Episode 35 – Does A “Santa Claus” Rally Depend On This Week’s FOMC Meeting?

SCRIPT:

Hello and welcome to another episode of “A Brighter Future,” Laidlaw & Co’s Podcast Series.  I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and I am joined again today by David Garrity, Chief Market Strategist for Laidlaw & Co.

David, we had a “touch of spring” this weekend with temperatures warming up in many parts of the Northeast, just as the FedEx & UPS trucks were warming up to deliver the first doses of Pfizer’s vaccine.  In the markets, we saw stocks close the week lower, led by the real estate and financial sectors, as the jobs recovery appears to be stalling while talks between Republicans and Democrats over another round of fiscal stimulus continue to drag on.  And that is where I want to start our discussion today…

Question 1: 

David, does a postponed stimulus package, while U.S. workers are claiming unemployment insurance at unprecedented levels and as further economic restrictions from rising cases constrict growth, pose the biggest headwind for the markets?

Rick, while we did enjoy the brief respite of warmer weather this weekend, we decided to go for a hike over some rough terrain in The Blue Hills Reservation nearby where after clambering over slippery rocks and muddy inclines to get to the summit to enjoy the lovely vista of Boston and its environs we had to break our own path to get down again as my headstrong 14-year-old son was determined he knew the best way through the forest thick with undergrowth. In a way, the weekend experience captured well the character of the current market as being one criss-crossed by many possible paths, but with no clear way forward and the distinct risk of a nasty fall down steep rocky slopes. A good reminder, if any, to go slow and only with sure footing. 

That said, Rick, I would rather consider risks to the market as being more pitfalls than headwinds of which the economy decelerating in the face of COVID’s resurgence is only one.

Question 2:

David, as follow-on question, it appears the market and investors are largely focused on the prospects of a brighter outlook driven by vaccine rollouts.  To this point, the S&P 500 has hit 30 new all-times highs in 2020, 17 of them recorded after the late-February pandemic-induced bear market, and four of them recorded in the last two weeks. Is this remarkable strength justified considering the recent loss of momentum in economic data, or has complacency settled in?

Rick, while we previously discussed a COVID vaccine’s role as the leading horseman of the recovery, we view the market’s strength since the November election as a sign of investor confidence that the incoming administration will provide a measure of competence and order that will accelerate the containment of COVID, something that the current administration’s indifference and chaos allowed to flourish to the attendant suffering and loss of many. Apart from the positive sentiment following the election, note that the corporate earnings recovery is unfolding well and should serve to increase Wall Street estimates as we move into 2021. 

If investors are thought to become complacent, it can be shown there are multiple factors supporting their apparent confidence in a brighter future. Still, as we will touch on later, there are also a number of signs that rational confidence may be boiling over into unbridled exuberance, something to be warned against.  

Question 3:

David, for the past week or so, I have started to hear a topic discussed every year about this time, no matter what stock market performance has been over the prior 11 months.  Whether the market has been naughty or nice really, every year stock investors ponder the question of whether there will be a “Santa Claus rally” to finish out the year.

Technically, the “official” time frame for a Santa Claus rally is the week of trading between Christmas and New Year’s Day. But why not throw a “Market Party” for the entire month of December, if possible.  In fact, historically December is one of the strongest months for stock market performance, looking back over the past 65 years.

However, given that the S&P 500 just posted its best November performance since 1928, up +10.8% and is up just over +14% on a year-to-date basis, is it possible Santa came a little early this year?

Rick, you were kind recently to share the SNL take on the “December To Remember” car commercial in which parody an unemployed, cash-strapped father purchased a Lexus much to the chagrin of his wife, the recipient of the gift. While it may not have been as touching as O. Henry’s “The Gift Of The Magi” published 115 years ago, it did serve to capture the insight that perhaps the current stock market is reaching beyond its means. 

In this we might say that Federal Reserve Chairman Jerome Powell has been playing well the role of Santa Claus since March 2020 and with the recent nomination of Janet Yellen as Treasury Secretary we now have Mrs. Claus. If Senate Majority Leader McConnell does not reprise the role of The Grinch, we can still stand a decent chance of a “Santa Claus” rally, especially as this Wednesday’s FOMC meeting may bring tidings of monetary policy comfort and joy.

Question 4:

I want to shift gears and talk about another big topic from the past week – the hot IPO market.

As we touched on last week, the pendulum of investor sentiment has clearly swung from fear of losses, to fear of missing out.  In addition, the phrase “this time is different” supposedly one of the most dangerous to utter in the investing realm, came to mind as we watched AirB&B explode to the upside one day after DoorDash did the same thing.

With the past as our guide, is there anything that our listener’s can learn from the IPO market?   Also, could this time really be different as at least these companies are more mature than the infamous Pets.com and their Sock Puppet

Rick, the parabolic moves seen in an increasing range of speculative risk assets such as IPOs, SPACs and cryptocurrencies brings to mind what economist John Kenneth Galbraith in discussing the Crash of 1929 described as “the bezzle.” 

In The Great Crash of 1929, John Kenneth Galbraith describes the bezzle as the “inventory of undiscovered embezzlements,” that grows in times of rising markets. When the markets collapse, these schemes are exposed and lead to large losses for investors. 

Galbraith identified a sweet spot after the embezzlements have been committed and before they are found out, “Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the embezzlee, oddly enough, feels no loss. There is a net increase in psychic wealth.)” 

To me, the bezzle of the current bull market isn’t stocked with Ponzi schemes and outright frauds, but rather it is built on the notion that risky assets have become practically risk-free thanks to central bank and government fiscal policies. Like Icarus, the market will eventually drop from its heights and the current bumper crop of bezzle will be exposed.

Question 5:

David, the pandemic has accelerated geopolitical transformations such as a bipolar U.S.- China world order, and a rewiring of global supply chains for greater resilience – with less emphasis on efficiency.  As a result, it appears a strategic U.S.-China rivalry looks here to stay, with competition and bifurcation in the tech sector at its core.

I know as recently as last week in our Investment Committee Meeting we discussed the need for investors  to have exposure to both poles of global growth.  Knowing as much about China as you do, do see assets exposed to Chinese growth now becoming a core strategic holding?

Rick, the recent moves by the PRC government to impose restrictions on the Chinese technology sector should give investors pause as to the risks associated with the market which can be at times quite opaque as the government pursues its own policies that may be at cross purposes with investors. Meanwhile, note that last week, Chinese stocks suffered their worst weekly decline since September, as concern over high valuations and the tightening supply of cash weighed on the market. 

The Chinese stock market has done well this year based on the faster recovery from COVID, but it is likely that as other regions recover with the distribution of COVID vaccines in 2021 that the Chinese stock market will lag the global averages. While the depreciating U.S. Dollar has us looking to international markets, our suggestion for investors looking for exposure into China is to do so by investing in the ETFs for Singapore, South Korea and Taiwan as they contain companies that are exposed to the China market, but not directly subject to the whims of the PRC government.

Question 6:

David, as we bring another episode of “A Brighter Future to a close, we are heading into a big week with a Fed Meeting.

Some Fed watchers think the central bank could begin to move their $80 billion monthly Treasury purchases toward the longer end of the curve to put an artificial ceiling on longer-term interest rates. But the overall size of the purchases probably won’t be increased.

They also could provide guidance about how long they will continue the current pace of securities buying but can we assume they wouldn’t want to do anything to disturb things while Congress continues to fail to agree on a much-needed new fiscal relief bill?

Rick, the Fed has been unfailingly accommodative throughout the COVID crisis and we expect this week’s meeting to offer reassurance that this support remains constant. Yes, it is understood by the Fed that Congress has been delayed in providing further fiscal relief, the need for which has been underscored by Fed Chair Powell in his recent testimony before Congress. 

To that end, we expect the Fed to provide strong indications that it will engage in quantitative easing with the aim of capping yields at the long end of the Treasury curve and it is not out of the question for the Fed to increase its monthly purchases from the $80bn level. Liquidity continues to be on offer from the Fed as we move towards the inauguration of the new administration in January 2021.

Episode 34 – Time Investors Head Overseas, Far From The Madding Crowd?

SCRIPT:

Hello and welcome to another episode of “A Brighter Future,” Laidlaw & Co’s Podcast Series.  I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and once again I am joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

David, I hope you had a nice weekend and you were able to stay warm as a cold front rolled into the Northeast.

Rick, the snowstorm that rolled through on Saturday served as an excellent reminder to press ahead on holiday preparation activities like getting mailing lists together and designing a holiday card for the season that could bring joy to what has been an otherwise dark year. Also, the storm brought a decent snowfall that should help to bring the start of the ski season to the Northeast, we hope. 

So, as we get to work shoveling the snow and salting the steps, we are mindful of the need to wrap things up soon for the holidays and to get ready for the year ahead. In this we also remember that our forebears faced the challenges of their time such as the attack on Pearl Harbor 79 years ago today and through their courage, perseverance and not a small bit of good luck managed to bring us to where we stand today. May we today do the same for those dear to us so they may have a brighter future tomorrow.

Question 1:

David, the cold front’s movement did not cool off the markets, as they stayed hot with stocks edging higher last week extending this historic rally into the first week of December.

Despite a notable slowdown in hiring that was revealed in the November jobs report, major indexes closed at record highs and Treasury yields rose, reflecting expectations for additional fiscal stimulus.

The U.S. economy added 245,000 jobs in November, missing estimates amid a spike in COVID-19 infections and renewed restrictions in activity. The unemployment rate declined to 6.7% from 6.9%, but the participation rate also declined, indicating that more people exited the labor force.   A potential “silver lining”  is that the downshift in job gains could apply pressure to lawmakers to reach an agreement for a new stimulus package before the end of the year.

At the same time though, as Howard Mark’s of the Oakmark Fund said recently, “fear of missing out has taken over from the fear of losing money. If people become ultra-risk-averse, that’s how you get great bargains. Because they’re risk averse, they won’t buy. They sell at low prices. But if people are risk-tolerant and afraid of being out of the market, they buy aggressively, in which case you can’t find any bargains. That’s where we are now. That’s what the Fed engineered by putting rates at zero.”

So, let’s start our discussion there this week, and make this a multi-part question:

1. What are your thoughts on Howard Marks comments?

Rick, to me the words of Howard Marks carry a lot of weight as he has been a successful investor over a number of market cycles doing so by buying when prices were low due to financial distress and selling when prices were irrationally exuberant. If Howard Marks is making cautionary remarks it prompts me to look for where there may be crowded trades that may have developed in the market.

Experience shows that when the financial markets demonstrate a high level of consensus, in this case namely that 2021 will be a year of strong economic recovery globally, it is a rare thing for the consensus view to play out in its entirety. Right now, the crowded trades appear to be: short the U.S. dollar versus cyclical developed-market currencies, long copper and long Bitcoin. On the other hand, bullish positions on oil and gold are less crowded, as are overweight emerging-market equities relative to developed ones. 

Along with Marks’ comments, last week brought an interesting paper co-authored by Yale economist Robert Shiller (see: https://www.project-syndicate.org/commentary/making-sense-of-soaring-stock-prices-by-robert-j-shiller-et-al-2020-11). Shiller is notable for his analysis of cyclically-adjusted price-earnings (CAPE) ratios which he used to predict the bursting of the “Web 1.0” stock bubble. 

Shiller’s suggested tool for handling the gap between the CAPE and interest rates is what he terms the “Excess CAPE Yield” (ECY) which is a spread that expresses CAPE as an earnings yield, rather than a multiple, and then subtracts the 10-year interest rates. According to Shiller, the ECY has been effective in predicting subsequent returns over the following 10 years. The ECY currently suggests that the U.S. market should be in line for average real annual returns of about 5% per year for the next decade.

