date this index broke into the positive 2.4% and for the one-year then ended in July, it is up 12%. In the first couple trading days of August, this index is now less than 1% below its all-time high level. The NASDAQ Composite continues to be the forerunner in all the indexes, up 6.9% during July and year-to-date is up 20.4%. The one-year return on this index is an almost unbelievable 32.8%. This index has outperformed mainly because it is where so many of the young tech companies reside. If you think this is just a flash in the pan, the ten-year return on this index is an excellent 18.2% annually.
The Dow Jones Industrial Average was up 2.5% during July but continues to be down 6.1% for the year. The one-year return on these 30 largest stocks is, however, positive at 0.8%. Just for purposes of comparison, the Bloomberg Barclays Aggregate Bond Index was up 1.4% for the month of July, up 8% for the year 2020 and for the one-year period up 10.2% for the period ending July 2020. While this was an excellent year so far for the bond index, a couple things are truly interesting.
Ava and her mask social distancing
Most times the stock market and the bond market move in opposite directions. If stocks are up, bonds are down and if bonds are up, then stocks are down. However, this year those stocks and bonds have rallied significantly so far. That is not normally the case, in that the ten-year annual returns for all the stock market indexes are double digits. The ten-year return on the bond index is a meager 3.8%. I will explain later in this posting why one of the major reasons the stock market continues to go up in an otherwise negative economy has much to do with the real-world effect of negative normalized rates of returns.
Almost every day I am confronted by an investor asking with great anger and disbelief, “How can we continue to be invested in stocks when the valuation is absolutely crazy at the current time? As of the end of July, the 12-month trailing P/E for the S&P is 26.8 versus 18 at the end of March.” They give me this example with the conviction that this level of P/E earnings is unsustainable and is at a historic height. I am always confused why investors always look at the past and never the future, which is much more important.
There is absolutely no questions that based on the disappointing earnings for 2020, that stocks are historically high. However, history will always rate 2020 as an outlier. What good information do we have in valuing stocks at a 26 multiple when we know that earnings are depressed - but earnings are likely to improve. It is now the current projection of the S&P, that earnings over the next 12 months should improve by over 48%. If earnings are to improve, as suggested, at 48% should you evaluate the market based on the trailing price earnings or evaluate it on its prospects? Clearly, anyone who has been investing for any period of time knows that whatever has happened in the past is in the rearview mirror, but what we should all be considering is not the past, but the future. Based on future earnings, the market is more closely valued at its March levels than its July levels. Some segments will see greater than 48% – think airlines and hotels.
The Schultz family at Sea Island
The evidence that the economy is improving is virtually everywhere, but you just have a hard time evaluating it because the media is so negative on the economy. In reading the news over the last couple of weeks I picked out items that were clearly positive for the economy, yet seemed to be ignored by the public. The State of Georgia recently announced that their collections of income tax and sales tax for the month of July was 17% higher than the month of July 2019. Take into perspective that analysis. All of us will acknowledge that in July 2019 the economy was very strong and the population was almost fully employed. However, during the month of July 2020 unemployment was high and the economy sputtering. But the reason should be fairly clear.
Retail sales have taken a major move up since the lockdown. Part of this, of course, is pent-up demand, but yet retail sales have come back a lot quicker than anyone expected. I will explain this phenomenon later on based on Zero-Sum economics. Also, even though there were huge amounts of the population not working in July, that doesn’t mean that they weren’t being paid. Due to the massive Federal Reserve influx of money, most of these unemployed were making similar amounts of compensation unemployed as they were making employed. People forget that unemployment benefits are taxable and withholding is required. Once again, even though the media would like you to believe the economy is completely in a state of disaster, the facts belie such headlines.
There seems to be a general lack of knowledge of Zero-Sum Economics. I have clients come in all the time and complain to me that it is impossible for the market to go up because all we have to do is look at the restaurants, airlines, cruise industry and retail to know that the economy is in shambles. Yes, no question, those statements are true, but where did the dollars that would have been spent on those industries actually end up?
Harper Wilcox, age 10, getting some fresh air at the beach
In a Zero-Sum Economy, if money is not spent on one item, but gets spent on another item, then the economy is at zero. If a family does not spend money on going out to restaurants, going on cruises, flying in airplanes or taking vacations, that is clearly a loss to those industries. If, however, that money is spent somewhere else, the economy does not suffer or, just as good, a family saved more. That is exactly what we are seeing today. Do you believe that there are not shortages in certain aspects of the economy? There clearly are, you see them every day, but you just do not realize it.