Bottom line, Rick, as we mark Marks’ words of caution and work to avoid crowded trades, there is good reason based on Shiller’s work to see markets as still being constructively priced for attractive returns and it appears that investing in emerging market equities, oil and gold may be good trades going into 2021.    

2. Have we returned to a market, as Barron’s referred to this weekend, where “bad news is good news” and where FOMO is driving investment decisions?

Rick, the November jobs report did send a very clear message that served to underscore Fed Chair Powell’s recent testimony before Congress, namely that the U.S. economy needs more fiscal stimulus and soon. 

That the balance in the Senate between GOP retaining control happens to lie in the outcome of the January 5th run-off election for two Senate seats in Georgia is serving to concentrate Majority Leader McConnell’s mind quite wonderfully around the idea of pushing for a fiscal stimulus vote this week. 

Failure to do so will give the Democrats a clear message to campaign on which would be that the GOP is happy for the U.S. economy to slide back into recession as they focus their time and effort on trying to overthrow the recent presidential election by raising doubts about the integrity of the election system. So, it’s time for Senator McConnell to get to work, and, yes, Rick, we are back in an environment where bad news on the economy is indeed good news for the market.

On the question of whether “fear of missing out” (FOMO) is the order of the day, we can see in the table below the equity market has rallied hard as the election season passed and, most importantly, that news of successful COVID vaccine tests has come out. 

Growth vs. Value: 4Q 2020 Performance
	October	Nov & Dec
Index	Change %	Change %
S&P 500	-2.8%	13.1%
S&P 500 Growth	-2.8%	11.3%
S&P 500 Value	-1.8%	16.1%
Growth less Value	-0.9%	-4.8%
Russell 1000 (R1K)	-2.5%	14.1%
R1K Growth	-3.4%	11.9%
R1K Value	-1.2%	16.8%
Growth less Value	-2.2%	-4.9%
Russell 2000 (R2K)	2.0%	23.0%
R2K Growth	0.7%	20.5%
R2K Value	3.7%	25.8%
Growth less Value	-2.9%	-5.3%

Note this record rally has been driven by a rotation into value stocks and small caps as the prospects for economic recovery in 2021 have grown with the view that vaccine distribution will prove sufficient to contain the COVID outbreaks that under the current administration have been unchecked.

So, while it could be termed a FOMO-driven market, my inclination is to see it as one supported by relief that COVID is being contained and that a new team is coming into power, one that will better address the issues of the day and restore a better order to America and its place in the world. 

Meanwhile, these market hopes are underpinned by the fact that the corporate earnings recovery from the 2Q 2020 bottom is continuing and has not yet been accurately assessed by Wall Street analysts. As we have said before, Rick, the stock market discounts earnings power 2 quarters out and Wall Street analysts have always underestimated company earnings early in economic recovery. 

In the 2010 cycle, the underestimation was -9%. Applying that to the current Street estimate for 2021 S&P 500 earnings of $169/share results in a more likely result of $184/share. This means the S&P 500 is now trading for 20.1x 2021 earnings, a reasonable early-cycle valuation as there is the chance for further cyclical earnings improvements in 2022 and beyond. Still, the multiple is only reasonable as long as companies continue to show better reported earnings with guidance of further improvement to come.

Question 2:

David – I know we are going to be publishing our Laidlaw 5 for 2021 in a few weeks (shameless plug), but I want touch on one of our 2020 Laidlaw 5 topics for a minute – Oil.

Last week we saw oil extend its gains to a nine-month high after OPEC and its allies agreed to increase production more gradually than previously planned.  The outcome of the OPEC+ meeting has been welcomed by the media and speculators as a sign of stability. Optimism about oil prices and a global economic recovery has grown, with a multitude of future oil price graphics spreading like wildfire on the internet.

While oil markets are relieved that OPEC+ will continue to cooperate and the group maintains the ability to move markets, some observers are skeptical as the cooperation by members of the group only came after days of dissent.  In what I have read, it seems that OPEC+ does not recognize that OECD economies are on life-support, as financial support mechanisms are keeping these countries afloat and in 2021 most of these financial injections or QE mechanisms will stop as debt levels are reaching disastrous levels.

In addition, the markets should realize that the recent deal is nothing more than an effort to present a “success story to the press” and while the cartel will be happy with $50 per barrel, with current market conditions, OPEC itself still doesn’t admit the threat of a re-emerging Iran, of strong Iraqi production, or of the potential lifting of sanctions by President-Elect Biden. The OPEC+ approach seems to be “if you don’t talk about it, it doesn’t exist”.

So, is this good for us as consumers (i.e. cars, travel in planes etc.) and what could we expect at the pump?

Rick, in our view, OPEC+ is whistling past the graveyard as the long-term shift towards electric vehicles is underway, something reflected in the rising valuation of Tesla and other manufacturers, and the near term as you indicate will likely see the return of Iranian supply to the market on the likely move of the incoming administration to relax sanctions in order to encourage compliance with the nuclear accord. A further element that may emerge as countries seek to implement the Paris Accords is the possibility of carbon taxes that would favor renewables over fossil fuels.

That said, the prospects for better economic growth globally in 2021 support higher oil prices, so I consider oil to be a reflation trade something that has been reflected in the commodity’s steady price gains over the past 5 weeks. As for gasoline pricing, the resumption of driving activity will clearly have an effect that will likely result in pump prices being higher at the end of 2021 from where they are now.

Relative to energy stocks, the return of oil prices over $45/barrel will benefit U.S. oil shale producers. As far as the stock market is concerned, 2021 needs companies to produce revenue gains on top of streamlined cost structures in order to drive share price appreciation. A recent FactSet analysis shows that the energy sector at +13.2% expected 2021 revenue growth is the highest of the 11 S&P 500 sectors. With the energy sector having high fixed costs, we expect the incremental revenues realized off the 2021 forecast will have high contribution margins, something to support energy as an attractive 2021 trade. 

Question 3:

David, let’s look at the Fixed Income markets for a minute, if the economy is going to gather steam in 2021, like many think it will with the arrival of COVID vaccines, it should lead to a steepening in the yield curve.  That steepening is often referred to as a “bear-steepener” trade, as it would be driven by yields on longer-dated bonds moving up at a faster clip than yields on shorter-dated bonds.

The idea that the shorter-dated paper would be slower to run is linked to a strong belief that the Fed won’t be in any hurry to raise the target range for the fed funds rate as the economy recovers.

The Treasury market has been seeing the recovery light so to speak for many months now but it has been more like a night light, though, as opposed to a flood light considering that the 10-yr note yield has been rather deliberate in its attempt to climb back above 1.00%.

While many had suggested the “bear-steepener” trade had gone into hibernation, last week we saw the 2s-10s spread widening to 83 basis points — a three-year high — from 69 basis points at the end of the prior week with the 10-yr note yield pushing up to 0.98%.

With the 10-yr note yield challenging its mid-November high (0.98%), which was the highest level since March, and sitting on the doorstep of the psychological 1.00% level, will the stock market tolerate a jump in long-term rates, especially since lofty equity valuations and multiple expansion have been catalyzed and rationalized on the back of low interest rates?

On a related question, does this force the Fed change to its asset purchase program to incorporate increased purchases of longer-dated paper in a bid to keep rates from moving up too far, too fast on recovery hopes?

Rick, what lies at the core of this discussion are the questions “where is inflation?” and “how soon will short-term rates rise?”. On the first question, based on the inflation breakevens imbedded in 5- and 10-year Treasury Inflation Protected Securities (TIPS) notes both are now higher than they were at the start of 2020. The levels then: 1.72%/1.80% and now: 1.83%/1.89%. Inflation expectations breaking out signal a market belief that the near future will see better economic growth than the very recent past. So, to the second question, this is now beginning to be reflected in Fed Funds Futures as late last week the CME FedWatch tool put a 6.2% chance on a September 2021 rate hike whereas previously it had been 0%. These are elements to consider as driving rates at the long end of the yield curve higher.

As outlined earlier in our discussion, I expect the stock market will be driven higher by the corporate earnings cycle that is unfolding supported by vaccine distribution and fiscal stimulus driving economic recovery. Treasury Secretary nominee Janet Yellen along with the Federal Reserve under Chairman Jerome Powell will likely hold back on tightening monetary policy and fiscal conditions in favor of letting the recovery take hold. Consequently, while we keep a keen eye on the fixed income market and its ability to call time on the equity market, it is not now approaching a point where the holiday punch bowl is likely to be taken away. 

Question 4:

David, as we bring another episode of “A Brighter Future” to a close, I want to get your your thoughts on something I know is important to our listeners –  The US Dollar.

Last Tuesday, we saw the Dollar Index

drop -0.65% to fresh multi-year lows last seen in April 2018.  As you know, I wrote about it on Wednesday AM and as well you had some great insights on what is happening during your recent interview on the TD Ameritrade Network and I thought maybe you could share those with our audience as I am sure many are questioning how many of those US Dollars they’ll be spending during this holiday season.

Rick, the Dollar index depreciation reflects a normal pattern seen in previous economic cycles in which it weakens relative to other currencies. Currency valuation is a function of GDP growth rate and interest rate spreads. Based on the points made in discussing fixed income, the currency markets in our view are pricing in the expectation of further monetary and fiscal easing in the U.S. going into 2021 and possibly extending into 2022. Relative to the global economy, Dollar weakness is beneficial as it in foreign currency terms serves to lower costs on Dollar-priced commodities. 

From what we mentioned earlier as a relatively uncrowded trade, investors in 2021 may wish to overweight non-U.S. markets, especially those of developing economies, against a backdrop of Dollar weakness. In terms of S&P 500 sectors with an above average revenue and earnings contribution from non-U.S. sources, technology and energy rank highly, something for investors wishing to remain only invested domestically to consider.

Episode 33 – DJIA 30,000 A Sign Of Animal Spirits, But Will Russell 2000 Take Wing In 2021?

SCRIPT:

Hello and welcome to another episode of “A Brighter Future,” Laidlaw & Co’s Podcast Series. I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and once again I am joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

David, I hope you had a happy and, of course, socially distanced Thanksgiving.

Rick, the holiday was as suggested a small and intimate family gathering in which the spirit of gratitude was shared, but not the infection of the day. Without the expectation that guests would soon arrive, we all had the chance to settle in and spend time together in conversation and remembrance. Over the weekend, we had the chance to visit the cemetery where my father’s family lies at rest and recall how they had come together to survive the Spanish Flu epidemic. Good lessons of commitment to each other, service to others and perseverance to always remember and not lose sight of, especially now.

Question 1:

So, David last week we saw positive coronavirus-vaccine news, which helped propel the Dow Jones up more than +12% for the month, crossing the 30,000 mark for the first time, and on track to have the best monthly gain since January 1987 while the S&P 500 and Russell 2000 both posted fresh record highs.   Economic data releases were light, putting the emphasis on the high-wire act investors are walking between positive vaccine news and rapidly climbing COVID-19 cases and hospitalizations.

But the question I want to start with today is Dow 30,000: Symbolic or Significant?  While “Dow 30,000” has a nice ring to it, the underlying factors that have gotten the market to this level are more significant than the number itself.  So, what does this number mean for investors?

Rick, as the Dow Jones Industrial Average is not a performance benchmark for institutional investors of anywhere near the magnitude of the S&P 500 index, the effect of its recent rise through the 30,000 level is more psychological than anything else. That said, animal spirits are just as important in supporting market advances as economic data and corporate profits. 

So, we will consider the development to be a further positive confirmation of a return of optimism to the stock market as investors look across the chasm opened in the economy by the COVID pandemic as the bridge offered by accommodative monetary policy, record fiscal stimulus and now the discovery of vaccines supports the prospect of a better economy in 2021.  

Question 2:

David – last week’s momentum was anchored on three developments that appear to have  given investors confidence the ill-effects of the pandemic may soon be mitigated, and the socio-economic stormy weather will be changing to calmer seas ahead:

First –  Pfizer, Moderna, and AstraZeneca all announced preliminary “high positivity” results

in the quest for a vaccine. Pfizer officially asked for FDA emergency approval under the

auspices of the Federal Warp Speed program. Should this and others follow we should

have inoculation available in late December – early January, and public availability

by March.

Second, we have indications there will be a smooth transition of power as the GSA approved President-elect Biden to start transition talks with federal agencies. While this belongs in the political venue, a smooth transition gives confidence to markets that all  essential stimulus programs will continue to operate effectively.

Third and finally, as long as both parties continue to cooperate on the transition phase, we can avoid a budget crisis as Congress has to pass a continuing resolution to extend the current one that expires December 11. Again, leaving politics aside, we need to resolve funding the unemployment benefits approved in the Cares Act and expiring on December 11. Failure to do so has economic consequences as we continue to grapple with a 6.9% unemployment rate.

However, while those three developments are good this is not a stool, it’s a chair and we need that fourth leg.   Everybody agrees we need a fiscal stimulus package to mitigate the ill effects of the pandemic, and the rising tide of jobless claims, but this “fourth leg” requires Congress to do their job. Do you believe Congress will do something on a piecemeal basis?   If not, does that present short-term risk and volatility for client portfolios?

Rick, seeing how the relationship between rising financial asset prices and liquidity provided by fiscal and monetary stimulus has been amply demonstrated during the COVID pandemic, it is hard to argue against the need for further fiscal stimulus not just domestically, but globally as well. 

As you state, weekly unemployment claims have been moving higher as the third wave of COVID infection has been sweeping across America and in the process fulfilling the predictions of health experts such as Dr. Anthony Fauci who warned that the onset of cold weather would bring substantial risk of increasing infection and mortality. 

While Congress is moving to provide extension to current unemployment benefit programs, there are still roadblocks such as the current administration’s insistence on receiving a further $2 billion for its southern border wall. Talk about obstructing progress when people need it most, but following the recent election the political climate remains highly partisan to everyone’s mutual detriment. 

To me, it is clear that American democracy needs a new deal in order to move forward, but it appears that unless both of the Senate run-off elections in Georgia coming in early January favor the Democrats the prospect is for piece-meal action at best. To cure what ails America now politically depends in large part on the ability of the incoming administration to prove effective in curing what ails America now physically. If it can do so, then it enhances the prospects for breaking the political barriers that impede the chances for rebuilding America better.   

Question 3:

David, strategists with many decades of experience normally think about gold in a certain way: as an inflation hedge and/or gauge.

Investors also don’t really have a handle on what gold is or what it represents. Many erroneously believe gold is some sort of inflation hedge, because of our experience in the 1970s. It’s also not a hedge against stock market crashes, as we discovered in March.

Gold is a hedge on government authorities making poor economic choices. Inflation is usually the result of those poor decisions, but people confuse cause and effect here. Gold is a hedge on policy makers screwing up, and there has been a lot of screwing up in the last 20 years.

Those who were around in the 1970s and saw gold hit $800 for the first time at the end of that decade, think back to soaring inflation and 30-year fixed mortgage rates well in excess of 15%. Then Paul Volker took the reins at the Federal Reserve and took away the “inflation punch bowl” The price of gold collapsed over the next couple of years and really didn’t find a bottom until 2001.

But here we are today with gold trading around $1,800 per ounce with prices in early August  exceeding $2,000  All of this is, of course, while inflation around the world is at extremely low levels with some of the developed economies teetering on the verge of outright deflation at times.

So, we are seeing almost no inflation, but gold is trading at a record high.  So, I’ll ask the question many investors are asking, Why?

Rick, as you mention, historically gold is viewed as a hedge against policy errors that result in rising inflation. Given that the Federal Reserve under Chairman Jay Powell has moved recently to relax its interest rate policy guidelines to allow for higher inflation rates, one might expect that gold would receive a material and sustained boost in its price level. 

This is further underscored by the likelihood of former Fed Chair and former head of the Council of Economic Advisors Janet Yellen being appointed Treasury Secretary. With Yellen’s background as a labor economist and an accommodative Fed, one might expect that over time labor wage levels may start to rise, something that could serve as an inflation driver as labor markets tighten. 

However, the price action in the bond markets do not reflect much in the way of inflation concerns, if any. The implied inflation rate calculated by comparing yields on Treasurys and on Treasury inflation-protected securities for the five years starting in five years’ time has risen only to 1.83% from 1.81% at the end of October, still below the 1.92% reached last month, the highest since August last year.

The best explanation for bond market yields remaining low lies in the expectation of monetary intervention by central banks as they move to keep long-term interest rates low so as to support economic recovery following the successful distribution of COVID vaccines. 

That said, while low interest rates serve to reduce the carrying cost of a gold position, the feared appearance of inflation that will drive gold prices higher lies well out into the post-COVID future.   

Question 4:

David, it seems like the 2021 S&P 500 “Price Target Game” is in full swing and quite a few firms are swinging for the fences!!  JPMorgan sees the potential for a move to 4500 by the end of 2021; Goldman Sachs thinks 4300 will be seen by the end of the year; and BMO Capital Markets thinks 4200 is within reach.

What’s not to like about such upbeat forecasts? If they happen to be right, there will be a lot of happy index investors this time next year.  However, right now I think there are probably a lot of relieved index investors. The S&P 500, which was down -32.2% for the year at its low on March 23, is now up +12.6%!

It has been an absolutely stunning turnaround in a year that has been absolutely stunning in myriad respects because of the coronavirus. However, 2020 isn’t done, though, and neither is the coronavirus.

In fact, it caught my attention last week when hedge fund manager Bill Ackman said what just about everyone is saying these days. He said he is optimistic about a recovery in 2021 but he also said “…the next couple of months unfortunately are going to be tragic and very difficult for the globe and for our country in particular.”

He went on to add that he is happy to be long with equity exposure, but that he thinks it is still prudent to have a decent-sized hedge should market volatility increase due to any number of uncertainties and after all his intention is to mitigate the risk of losing money for his investors.

It is easy to lose sight of that need in a raging bull market — and the market has been raging in November because so many people are looking for a bullish stampede next year.

So, David with the S&P 500 pushing up against its all-time high at the same time the number of coronavirus cases in the U.S. and globally are also growing dramatically, is there the potential it could lead to a tragic year end for the stock market?

Rick, it has long been said on Wall Street that no one gets fired for taking a profit. After the wild ride 2020 has brought and the gray hairs it has very likely created along the way, I would not be surprised at all that the stock market going into the end of the year will trade sideways. However, it is important for investors to consider that both the economic externals and the market internals remain constructive. 

As to economic externals, we remain in a supportive monetary policy environment and the chances are for some action on the fiscal policy front with the incoming administration. Relative to market internals, we have recently seen the Russell 2000 begin to outperform the S&P 500 as investors see the benefits from COVID vaccines working their way into the broader economy. While the S&P made a new all-time high on August 17th, it took the Russell until November 13th, and its prior all-time record was back in August 2018. 

Small-cap stocks rarely perform exactly in line with large caps over a 1-year period which means that, even with the Russell 2000 now matching the S&P 500 over the last year, there is the opportunity to make a profitable call on small-cap stocks in here as they tend to work better than large-cap stocks at the beginning of a business/economic cycle. This was the case in 1991, 1993, 2003, and 2009 – 2011. In each of those periods the Russell 2000 beat the S&P 500 over a 200-trading day holding period by at least +10 percentage points.

The takeaway here is that the Russell 2000 should outperform the S&P 500 over the next year. Ten points of outperformance is the usual early cycle difference in relative performance between the two, something offering sufficient potential upside to consider small-cap stocks now even at their recent new highs. 

Question 5

David, as we bring another episode of “A Brighter Future” to a close, I’d like to stay with the topic of the Fed and get your thoughts on the potential of Janet Yellen as our next Treasury Secretary?  Given that she is considered to be as “dovish” as Fed Chair Powell, could we be looking at more monetary and fiscal support for the economy than we are usually used to?

Rick, as mentioned in passing earlier, presumptive Treasury Secretary nominee Janet Yellen offers a superb mix of unique theoretical insights into the labor market well-grounded by institutional practice both as Chairman of the Federal Reserve and Chairman of the Council of Economic Advisors. Should Yellen be confirmed and in our view it is very difficult to imagine the circumstances under which her nomination will not move forward, she will represent a trifecta in economic policy management. 

So, in response to your question, Rick, not only are we likely to receive more monetary and fiscal support, but more importantly the means and methods and focus of these efforts will be guided in an adroit manner that likely has not been seen in some time. That said, the confidence of investors worldwide has been and should be bolstered by the prospect of improved economic policy stewardship under the leadership of Janet Yellen as Treasury Secretary.

Episode 32 – As New Bull Market Starts With Record Cash Inflows, Time To Ride Small Caps?

Synopsis: “A Brighter Future” – Episode 32

In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, discusses the early take on the incoming Biden Administration and positive COVID vaccine news, the takeaway from the November Jobs Report, the “Growth Scare” limiting market acceptance of strong Q3 2020 earnings, how will gridlock in Congress shape the Biden Administration’s impact on different sectors and other developments with Laidlaw & Company Chief Market strategist, David Garrity.

The topics discussed in this episode are: Will government transition uncertainties and the COVID resurgence “growth scare” dampen the post-election rally?, Will Labor Force Participation rate recovery continue absent widespread COVID vaccine availability?, When will the market fully buy into the corporate earnings recovery? and Is the Biden Administration simply a re-opening trade or a restoration bull market cycle?

Please tune in for more timely insights.

SCRIPT:

SCRIPT:

Hello and welcome to another episode of “A Brighter Future,” Laidlaw & Co’s Podcast Series.  I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and once again I am joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

David, last week we saw the S&P 500 close at a new record high and global equities post a second week of gains following news of progress in developing a COVID-19 vaccine. In fact, when we were taping A Brighter Future last week, we were still digesting the Pfizer/BioNTech announcement that their vaccine had 90% effectiveness in their large study which triggered a new wave of hope and optimism that a medical solution will address the health crisis and accelerate the economic recovery.

We saw cyclical sectors that had been negatively impacted by the pandemic and are more sensitive to the reopening of the economy outperform last week, while sectors that have benefited from the pandemic like the “Work From Home” stocks, underperform.  A similar rotation occurred across asset classes, with small-cap and international stocks outpacing U.S. large-caps.

The encouraging vaccine news is consistent with what we have been saying, that the economic recovery will be sustainable heading into and through 2021, but near-term uncertainties could still trigger volatility.

Mass production and widespread distribution of any vaccine will likely take months, and in the meantime the virus will continue to shape the direction of the economy, suggesting that balance and diversification across sectors and asset classes are warranted.

And it’s that balance and diversification where I want to start our discussion today…

Rick, with all the violent swings in the market over 2020, we need to be able to step back and assess the broader outline of the stock market. To that end this weekend I travelled with family up to the Presidential Range in New Hampshire. While usually starting to be covered with snow at this time of year, Mount Washington and the surrounding peaks were bare. In our hiking, we could make out clearly the easier paths and steeper slopes that might otherwise be obscured by the groundcover.  