Why do you think the grocery stores cannot keep up with toilet paper and paper towels? Those industries are clearly booming as others fail. New car sales have been at historic highs recently. Does that not mean that the manufacturing industry of cars is working overtime to meet the demand? It is my understanding now that golf courses are overwhelmed with people wanting to play and golf equipment and golf clothes reached all-time highs during the month of July. Once again, those dollars are being shifted from one segment of the market to another. One client reported to me that they had ordered a brand-new golf cart for their vacation home but there is such a backlog of orders that delivery has been postponed. Everywhere in the economy you see a negative, you need to look at the other industries in the economy that show strength. While certainly restaurant sales are down, pizza deliveries are skyrocketing. It is everywhere, but due to the negative influence of the media you just cannot see it. What is so clear to me has been largely ignored by the media, is there a reason the media emphasizes the negative and not the positives?
As mentioned in previous postings, the Federal Reserve and Federal Government have dumped over $3 trillion of money into the economy. If anyone understands the velocity of money, then you understand what $3 trillion dumped into the economy over 90 days does. The acceleration of spending must occur or there would be a huge savings component. In real dollar terms, that means if you received this money you had two options. If you elected to spend it, the velocity of money being at 7, would generate $21 trillion of economic growth. However, in times of great uncertainty with the unknown future of your job and family security, the other possibly was that you just saved the money for a so-called “rainy day”.
It is now reported that the American economy has over $5 trillion in cash sitting in checking accounts in banks and other places. Given that this savings rate would be deteriorating daily with the level of inflation, it is a pretty good bet that this money will either be spent or invested over the next 12 months. If spent, then the economy will continue to grow and if saved the financial markets will continue to go up.
As stability occurs in the economy, a greater percentage of this money will be spent creating a higher economy. Rather, if invested it will create a higher stock market going forward. One of the reasons that the stock market held up in this recent crazy time is the argument that there is really just nowhere else to put the money. Already the 10-year Treasury Bond is trading at 0.5% and is at a negative real interest rate. If you calculate the cost of inflation, the rate of return on that bond is likely negative at 1% per year. That means that every day that you hold that bond, you lose money after the cost of inflation. It is the same if you hold money with cash. You are losing money every day against inflation.
Lucy Wilcox, age 8, playing in the sand
Cash may give you a warm and cuddly feeling by having it on hand but the fact that every day you hold that cash you are losing the value of purchasing assets since the rate of return is now negative. So, the argument must be that I will hold bonds because I believe they will appreciate it the future because I know that they do not pay any rate of return. Remember that a $100,000 bond generates roughly $500 a year in income and every year that income is less than the cost of inflation.
But now we have come to the point where bonds have actually run out of basis points to decline. The ten-year treasury is at 0.5%, it does not have much further it could fall. Couple that with the fact that the Federal Reserve is in an all-out war to create inflation. By virtue of the Federal Reserve, flooding the economy with money is a clear reason to try to increase inflation to increase the economy. Nothing could be clearer than recently the price of the U.S. dollar has fallen as the price of gold has gone up. Gold moves inversely to the U.S. dollar since most of the gold is held outside of the United States. But these are clear signs that the Federal Reserve’s effort to increase inflation is working. With a very low return on bonds and a very real possibility of increased inflation, you are locking in real-value losses by holding either cash or bonds. This is one of the reasons why the market continues to be held up, notwithstanding the avalanche of negative publicity.
Three or four times a day, I am approached by investors saying “What if the Democrats were to win the election in November. Won’t the stock market suffer a major decline?” While certainly no one knows how the election will turn out, you must be prepared on all fronts. If the Democrats do win the election, and certainly if they win the Presidency and both bodies of Congress, I expect the market would decline, but not appreciably. The reason why it will not decline appreciably is for the reasons above - what are your alternatives? You may be in cash temporarily, but you will eventually migrate back to stocks. Will that period be a week, a month? Certainly, no one knows. However, it will not be long-term and certainly the period of time when the correction occurs would certainly not be worth the effort to trade around it.
I get so very tired of hearing the pundits criticizing the stock market as being only for the wealthy. Their argument is that the average person’s life is not improved by the value of the stock market and, therefore, any attempt to make it go higher is only focused for the rich and not the middle class. Obviously, those people are not very well educated in economics or the wealth effect.
First off, the general public is very much invested in the stock market. It is believed now that $2 billion per day flows into 401(k), 403(b) and 457 Plans which flow directly into the stock market. Fidelity Investments, the largest holder of 401(k) money, reported that during the March 2020 selloff, the 401(k) investors made little or no changes to their asset mix. This is the way it should be. Long-term investors should never react to short-term market fluctuations. It seems that 401(k) investors are becoming better educated on how to deal with huge market fluctuations that are principally controlled by market manipulators.
However, these pundits do not really understand the wealth effect. The wealth effect happens when the market goes up and money is withdrawn from those profits and spent on other things. Almost every day we have a client withdrawing money from their account to buy or construct something. It may be to buy a new car, it may be to go on vacation, but more times than not it relates to improving their home.