So too, the last week has opened some interesting perspectives on the stock market as small-cap Value stocks in the Russell 2000 rallied +9.23% and large-cap Growth stocks in the Russell 1000 retreated -1.18% as the Pfizer COVID vaccine news prompted a major rotation from Growth to Value. 

To capture this in the broader context of market shifts in 2020, we offer the table below which shows that Value stocks across the capitalization spectrum are -6% below their 52-weeks highs while Growth stocks have exceeded theirs by +11-18%. With the possibility that there may be a vaccine for COVID, the risks around Value stocks are starting to be mitigated.

Growth vs. Value: Performance from 2/19/20 Peak
	2/19 – 10/30	10/30 – 11/13	2/19 – 11/13	Recover %
Index	Change %	Change %	Change %	Of Peak
S&P 500	-3.4%	9.6%	5.9%	106%
S&P 500 Growth	6.7%	8.5%	15.8%	116%
S&P 500 Value	-15.9%	11.4%	-6.4%	94%
Growth less Value	22.6%	-2.9%	22.1%	22%
Russell 1000 (R1K)	-2.6%	9.6%	6.7%	107%
R1K Growth	9.0%	8.1%	17.8%	118%
R1K Value	-15.5%	11.4%	-5.9%	94%
Growth less Value	24.5%	-3.3%	23.7%	24%
Russell 2000 (R2K)	-9.1%	13.4%	3.0%	103%
R2K Growth	-0.9%	12.5%	11.4%	111%
R2K Value	-18.3%	14.5%	-6.4%	94%
Growth less Value	17.4%	-2.1%	17.9%	18%

Our thought last week that a new bull market cycle might form as we move past the election certainly received a positive response last week as, according to the FT, “investors ploughed more into global stock funds in the days after Pfizer unveiled its virus breakthrough on Monday than in any week in at least two decades, as the news electrified financial markets. Funds that buy stocks counted +$44.5bn of inflows in the week to Wednesday, including more than +$32bn that was invested in US stock funds, according to the data provider EPFR Global. It was the largest weekly haul by equity funds since EPFR has been collecting the data, as well as the second-biggest intake by US stock funds since 2000.”

Yes, indeed, Rick, it appears investors are making a downpayment on a bull market in 2021 and are looking for the market to scale to new heights.

Question 1:

Barron’s recently interviewed Louise Yamada, someone who I have followed since my days @ Smith Barney.   Louise is one of the leading Technical Analysts on Wall Street and she sees the “FAANMG” tech leaders making tops and being vulnerable to declines of “bear-market proportions.”

She goes on to say that since big tech is in essence supporting this market, if they give way, a cycle-ending structural bear market will erupt because a key tenet of technical analysis is that a bull market consists of higher highs and higher lows.

But, the “FAANMG” stocks have made lower highs and could be headed to breaking support.  In addition, the vaccine news sparked a rotation last week, providing a boost to pandemic laggards, while pandemic leaders trailed.

Technology, growth, and so-called “stay-at-home” stocks, strong outperformers during the rally since late-March took a back seat to  stocks that perform well in more normal economic conditions like cyclical, value and small-cap shares.

So is now the time for our listeners to consider:

1) Taking some profits in names like AMZN, NFLX, FB, AAPL, MSFT and GOOGL and

2) Moving those proceeds into financials, industrials, energy and maybe some small cap?

Rick, as I am also a Smith Barney alum, I too have appreciated Louise Yamada’s technical analysis insights as well as those of her colleague Alan Shaw for quite some time. Yet while technical analysis helps to provide a framework to define the boundaries of possible stock price moves, I believe the fundamentals still serve to drive the final outcome in terms of share price developments. 

To that end, it is important to bear in mind that COVID has had a significant and enduring effect on consumer behavior. According to the WSJ, “The pandemic’s disruptions have transformed how American consumers behave by accelerating their embrace of digital commerce, and the changes are likely to prove permanent, according to businesses studying and adapting to the changes. A recent survey by consulting firm McKinsey & Co. found that about three out of four people have tried a new shopping method and that more than half of all consumers intend to continue using curbside pickup and grocery-delivery services after the pandemic is over. Nearly 70% of consumers surveyed intend to continue buying online for store pickup.”

While good news on COVID vaccine developments offer reassurance, bear in mind that it will take time and considerable effort to bring the benefits to the broader population at large. However, the “FAANMG” stocks are in some cases facing greater competition as shown last week by Disney’s results being boosted by the performance of its streaming media service Disney+. The market gave a strong positive response as the stock broke above its pre-crash levels despite what might otherwise have been considered a negative development as Disney reduced its dividend payment to support additional Disney+ investment. Clearly, Netflix understands competitive pressures in the space are intensifying as deeper pocketed players with strong consumer franchises are getting into the game.

More importantly, as mentioned last week, there is still a “growth scare” as Wall Street estimates for 4Q 2020 and 1Q 2021 earnings remain below 3Q 2020 levels, this despite what has been a phenomenal performance during the 3Q 2020 earnings season. The caution is certainly attributable to the market recognizing that the current COVID resurgence is keeping consumers closer to home and the high probability that until the Biden administration takes office in late January 2021 there will not be an effective national strategy to address COVID.

That said, there should still be an allocation to Growth names such as the “FAANMG” for three reasons. First, the “growth scare” implies a slow and possibly halting path to recovery during which the greater earnings certainty of the “FAANMG” should support a premium valuation relative to the S&P 500 index. Second, technology remains the primary driver of disruption that results in either the creation of entire new markets or results in substantial market share shifts within existing markets, something that should be a core portfolio holding. Third, new product cycles are unfolding at both Apple (i.e. iPhone) and Microsoft (i.e. Xbox) that will serve to sustain, if not accelerate, growth. With that in mind, it still makes sense for there to be some degree of profit-taking in a group that has led the broader stock market off its March 2020 lows, especially as COVID vaccine news has brought hope the broader global economy will recover over the course of 2021 and accelerate going into 2022.

With accelerating economic recovery as a stock market backdrop, investors should be looking for sectors and companies that can produce high positive earnings leverage off the expected revenue growth. Such sectors characterized by high fixed costs are Consumer Discretionary, Energy, Industrials and Materials. In this scenario, it also makes sense to increase exposure to small caps that are similarly leveraged. Last week’s breakout move by the Russell 2000 through its January 2020 high confirms the stock market sees the potential in small caps. Meanwhile, with Financials, the yield curve may be capped at the long end as central banks are managing long-term interest rates through quantitative easing.  

Question 2:

David – we have spoken a lot about the return of the consumer, but the soaring coronavirus cases could spur shutdowns that might be less draconian than those earlier this year yet would still hit the economy.  According to J.P. Morgan, consumer spending by the company’s 30 million Chase credit- and debit-card holders has fallen “notably” in its latest data through Nov. 9, down by some -7.4% from the figure a year earlier.   Drops have been larger in states where Covid-19 is spreading most rapidly, but the data suggest a widespread pullback.

In addition, last Thursday Federal Reserve Chair Jerome Powell commented that while he sees the economy in a solid recovery, “with the virus now spreading, the next few months could be challenging.”   When you consider that it took only two weeks of closures in March to drag down first-quarter GDP by -5% and then it was   the $2.3 trillion Cares Act that helped to produce the stronger-than-expected rebound in the third quarter, at a +33.1% annual rate, does the fact we are now facing a fading chance of a fiscal response to a renewed downturn worry you?

Rick, call me early, but I have been banging the drum on the need for further fiscal stimulus since July as we view the stock market as being in large part for 2020 a liquidity-driven flywheel requiring steady and rising levels of fiscal stimulus and monetary easing to sustain the economy during the COVID depression. 

Needless to say, Congress was unable to accommodate this need due to increased partisan differences in the run-up to the U.S. elections. Failure to do so has left the economy vulnerable to the as yet unchecked spread of COVID which as noted earlier is resulting in the “growth scare” reflected in Wall Street earnings estimates. 

About the best thing that can be said about Congress now is that the likelihood of a divided Congress is that tax rates will remain unchanged for longer and broad-scale policy programs may be more difficult to implement. 

For now, we unfortunately have one political party more concerned about contesting the recent election results than it is in looking after the health and well-being of its constituents who are suffering severely under COVID. This indifference will likely not be forgotten come the 2022 midterm elections. 

Question 3:

David, it has been some time since we talked about investing outside of the United States, but last week International stocks gained +4% compared with +2.2% for U.S. equities, signaling increased optimism in the longer-term global rebound.  When you consider that in international markets we find…

• 7 of the 10 largest automobile companies
• 7 of the 10 largest diversified telecommunications companies
• 8 of the 10 largest metals and mining companies
• 6 of the 10 largest electronic equipment and instruments companies
• 5 of the 10 largest household durables companies

International stock investments provide a diversification benefit relative to an all-U.S. equity allocation and just last week, in an Bloomberg Radio interview,  Brian Levitt from Invesco said “in general, investors are woefully under allocated to markets outside the United States”

Would you agree and, if so, are there any specific markets you would suggest our listeners consider?

Rick, it is true that most U.S. investors are underinvested in other markets globally. In this respect, we have highlighted that, among the 11 S&P 500 sectors, Technology has the greatest exposure to non-U.S. markets and as such is an indirect global diversification portfolio allocation. Also, we have discussed previously that the U.S. Dollar has a cyclical tendency to weaken early in economic cycles. To this we add that relative economic growth rates are important as there is now a distinct differentiation taking place in global markets between those countries whose economies are growing as they put in place policy measures to contain COVID successfully and those countries that have failed to do so.

In this regard, Asian markets have outperformed in 2020. For example, the MSCI China index has outpaced the S&P 500 index by +15% so far this year, this despite last week’s drops in names like Alibaba (-13.1%), Meituan (-6.4%) and Tencent (-2.0%) in response to the PRC government moving to rein in its Technology sector by pushing out the Ant Financial IPO. 

More broadly, the MSCI Emerging Markets index (“EM”) was up only +0.8% last week and is lagging the S&P 500 by -3.3% so far this year. We continue to worry that EM is too heavily weighted to Chinese Big Tech and more generally the country’s stock market, although we like this asset class better than MSCI EAFE index (non-US developed economies) which has too little Tech exposure relative to the S&P 500 or Emerging Markets.

For investors who are interested in the greater economic stability in Asia and wish to have Tech exposure, South Korea (ETF ticker EWY) and Taiwan (ETF ticker EWT) markets may offer a better means of gaining exposure than taking on the unpredictability of PRC regulation.

Question 4:

David, as we bring another episode of A Brighter Future to a close today, I want to get your perspective on what is going on in the credit markets.  I know our Investment Committee has for some time been reducing our exposure to the high yield bonds and I recently read a research report that said there are two conflicting views in the credit markets.  On one hand, with expectations of a gradual economic recovery coupled with fiscal and monetary stimulus, high-yield credit spreads are expected to tighten from here as trends in defaults slow.

On the other hand, as a result of historically high debt issuance in recent months, many balance sheets are even more leveraged than they were before COVID-19, and concerns are mounting about if companies in troubled sectors will be able to “earn” their way out an eventual default.

With the Fed backstopping fallen angels, it is no wonder those names have rallied similar to what happened during the 2008 Great Financial Crisis.  However, unlike a decade ago, distressed names are missing out so far, which begs the question: are the high-yield credit markets as healthy as the current spreads indicate?

So, David, is the slow recovery for distressed debt a canary in the (high-yield credit) coal mine?

Rick, despite facing the short sharp shock of demand destruction from COVID, high-yield credit spreads have continued to narrow after blowing out in March 2020 as lockdowns were implemented. High-yield spreads last week were +462 basis points (bp) over Treasuries, and as noted have been steadily tightening back to the +403bp seen at the end of January 2020. 

To our view, this progression reflects successful positioning by the Federal Reserve as to its ability to intervene if needed and a sign that investors accept the idea that 2021 will see better corporate cash flows across the credit spectrum. Separately, as high-yield spreads and small-cap stock performance are highly correlated, investors should understand this is supportive of the current strength in the Russell 2000 index. As has been said by others, the market’s muscle is now in the Russell.

Episode 31 – With U.S. Election Now Passed, Time For A New Bull Market Cycle?

Synopsis: “A Brighter Future” – Episode 31

In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, discusses the early take on the incoming Biden Administration and positive COVID vaccine news, the takeaway from the November Jobs Report, the “Growth Scare” limiting market acceptance of strong Q3 2020 earnings, how will gridlock in Congress shape the Biden Administration’s impact on different sectors and other developments with Laidlaw & Company Chief Market strategist, David Garrity.

The topics discussed in this episode are: Will government transition uncertainties and the COVID resurgence “growth scare” dampen the post-election rally?, Will Labor Force Participation rate recovery continue absent widespread COVID vaccine availability?, When will the market fully buy into the corporate earnings recovery? and Is the Biden Administration simply a re-opening trade or a restoration bull market cycle?

Please tune in for more timely insights.

SCRIPT:

Hello and welcome to another episode of “A Brighter Future,” Laidlaw & Co’s Podcast Series.  I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and once again I am joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

David, I hope you had a nice weekend and you were able to relax a little because while the election is now over we still have COVID and a shaky economy.

Rick, the weekend brought sunshine and 70-degree temperatures that were in distinct contrast from the 5” inch snowfall and frost of just a week ago. It was as if the weather was mirroring the change on the margin in the U.S. political landscape with the declaration of victory for the Democratic Biden-Harris ticket. 

While the break in the weather was welcome, it is critical for everyone to bear in mind that cold weather will still set in during the days ahead. In terms of the election, important to honor the fact that over 70mm voters cast their ballots for the incumbent, so the road forward is going to rely heavily on finding a way to heal the country.

To that end, the new administration is setting as its top priority the goal to contain the COVID pandemic that is plaguing the country and the world. We will watch with great interest the announcement of the new team of experts being brought on to conquer this challenge. 

If the new administration can bring meaningful relief from COVID before the end of Q2 2021, the country as a whole should be reassured as to the efficacy of good government. With this kind of leadership in action, perhaps for the world at large a broader faith in the future of America as leading in the vanguard of democracy will be reaffirmed.

In this regard, this morning’s news of positive COVID vaccine developments from Pfizer (PFE) is very timely. If the developments hold true, there should be a sufficient amount of vaccine available for 650mm recipients by the end of 2021. Good news indeed and a welcome break.    

Question 1:

As I said in the opening, the election is now behind us and the markets appear to like the outcome.  U.S. stocks logged their best weekly gain since early April, logging a +7.3% gain for the full week.  It appeared that markets found some relief in the prospects of a divided government, with a Biden presidency and a Republican-controlled Senate reducing the likelihood of immediate tax hikes and increased regulations, while not removing the potential for an agreement on some form of fiscal-aid package.

So, can investors let their guard down when it comes to election-driven volatility?  In addition,  do last week’s gains mean the economic recovery, along with monetary- and fiscal-policy tailwinds, will be behind the wheel as we advance, not simply the occupant of the Oval Office?

Rick, while the election is behind us, the transition to the next administration taking office which will occur over the next 10 weeks is not. Specifically, as the incumbent has not conceded defeat, the current administration has refused to authorize the customary access to government facilities and resources given to transition teams. 

Clearly, the handover of government may not proceed smoothly, which would be just another incidence of the chaos that has been the hallmark of the current administration. That said, investors need to be watchful as there are still rivers that must be crossed on the road to 2021. 

Away from the transition to the new administration, investors clearly have shown signs of experiencing a “growth scare” around the resurgence of COVID. The NY and Atlanta Fed nowcast economic models only show projections of +2.9 to +3.5 percent for Q4 2020, a slowing pace of growth that could risk tipping over into contraction. This reflects real-time indicators (e.g. local and airplane trips) that consistently show slowing patterns of American mobility. Along with this, Google searches for a range of COVID-related topics is rising again (much as in March and June), indicating popular concern that could curtail consumer confidence.

That said, the Pfizer COVID vaccine developments are offering greater confidence that 2021 and 2022 will see a re-opening process for the global economy. While the market is poised to break-out to higher levels off the back of a Cyclical/Value rally, it is important for investors to recognize that the “growth scare” is real as long as COVID remains relatively uncontained. 

Separately, while the new administration promises a more highly-coordinated COVID containment approach, we will still have to wait out the next 10 weeks before it can be implemented. 

There is a brighter future that lies ahead, Rick, but it will still take some time to arrive. Note that based on past cycles market optimism tends to overshoot off the bottom. Also, incremental COVID outbreaks may well cause unsteady economic progress as we move into 2021.

Question 2:

David, largely overshadowed last week was the Fed’s latest interest-rate decision and Friday’s Jobs Report.

On the Fed, not surprisingly the central bank left its policy rate near zero and reiterated its commitment to keeping rates lower for an extended period to support the economy.

As far as the jobs report, Friday’s number showed the U.S. economy added 638,000 new jobs in October, pushing the unemployment rate down to 6.9%.  So, while unemployment is still double where it was before the pandemic, and the pace of new monthly job additions has slowed, what I have read indicates the October data is actually quite positive in that it confirms the labor market continues to heal, even if more slowly than we’d all prefer.

As far as monetary policy, historically stocks have performed well in periods of loose monetary settings.

So, regarding the Fed, should our listeners expect as any tightening by the Fed is a few years away that Fed policy will serve as a potential tail-wind for the markets as we advance into 2021?

And on the jobs number, can we see the continued strength in the job market as a sign that the economic recovery is still on track?

Rick, relative to the Fed meeting last week, the result was no change in interest rates and the commentary following the meeting was largely a reiteration of Fed Chairman Powell’s last testimony before Congress. Namely, that further fiscal stimulus is needed to put the U.S. economy on a better footing and that the Federal Reserve remains on stand-by to provide what further monetary accommodation it can as needed. 

To our reading, with the possibility of gridlock in Congress should the GOP retain control of the Senate, the likelihood of lower interest rates for longer is greater since any fiscal stimulus package to pass Congress will likely be smaller.

Meanwhile, last Friday’s Employment Report did show some encouraging developments. Particularly, the Labor Force Participation rate for October showed some improvement from September (81.2%, up from 80.9%), but still a slow recovery from the April 2020 low (79.9%). Nevertheless, given the “growth scare” concerns it will remain important for investors to watch high-frequency indicators such weekly unemployment claims and other kinds of alternative data related to consumer mobility.

Question 3:

David, another thing that was overshadowed last week was Earnings.  We literally had hundreds of companies reporting their  earnings last week and like the hundreds that reported before them, the overwhelming majority reported much better than expected results.

When the week began, the blended Q3 earnings year/year growth rate, according to FactSet, was -9.8%.  Following the reports on Friday morning, it had improved to -7.5%.

In addition, as of Friday with 89% of the companies in the S&P 500 reporting actual results, 86% of S&P 500 companies have reported a positive EPS surprise and 79% have reported a positive revenue surprise.  If 86% is the final percentage, it will mark the highest percentage of S&P 500 companies reporting a positive EPS surprise since FactSet began

tracking this metric in 2008!!

Finally, in aggregate, companies are reporting earnings +19.3% above estimates compared to the five-year average of +5.6%, according to FactSet!

So, can we assume that while the earnings reporting might have taken a backseat to the election, the continuation of huge earnings surprises helps to substantiate rich valuations for many companies.  Which in turn, exposed the promising potential for a big pick-up in earnings in 2021 driven by the arrival of a COVID vaccine (a demand driver) and the improved operating leverage from cost-cutting actions in 2020?

Rick, clearly the focus on the election since the start of October has obscured the significant positive that corporate earnings performance lends this market. As you highlight, Q3 2020 results have come in so strong that the quarter is ending up at $38.58/share for the S&P 500. That is +16.3% better than what analysts had in their models at the end of September. 

However, apart from the election obscuring the news of better-than-expected earnings performance, investors are also experiencing something of a “growth scare” as the Q3 2020 performance is not seen as sustainable as concerns mount that with the resurgence of COVID fears of a “W-shaped” recovery rise. This is underscored by the fact  that S&P 500 earnings estimates for the next two quarters are lower than Q3 2020 (Q4 2020 $36.86/share, -11.8% year/year; Q1 2021 $37.83/share, +13.5% year/year). 

Still, looking ahead, S&P 500 earnings are forecast to surpass the 3Q 2019 peak of $42.21/share by 3Q 2021 ($43.88/share, +13.7% year/year). As the stock market tends to look 6 months ahead, we expect that positive COVID vaccine news from the likes of Pfizer (PFE) will serve to bolster confidence in the likelihood this forecast earnings curve will be realized. A shot in the arm the market needs to move higher into 2021.

Question 4:

David, as we bring another episode of A Brighter Future to a close today, I’d like to finish where we began and talk about what our listeners can expect longer term from a Republican Senate and a Biden presidency.   Specifically on things like:

• Taxes

• Stimulus

• Growth vs. Value

• Lockdowns

• Sector Winners

• Sector Losers

Personally, I think the framework for this outcome should be the last two years of the Obama administration, where essentially nothing occurred from a policy standpoint, and the market grinded out small returns (S&P 500 rose about +11% over those two years on a total return basis). Point being, not great numbers, but the outlook over the medium and longer term for equities remains constructive beyond politics.  What are your thoughts?

Rick, while it may be instructive to look at the last two years of the Obama administration for an investment template, I think it could be premature as control of the Senate is likely to be determined by the two run-off elections in Georgia coming in January 2021 that may result in a 50-50 tie with VP-elect Harris holding the deciding vote. However, even if the GOP does not hold the Senate, the Democratic position is only one of a slight advantage so the ability to pass broad policy initiatives will be limited. 

That said, tax policy will be hard to change, stimulus packages will most likely err on the low side, Growth will offer a clearer advantage over Value until the global economy recovers off broader availability of COVID vaccines, and better COVID containment will likely be due to executive orders.

Under the Biden Administration, the more closely a company interacts with individual American consumers, the more pressing are matters of COVID restrictions and wages. For technology and industrial companies, trade and visa policies are key. With the promise of a more effective COVID containment effort under Biden, demand for consumer-facing businesses will recover faster, but the partial offset is the possibility of higher costs reflecting an increase in the minimum wage. 

With Biden more likely to return to multilateral trade regimes as a means to address the challenge of state-subsidized competition from China, manufacturers particularly in the aerospace sector will  benefit. Producers of materials as steel and aluminum are likely to continue to benefit from tariff protection. 

For technology companies there will be continued regulatory scrutiny, but in our view the moves will be incremental. On balance, the possibility of a return to greater global economic cooperation offers an opportunity for semiconductor companies to maintain market leadership, although China is clearly intent on establishing its own national champions. 

On balance, Biden is good for the technology sector, with the possible exception of social media companies such as Facebook that were the conduits, unwitting or otherwise, for social destabilization efforts around the election and over the course of COVID. For that kind of chaos, a price is likely to be paid.