Reid and Caroline Schultz watching the sunset on the water - ages 4 and 6
When money is withdrawn from the stock market and used to add an addition to your house, suddenly that money employs people. It employs people from the Main Street economy for both the construction workers and the people who build the materials. If a client takes money out of the stock market to buy a car, does that not put money in the pockets of the people who manufactured that car? There are so many examples o
f money coming out of the market to create liquidity to Main Street, for those pundits to argue that it is immoral to advocate stock market performance have, by the definition of the wealth effect, been proven incorrect.
Every day we see the effect of low interest rates improving the economy. Housing sales are booming, and construction workers are working at maximum levels. As clients take money out of the stock market and benefit from lower interest rates to refinance their mortgage or add additions to their house, they create wealth, as almost assuredly inflation will positively impact the value of their home ownership. Every day we see the wealth effect taking place as the market moves up.
The exact opposite happens as the market moves down. What you see are people who are invested that are less likely to take profits since the profits are lower and, therefore, there is negative wealth effect. It is not that investors use their excess cash to invest, but it is rather that they do not withdraw from their investments in a period of a down stock market. Over the last four months we have seen extraordinary gains in the stock market, and we are seeing extraordinary withdrawals to buy consumer goods. I do not understand how you could argue that this is anything but good for the economy.
Since there is virtually nothing to watch on T.V. nowadays except for Major League Baseball, in my case, I often drift into old YouTube comedy routines. During my era, one of the most famous was the comedian George Carlin. I ran across a couple of his concerts over the last few weeks and enjoyed his complete “off the wall” look at his neighbors and the American economy. One that I found terribly interesting was his analysis of the fear of germs. In his way of thinking, this country has become completely neurotic, with the population in the U.S. obsessed with security, safety, crime, drugs, cleanliness, hygiene, and germs. His words, not mine. But clearly, he has a point since we have, in my opinion, so grossly overreacted to this pandemic that it warrants further discussion. My favorite example is how we have become so neurotic with germs that even in prisons they swab the prisoner’s arm with alcohol before giving him a lethal injection! Think about that for just a second. For a person that they are clearly trying to put to death, they are concerned that he might get an infection. Overreaction – no question.
Each time I read the statistics of the pandemic, I wonder whether it is political in nature. Why are some states more restrictive than others when it comes to allowing the population to go back to work? In New York, as an example, they have still not even reopened their indoor dining rooms, yet they have announced that schools will be open in the fall. So, how does that even break down in economic terms?
The famous comedian George Carlin
If you analyze the various states for joblessness claims and those that are receiving benefits, it should be clear which states are abusing those rights and those that are not. In the most recent employment report dated July 18, 2020, 18.1% of all workers in the state of California are receiving unemployment benefits. In New York, that ratio is 16.3% and in Connecticut it is 15.2%. If, however, you compare it to other states, 3.6% of the workers in Iowa are receiving benefits, 4.5% in Utah, and 4.9% in Alabama. You do not have to be a mathematical wizard to see the contrast between those states that would prefer a change in administration as compared to those states that are likely not to want a change. Political – who knows?
The evidence is everywhere that the economy is improving, notwithstanding the horrific headlines you read daily. It is also fairly clear that earnings next year will rebound to normalized levels and, therefore, the value of the stock market is not overvalued, but is at a reasonable level. I do not expect a major downturn, but if there is, it will quickly recover and your long-term investment goals should be reached. This virus is a terrible plague on the economy, but it is time that all of us recognize what the risks are and move forward. We turned loose the American spirit and put Americans back to work at home, now we need to turn loose the American spirit and have the public eat in restaurants, fly on planes, stay in hotels, and move on with the rest of their lives.
The month of July also brought another recognition for Rollins Financial, Inc. It is a very humbling thought that for three years in a row we have been selected as one of the Top 300 Registered Investment Firms in the United States. That is really hard to contemplate given the scope of that recognition. To put it into perspective, there are probably 300 companies in the Greater Atlanta area alone that classify themselves as Registered Investment Advisors and we were in those that were selected out of all of the firms in the United States. I guess you can always say that it wasn’t an overnight success, since it took us 30 years to get here. When we received the recognition back in 2015 by CNBC TV as being the 20th best Registered Investment Advisors in the United States, we had $272 million under management. Today we manage for clients’ roughly ¾ of a billion in assets. Obviously much of our success is from the willingness of our clients to let us help them in planning for their retirement, but all of us should acknowledge the fact that we continue to grow and get referrals when clients make money. No other attribute is more important in the growth of a firm like ours. If we have not said so recently, we certainly appreciate all our clients that we help to reach their goals.
On that note, come visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.
As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best Regards,
Rollins Financial, Inc.