Overall, we believe the Biden Administration represents not just a re-opening trade, but more importantly a restoration bull market cycle that is founded on the broader policy effort to build back better not just for the U.S. economy alone, but for the world at large.

Episode 30 – What Elections Should Investors Make Heading Into 2021?

SCRIPT:

Hello, and welcome to another episode of “A Brighter Future,” Laidlaw & Co’s Podcast Series.  I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and once again I am joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

David, I hope you had a nice weekend, I can tell you I had the best weekend ever as I was the “Father of the Bride” for my beautiful daughter. It was truly a magical and perfect weekend, even my woeful Eagles managed a victory albeit against another team from the NFC Least

Rick, congratulations on being able to host a COVID-safe wedding over the weekend. I trust the blushing bride was able to wear a veil sans face mask and that all in attendance are safe and well. Family events are important for the ties they create and reaffirm, so again congratulations on the occasion. 

Meanwhile, having grown up in Washington DC as a fan of the now-generically-named Washington Football Team, I was appreciative of the assist they provided yesterday to the Eagles by drubbing the Dallas Cowboys. Even so, the Eagles only remain atop the down-trodden NFC East by the narrowest of margins. Talk about being the best house in a bad neighborhood, seriously. 

Question 1

David – last week following three consecutive weekly advances, stocks declined modestly. The news flow was dominated by headlines around the negotiations for another round of fiscal relief from Washington before the election, now one week away.  The 10-year Treasury yield rose to the highest level in four months amid expectations that a potential Biden win would lead to a larger relief package to support the economy.

Aside from the speculation about potential election outcomes and policies, economic data for the week was encouraging to the long-term outlook, showing an improvement in jobless claims and continued strength in the housing market.

Current conditions are prompting a perception among some investors that the election represents a binary outcome for the market. While I would agree that next Tuesday, November 3rd, may be viewed as a seminal moment in our country’s political landscape, when it comes to investing, it’s the much broader periods of time – not singular moments – that matter most.  In fact, history shows us that the market is not partisan over the long run, but hates uncertainty in the short run.  Elections bring uncertainty, but as that uncertainty fades, stocks reconnect to fundamentals which are influenced – but not solely determined – by Washington policies.

So, let’s start our discussion there today, first on a Macro, Broader level what can investors expect for the next four (4) years from a Biden Presidency and then the same question if President Trump is re-elected?

Rick, as we now stand on the brink of the election next week, the outlines of what lies ahead have hopefully become clearer, namely for there to be significant change in political and fiscal direction the same party will have to control The White House, The Senate and The House of Representatives. A mixed election outcome will very likely result in further partisan conflict and paralysis in Congress at a time when the country desperately needs a consensus that allows us to move forward. 

That said, a second term for the incumbent should expect to see further cuts in the social programs put in place since the Great Depression. The Affordable Care Act will most likely go under the knife given the composition of the Supreme Court. Social Security and Medicare will be undermined as their funding is redirected or eliminated. Workplace protections will be reduced as employers are given blanket exemption from litigation under COVID. Bottom line, the foundations put in place to support the creation of the middle class society seen in post-WWII America will be broken. 

With income inequality likely to accelerate as a result of these developments, the chances of increased social unrest are high. Against the backdrop of a country with high gun ownership, the dangers of civil unrest are magnified as citizens believing there is no legitimate recourse may ultimately resort to violence. 

Meanwhile, a mixed Congress under a second term is likely to result in a weaker U.S. economy in 2021 and 2022 as chances are any additional fiscal stimulus will not provide a sufficient degree of support to stave off material reductions to capacity at various levels in both the private and public sectors.

Stock selection in this scenario favors the following sectors: Technology, Defense, Industrials, Staples, Beverages, Large Caps.

Under a Biden “Blue Wave” scenario, the likelihood is for there to be the sizeable $5+ trillion fiscal stimulus that the capital markets have come to anticipate and which has served to offset the negative headwinds from COVID infection rates rising worldwide. As you noted earlier, this expectation has not only supported the stock market, but done so to the extent that the down-trodden Value stocks have started to outperform. For this to continue, one has to believe that defeat will not be snatched from the jaws of victory. 

Nevertheless, this isn’t to say a Biden presidency with Democratic majorities in the House and the Senate will have an instant restorative effect on the U.S. economy. Substantial degradation of the U.S. government has occurred under the incumbent with important posts going unfilled either by deliberate design or outright neglect. Institutional capability must be restored. 

Furthermore, we believe that Democratic Presidential nominee Joe Biden prefers to act in a bipartisan manner if possible, something which will be especially important given how far U.S. politics have veered disastrously into partisan waters. While bipartisanship may not allow the fastest course of action, it most likely results in the more productive course of action over the long term. So, in this case, the likely course for the U.S. economy is one where the recovery strengthens steadily over the course of 2021 and into the 2022 midterm elections.  

Stock selection in this scenario favors the following sectors: Technology, Financials, Industrials, Small Caps.

Question 2

David, let me stay with this theme of a Biden victory and get your take on something that has been creeping into the Bond Markets, the prospect of the Democrats winning both the White House and the Senate to add to their control of the House of Representatives or the Blue Wave.

The bond market appears to be anticipating the eventual enactment of more forceful stimulus in a Democratic sweep by pushing up longer-term Treasury yields. In fact, last week we saw the 10’s-2’s yield spread test its 2020 highs.

So, David is this a positive sign of a sustainable recovery, or a warning sign for an economy that depends on the twin stimulants of ultralow interest rates and record peacetime fiscal deficits?

Rick, the return of a positively sloped yield curve should be viewed as a good thing and has had a salutary effect on the stock market performance of the Financials, among others. As mentioned earlier, the view of a Biden “Blue Wave” has images of massive fiscal stimulus dancing in investors’ heads with a view towards rotating into down-trodden Value names. 

Before we become fearful of what rising long-term interest rates might bring in terms of a sell-off in the highly-valued Growth names that have led the stock market off its March 2020 lows, remember that The Fed along with other central banks remain disposed to providing maximum accommodation for economic recovery. 

In allowing inflation to run higher than prior targets, the prospect of possible Fed intervention is less of a threat than in the past. That said, the stock market appears for the present to be immunized from the risk that rising interest rates may previously have posed.

Question 3

David, as we bring another episode of A Brighter Future to a close, I want to talk about something that has not been on a lot of people’s radar in light of the election, stimulus and the search for a vaccine – Cryptocurrency.

I bring this up because last week we saw Bitcoin, the world’s largest cryptocurrency, jump above $13,000 this week for the first time since July 2019.

It appears the surge began when PayPal announced on Wednesday that its users will soon be able to buy, hold, and sell cryptocurrencies on its platform and it even prompted Billionaire investor, Mike Novogratz, to say that PayPal’s move was “the biggest news of the year in crypto.”

Does much of the new interest in Bitcoin stem  from its potential use as a hedge against inflation?  It does make sense, as Bitcoin is  decoupled from monetary policy but would you agree with Paul Tudor Jones who on Thursday  said the coin was “the best inflation trade” and that he thinks its rally is only in its “first inning?

Rick, as we discussed back in May 2020, one of the major weaknesses in the case for cryptocurrencies generally and Bitcoin in particular has been a highly limited ability to use them for everyday transactions. In this way, while Bitcoin might have been considered to be a possible store of value given the limited supply that could be created via mining, it was a store of value that came with substantial friction as it could not be used for settlement purposes. 

Now, with PayPal being granted a conditional Bitlicense by the New York State Department of Financial Services, the path towards greater acceptance of Bitcoin and other cryptocurrencies for everyday use is being opened. As PayPal’s announcement notes, “Consumers will be able to instantly convert their selected cryptocurrency balance to fiat currency, with certainty of value and no incremental fees. PayPal merchants will have no additional integrations or fees, as all transactions will be settled with fiat currency at their current PayPal rates.” 

That a significant payment processor such as PayPal is now accepting cryptocurrencies in our view makes it only a matter of time before other processors such as Visa, Mastercard and the major clearing banks for competitive reasons become similarly licensed. What may seem like a small step for PayPal just marked a giant leap for Bitcoin and the cryptocurrency asset class. 

That said, I don’t know many investors who profited from going against Paul Tudor Jones and if you recall from our May 2020 conversation we highlighted then his whitepaper outlining the investment case for Bitcoin. With that, it may be time now to consider including cryptocurrencies as a possible portfolio holding in the alternatives category. 

Episode 29 – What Will Drive Stock Market Returns In 2021?

SCRIPT:

Hashtags & Stock Symbols: #StockMarket #SP500 #Growth #Value #Disruption #Earnings #Fed #Economy #COVID $DIA $SPY $QQQ

SCRIPT:

Hello and welcome to another episode of “A Brighter Future,” Laidlaw & Co’s Podcast Series.  I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and once again I am joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

David, I hope you had a nice weekend, caught some playoff baseball or college football and enjoyed the almost “picture perfect” weather here on the east coast.

Rick, it was a great weekend indeed with walks in the woods, kids diving into piles of leaves and pumpkins being carved, albeit with some modifications unique to 2020. Namely, as a nod to the current COVID pandemic, the pumpkins were given ears so they could wear N95 masks. While this may not serve to limit the spread of the Coronavirus, it nevertheless served to raise everyone’s spirits in anticipation of Halloween coming at the end of the month.

Question 1

David – last week we saw stocks oscillate between positive and negative territory, reflecting a tug-of-war between rising concerns and encouraging economic data. Weakness stemmed from a continued stalemate in stimulus talks, along with the recent rise in COVID-19 cases and the accompanying worries over implications for the continued reopening of the economy.  Markets did find a lift from a positive U.S. retail sales report that showed consumer spending rose strongly in September despite the lack of renewed aid from Washington, signaling some resiliency to the recovery.

So, while I know we both believe that the broader fundamental outlook remains intact, is it fair to say that policy support, the path of the virus and the discovery of an effective vaccine, will be key drivers in the months ahead, after we pass the election, of course?

Rick, we have previously discussed “The Four Horsemen of The Recovery” which we see as Stimulus, Economic Data, The Fed, and Vaccine. Before we discuss each driver, it may be helpful to quickly check on stock market performance so far in 2020:

Growth vs. Value: 2020 Performance By Quarter
	1Q20	2Q20	3Q20	4Q to date	YTD
Index	Change %	Change %	Change %	Change %	Change %
S&P 500	-20.0%	20.0%	8.5%	3.6%	7.8%
S&P 500 Growth	-14.8%	25.7%	11.4%	3.7%	23.7%
S&P 500 Value	-26.0%	12.4%	3.9%	3.7%	-10.3%
Growth less Value	11.2%	13.3%	7.5%	-0.1%	34.1%
Russell 1000 (R1K)	-20.6%	21.2%	9.0%	4.0%	9.1%
R1K Growth	-14.4%	27.4%	13.0%	3.7%	27.9%
R1K Value	-27.3%	13.6%	4.9%	4.3%	-9.7%
Growth less Value	13.0%	13.9%	8.1%	-0.5%	37.6%
Russell 2000 (R2K)	-30.9%	25.0%	4.6%	8.4%	-2.1%
R2K Growth	-26.2%	30.8%	7.1%	8.0%	11.7%
R2K Value	-36.2%	18.8%	1.9%	8.9%	-15.9%
Growth less Value	10.0%	12.0%	5.2%	-0.8%	27.6%

Clearly, Growth has massively outperformed Value over the course of the year as investors flocked to companies benefitting from the overall transition to “work from home” and the impact of social distancing on leisure and entertainment activities. For example, Gartner reported worldwide 3Q 2020 PC shipments were up +11.4% – the strongest growth in a decade. Google Chromebook sales (not included in the PC data) were up an astounding +90%. NPD data to August shows +23% growth for 2020YTD video game sales versus last year. Also, App Annie reported that hours spent on mobile apps around the world were up +25% percent for Q3 2020 year/year.

Still, we can see in the stock market that Value has been doing better so far in October as the market anticipates an improved economy in 2021. One question we will come back to in our conversation is whether it is time for investors to rotate to Value from Growth.

Now to handicap the ponies, Stimulus has become the football in the political brinksmanship ahead of the November 2020 general election. While there is constant news of negotiations between Congress and The White House, we are reminded of the line from Shakespeare’s “Hamlet” namely, “Words, words, words” which is to say that nothing will happen until after the election with the benefit to come in 2021. The prospects of a Democratic “Blue Wave” election outcome will bring with it the likelihood of a greater fiscal stimulus program, perhaps on the order of $5 trillion with the partial offset being higher income and capital gains tax rates. A mixed election outcome that leaves the Senate in GOP hands will probably be negative for the stock market as the amount of additional fiscal stimulus will be less.  

Relative to Economic Data, the news has become mixed since the end of the supplemental unemployment assistance at the end of July 2020. Last week saw an uptick in the weekly unemployment data with an unexpected increase of +53,000 new claims on a seasonally adjusted basis (+76,670 not seasonally adjusted). There have been other weekly increases since May 2020, such as July 18th (+114,000) or August 15th (+113,000), so this is not all that unusual. Still, seeing this widely watched measure of labor market conditions moving in the wrong direction prompts closer inspection. One should understand that weekly unemployment data reports have been degraded for the following reason: national data has not included fresh unemployment insurance claim numbers for California for almost a month now.

Every week since September 19th, California’s initial claims have been 226,179, essentially unchanged from the May 9th level of 212,667. This reflects work by the California Employment Development Department to develop more robust systems, an effort that has caused a multi-week delay in processing new claims. Since California has 29% of all unemployed Americans receiving unemployment insurance, we have not been getting the full picture for the past month.

Meanwhile, other high-frequency economic indicators such as the NY Federal Reserve’s Weekly Economic Index (WEI) continue to show generally steady improvement in the US economy. The WEI uses a set of high frequency indicators to evaluate American economic output in almost real-time. These include initial/ongoing claims for unemployment insurance, same-store retail sales, steel production, gasoline and electricity usage, and other data points. For the WEI, the weekly reading is for a -3.9% GDP decline versus the 13-week average of a -5.6% GPD decline.

Relative to The Fed, the indications remain that Chairman Powell is prepared to do what is necessary to continue to provide monetary support for the economy while continuing to reiterate The Fed’s position that further fiscal stimulus efforts are necessary and required for a sustainable economic recovery. 

Relative to Vaccine, all indications are that multiple efforts remain underway, but last week did bring news that the FDA is holding firm on ensuring that necessary vaccine safety protocols are followed prior to remedies being released for wide-scale distribution. This may not necessarily have been met with approval from The White House given the promises made there that a vaccine would be developed before the November election. 

For now, from yesterday’s “Meet the Press,” we are reminded by Dr. Michael Osterholm, director of the Center for Infectious Disease Research and Policy at the University of Minnesota, that with infections rising and compliance eroding, “the next 6 to 12 weeks are going to be the darkest of the entire pandemic.”

Bottom line, while the election will soon be passed with a greater stock market upside should a Democratic “Blue Wave” be the outcome, the economy is managing to hang in there despite the delay in passing further fiscal stimulus, the Fed is as supportive as ever and COVID still has no vaccine to stop it and the world is falling prey to pandemic fatigue. For the current stock market race, I will put my money on Vaccine to win, Stimulus to place and Economic Data to show.

Question 2

David, as we have talked about on past episodes of “A Brighter Future,” the longer-term outlook for stocks is positive with support from

economic growth, corporate earnings and interest rates.

However, in reading the research reports that I have it appears most don’t believe the gains experienced since March will be matched in the

months ahead, but instead a new bull market could emerge due to an earnings uptick in the latter part of 2020 and then rebound strongly in 2021.

I know you increased our Year End 2020 S&P Target to 3800 which represents an increase of +9% from current levels, excluding dividends but how do we get there?

Also, do you agree with the recent Bloomberg report that said EPS could be up +27% for the FY2021?

Rick, we mentioned previously it is company profits that will drive the S&P 500 index higher. At start of September we said the 3Q 2020 earnings season would bring a repeat of the solid performance seen in 2Q 2020 when 83% of S&P 500 index companies beat EPS estimates (average outperformance +22.4%, a record) and 64% beat revenue estimates (average outperformance +1.6%). With the start of 3Q 2020 earnings season last week, we have not been disappointed.

So far, some 10% of S&P 500 companies have reported earnings, outperforming expectations by a substantial margin as 86% have surpassed Wall Street earnings (note the 5-year average is 73%). The average amount of the earnings beats is +21.7% over forecast on only a +3.6% beat on revenues. 

This is the classic relationship between revenues and bottom line results of an early-cycle earnings recovery. Revenues only beat modestly, but profits are coming in much better as companies have cut costs so dramatically. 

In sum, these better-than-expected results have begun to reduce the -21.2% earnings comparison analysts had in their Q3 models at the end of September. As of Friday 10/16, this comparison had narrowed to -18.4% versus Q3 2019. As such, Q2 2020 was the trough at a -32.0% comparison, so we are clearly past the corporate profits trough. Also, Wall Street analysts’ aggregate Q3 2020 EPS estimate for the S&P 500 is now $34.10/share, up +3.5% from September’s end. Estimates for Q4 2020 are rising as well, up +1.1% to $36.49/share.

Bottom line, Q3 2020’s annualized earnings run rate (4 x $34/share, or $136/share) is now back to 2017’s S&P 500 EPS level ($133.50). This is an impressive recovery in earnings power over a very short period of time. While it would be very welcome to have another fiscal stimulus package soon, Q3 2020’s reasonable earnings rate shows why markets feel they can wait if they must. This is not 2009, when S&P 500 earnings were coming off zero in Q4 2008.

All told, the corporate earnings performance we are seeing so far gives us sufficient confidence to reiterate our S&P 500 index price target of 3800.

Question 3

David, there has long been a discussion of “Growth vs.  Value” but you recently made a great point that the better discussion might be “Disruptor vs. Disrupted.” Can you share with our listeners our conversation from this weekend, I think it’s a great topic with some very insightful observations?

Rick, last week brought the news that highly-regarded value-focused investment firm AJO Partners was closing down and returning capital to investors. To explain the decision, founder Ted Aronson said, “The drought in value — the longest on record — is at the heart of our challenge, we still believe there is a future for value investing; sadly, the future is unlikely to arrive fast enough — for us.” So, if Value investors are closing up shop, what is the flaw in the Growth vs. Value investment style discussion?

Our view is that the ranks of Value stocks are populated with companies whose business models are being disrupted. To that end, the classification should be not Growth vs. Value, but Disruptor vs. Disrupted. When the economy reaches a point where marginal gains start accruing to the Disrupted, then Value will rally. This is a more accurate characterization of the upcoming turn. 

Along with the Disruptor vs. Disrupted distinction as superior to the Growth vs. Value classification, we should note the possibility that dividend payouts from Value names are likely to enter secular decline as the Disrupted need to reallocate capital towards self-disruption, much like Disney ($DIS) cutting its workforce and putting funds towards growing its streaming service or like IBM ($IBM) splitting off its growth operations (e.g. AI, cloud and quantum computing). If Value stock dividend streams decline, it undermines their appeal from a total return perspective. 

As investors know, the basic equity valuation model is P = DIV / (r – g). If g < 0, then the effective discount rate increases. If that’s a secular phenomenon, then the case for Value stocks suffers as total returns come under pressure. Under this scenario we might say, Value: while not a feasible long-term investment approach, it can be a good trade.

Meanwhile, given the disparate impact of COVID on economies across the globe, whatever normal we return to, it will be one in which the world has been re-ordered. To our view, there is unlikely to be a return to what we had before. While there is an overwhelming tendency over time for reversion to the mean, the question we should address is what exactly will that mean be. 

For now, the experience has been that Value outperforms early in the economic cycle when operating leverage rates are highly positive and driving in an accelerated manner operating cash flow levels higher, something underpinning the positive stock market performance of Industrial stocks now. This amounts to a cyclical trading opportunity, but not a long-run core portfolio holding.

In my view, this is reminiscent of the old Wendy’s commercial but the copy has been changed to: “Value: come for the sizzle, but where’s the beef?”

Question 4

David, as we bring this episode of “A Brighter Future” to a close with two weeks until the 2020 Election, I want look at its impact on the markets.  Investing during an election cycle can be challenging on the nerves and 2020 promises to be no different. As we enter the final days before Election Day, news headlines on topics such as the presidential debates, campaign rallies, and a candidate’s COVID-19 test can draw strong emotions among investors and potentially move markets.

Historically, elections have impacted the market when they were imminent, especially in the final two to four weeks. Equity market volatility, represented by the VIX Index, has been slightly elevated in the month before an election on average and has been as much as +20% higher than the long-term average during the final two weeks prior to Election Day, the time we are in right now.  So, what should people do?  Do you sell now and lock in your gains at Lower Capital Gains rates since Biden says he will raise taxes and the polls says Biden is going to win. Do you “stay the course” as the market will probably “rip higher” no matter who wins since each side (Republican or Democrat) will implement more stimulus?

Rick, the lesson from history is that Presidential elections are no reason for investors to take their money out of the stock market. 

Let’s assume an investor with $10,000 were to decide to wait out the first 100 days of each administration, what would be the difference between this investment strategy versus one where the investor remained fully invested in the S&P 500 index? The results show that staying fully invested allows the investor to realize 1.8x greater returns. In an analysis covering a period from 1957 to the present, the $10,000 grows to $790,000 if fully invested, only $426,000 if not, a 1.85x better result. In a shorter time-frame analysis covering from 1980 to the present, the $10,000 grows to $324,000 if fully invested, but only $169,000 if not, a 1.92x better result.

Other analyses looking at stock market performance over U.S. Presidential elections show the S&P 500 has generated an average price return of +0.9% with 60% positive in the one month prior to election day since 1945 (excluding recessions), with a high of +5.1% and a low of -2.3%. The price return in the one month following election day has been +1.3% on average with 60% positive since 1945 (excluding recessions), with a high of +5.8% and a low of -6.2%.

Bottom line, we believe investors are best served to remain exposed to equities through the upcoming November 2020 election in order to realize superior long-run returns. 

Episode 28 – Will 3Q 2020 Earnings Season Offset Market Uncertainty? 3Q 2020 Earnings Season Offset Market Uncertainty?

SCRIPT:

Hello, and welcome to another episode of “A Brighter Future” Laidlaw & Co’s Podcast Series.   I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and once again I am joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

David, I hope you had a nice weekend and had an opportunity to get outside and take advantage of the beautiful fall weather on the East Coast.

Rick, it was a lovely weekend indeed for hiking in the woods, enjoying fires outdoors, picking apples, choosing pumpkins and selecting ugly gourds. In the process, I found one that looked quite like the coronavirus. Kind of scary how nature is imitating life these days. 

Meanwhile, the idea of “ugly gourds” seems a fitting starting point from which to begin our market discussion as September certainly was the volatile month we expected. However, while things may appear ugly in the market, there is always opportunity to be found.

Question 1

David – last week we saw stocks finish a turbulent September down -4%, as the six-month rally from the March low took a breather.  On a positive note, though, for the week stocks were able to brush off the uncertainties around the economic recovery and finish the week higher on hopes that Congress will reach a deal on another coronavirus-relief bill.   We also had attention turn back to the virus and its effects after news that President Trump and First Lady Melania Trump have both tested positive for COVID-19 and that they will be going into quarantine.

On the economic front, the U.S. economy added 661,000 jobs, marking a slowdown in the pace of job gains, but the unemployment rate came in better than expected at 7.9%. It does appear thought that the economic recovery is entering a slower phase, so do you still feel that gradual improvement in the labor market, along with low interest rates and fiscal stimulus, should provide support to both the market and the economy?

Rick, as has been written elsewhere, the pandemic depression is over, but the pandemic recession has only just begun. Friday’s September Employment report did mark a deceleration in the rate of the economy’s recovery from the April 2020 lows when 23 million Americans were unemployed. 

Even if you exclude the sectors directly affected by the pandemic — air transportation; arts and entertainment; hotels; restaurants; and both private and public education — the number of jobs in America was -4.6% lower in September than in February. That is not far off the -5.3% contraction in total employment that took place during the entire 18 months of what is now known as the Great Recession, and around 3x worse than the job losses in the 2001 recession.

While the headlines showed a decline in the unemployment rate to 7.9%, better than the expectation of 8.2%, the more concerning fact is that this is due to the Labor Force Participation (LFP, the percent of adult Americans either employed or looking for work) falling from 61.7% to 61.4% last month. In February 2020 it was 63.4%, but it is 2 percentage points lower now. This decline means that there are now 5.2 million fewer Americans in the labor force than there were 7 months ago, hardly what can be called a recovery.

So, there has been significant structural damage done to the economy that will take until 2023 at the earliest to remedy, according to Moody’s Economics who estimates that 5 million people will find it difficult to get new work after the pandemic as their old jobs have either disappeared or changed significantly.

To my view, all this clearly indicates that further fiscal relief is necessary. However, with the Senate not convening due to GOP senators contracting COVID, the possibility of this relief is receding until after the November election. Meanwhile, the slowing recovery is facing a resurgence of COVID infection rates. 

Bottom line, we continue to look for market volatility going into the election with the nearest term positive factor to offset the negative aspects of COVID’s impact being the 3Q 2020 earnings season that will kick off starting next week.   

Question 2

David, there was no escaping politics this week. There was the ongoing saga of stimulus negotiations; there was the first presidential debate; and then there was the confirmation from President Trump that he has the coronavirus.

Not to be outdone, there was the September employment report, which, like most employment reports leading up to an election, carries a political charge given what it reveals about the status of the labor market.  That status can be characterized as greatly improved since the pandemic lows this spring, but with plenty of room still for improvement.

It was roughly five months ago that we talked about this lagging indicator that packs some voting punch. In some respects, that feels like yesterday. In other respects, it feels like a lifetime ago. Time, though, is of the essence now with just 32 days until the election.

What we said in April was that the unemployment rate is going to loom large over the 2020 election, particularly in the battleground states of Arizona, Florida, Michigan, North Carolina, Pennsylvania, and Wisconsin where political pundits think the 2020 presidential election will be won.

There won’t be another employment report before the election, so we won’t know what the employment situation means politically until the election results are tabulated, but make no mistake about it, the employment situation is a political matter.

So mindful of that, David, is it fair to say that the stock market is in “a fog of war” right now because the employment situation looks better in relative terms than it does in absolute terms?

Rick, although Oscar Wilde was not in finance, I believe that when it comes to discussing the recovery and the markets most market participants would agree that the current situation is well summed-up by Wilde’s statement that, “we are all in the gutter, but some of us are looking at the stars.” 

The problem here is, as you say, that our near term view has become clouded by the chaos that is descending in the run-up to next month’s election with the resurgence in COVID infection rates and the faltering pace of recovery as yet unsupported by a renewal of fiscal relief measures.

However, while broader economic indicators may not provide much insight ahead of the election, we can look to the earnings reports coming from S&P 500 index members to give us a better idea as to just how well companies have dealt with the fallout from the pandemic. 

On this score, Wall Street analysts have been increasing their earnings expectations ever since the end of Q2. On June 26th they were looking for an aggregate $31.85/share on the S&P 500. As of last week, that number was up +4.0%, to $33.11/share. That may not sound like much, but analysts almost always cut their numbers during a quarter, so any increase in estimates shows their confidence in incremental earnings.

Bottom line, while the  stock market may be in a period of fog ahead of the election, the corporate reports will provide points of illumination to line the path forward for the market.

Question 3

David, COVID-19 is a health and economic crisis unlike any other in modern history, with profound short- and long-term socioeconomic implications. Like other crises in the past, this too shall pass, but life on the other side of the pandemic will look different.  I think that while the new normal creates new challenges, it also seems poised to accelerate trends that were already underway that have the potential to enhance productivity and drive efficiencies.

For example, over the past six months, consumers have adapted to online shopping, video conferencing and working from home. In fact, online sales was the only major retail category to post an increase during the height of the pandemic, and its market share is poised to continue well after the crisis is over.

So I’d like to get your thoughts on three (3) areas that I believe will be the most impacted:

First, as a catalyst for rapid tech adoption condensing timelines from years into months.

Rick, we have discussed in earlier episodes that COVID has served to compress technology adoption cycles from what were expected to be years to months, if not weeks. Clearly, this has served as the foundation of the Tech sector’s stock market leadership in the recovery from the March 2020 lows. 

To the extent the global economy experiences the grindingly slow recovery that many expect, then we look for the Tech sector to see continued growth as consumer and corporate behavior changes and coalesces into a more technology-driven new normal.

Bottom line, we do not see as yet sufficient reason for investors to consider moving away from the Tech sector as being a core portfolio holding.

Second, a shift in capital and resource allocation priorities. The pandemic exposed vulnerabilities in supply chains and the flow of goods, which might lead to some manufacturing returning to the U.S. and businesses spending more on automation.

Rick, the move to shorten supply chains and build more robust arrangements is something that had already been triggered by the current administration’s efforts to remake the global trading system, starting first with the U.S.-China relationship. With steps already being planned in response to the trade wars, the disruption from COVID only served to speed their implementation. 

These steps have led to businesses increasing the amount of automation in areas such as 3-D printing to improve the availability of components for finished products, if not the finished products themselves. Other steps may involve the use of drones to speed delivery of goods to intermediate and end customers. These and other innovations are developments we look to help support the broader economy’s recovery from the COVID pandemic.

Finally, the legacy of debt left behind by the crisis. Our government debt is expected to balloon to 108% of GDP by 2021, up from 79% in 2019, the highest in our nation’s history !!

Rick, the increase in the amount of U.S. government debt outstanding reflects not only the cost of COVID relief efforts, but also the impact of the 2017 tax reform which despite its passage has to date failed to produce the much-touted acceleration in U.S. economic growth promised beforehand. 

Meanwhile, we at least have the benefit that the debt service cost associated with total debt outstanding is lower as a percent of the U.S. government budget than it has been in years past. With interest rates expected to remain low for an extended time as a result of monetary policy and structural shifts in the economy, we are mindful of the costs incurred around fending off COVID, but believe it is critical to stabilize the U.S. economy first before addressing the issues around U.S. government debt. 

Question 4

David, as we bring another episode of A Brighter Future to a close, I’d like to get your thoughts on a topic that was covered by Barron’s this weekend – Looking for Opportunities outside of the U.S.

As Barron’s noted, “European and Japanese stocks rarely get a second glance from growth-obsessed investors mesmerized by U.S. technology stocks.”   U.S. stocks are pricey and there are attractive valuations and overlooked growth stocks in outside of the U.S.  Plus, many European countries and Japan were able to get a handle on the coronavirus before recent flare-ups, and are also poised to benefit early from a recovery in the global economy.  Even Warren Buffet recently invested $6 Billion into five Japanese trading companies, so should we be following his lead?

Rick, while the article you mention highlights the lower P/E valuations available to investors in companies outside the U.S., the fact still remains that growth is something that investors prize as long as it can be purchased at a reasonable price. In a world beset by COVID growth remains uncertain until such time as a vaccine can be found and successfully distributed. 

In this environment, we have clearly seen the Tech sector outperform as its adoption curve has steepened appreciably with consumers and corporates alike having sought to find new ways to operate successfully. Unlike other sectors, the Tech sector carries within it the ability to disrupt existing actors in a wide range of economic sectors and in the process improve productivity, reduce costs and underpin economic growth. 

While China has made strides in developing its technology sector in large part of its China 2025 program to reduce its reliance on foreign providers, the U.S. still remains the dominant nation in the Tech sector globally. To that end, we believe a shift to market leadership by non-U.S. markets and their constituent companies will require a COVID vaccine.

Meanwhile, there are large markets that are undergoing substantial technology-driven change. Consider, for example, the autonomous vehicle (AV) market. Regardless of all the delays to date, autonomous vehicles are still an important disruptive technology and they will certainly arrive one day. But which country will get a real product into the market first? Last year the global light vehicle market totaled 65 million units, and zero were true AVs. What will those numbers be in 2030? And, more importantly, where will they be produced? At this point it is still a horse race with very large payoffs for finishing first. 

AVs are yet another example of the China vs. US vs. Europe technology race that punctuates so much of how disruptive technologies are actually developed in the 21st century. China has the edge in commitment, the US in technology, and the Europeans in a thoughtful legal framework for validating algorithms. This may be the most important disruptive product in development where we simply don’t know who will cross the finish line first.

Me, I will invest in the country with the best technology first, so I’m going with the U.S. while keeping a close eye on the competition.

Episode Title: Episode 26 – September May Be Choppy, But Will There Be An October Surprise?

SCRIPT:

Hello and welcome to another episode of “A Brighter Future” Laidlaw & Co’s Podcast Series.   I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and once again I am joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

Question 1

David, I hope you had a nice weekend.  It seems like fall has arrived a little early on the East Coast with a chill in the air, much like the chill we’ve seen in the markets recently as U.S. stocks closed at a six-week low, driven by weakness in technology stocks, which exerted an outsized influence on major indexes because of their size.  Even though more than 70% of the S&P 500 stocks were higher, the index closed lower for the third week in a row.

On the flip side, cyclical, small-cap and international stocks, and oil, all rebounded, finishing positive for the week.

In addition, the Federal Reserve signaled that it will keep rates near zero through at least 2023 to help the economy weather the health and economic crisis.  In addition, economic data showed that the recovery is progressing, but the pace of improvement is slowing.

So, with fall officially ousting summer this week, David, what are your thoughts on how things are setting up for the rest of 2020?

Rick, while we have been expecting a bumpy September in the belief that volatility will increase heading into the November 3rd general election, now just 43 days away, there have been also this month events serving to knee-cap what I will term the “Four Horsemen of The Recovery,” namely Stimulus, Economic Data, The Fed, and Vaccine. Before we discuss these, it may be helpful to place the September 2020 pull-back in contrast with the July-August advance:

Growth vs. Value: 3Q 2020 Performance
	July & Aug.	September
Index	Change %	Change %
S&P 500	12.9%	-5.2%
S&P 500 Growth	17.2%	-7.4%
S&P 500 Value	7.4%	-1.4%
Growth less Value	9.8%	-6.0%
Russell 1000 (R1K)	13.3%	-5.0%
R1K Growth	18.7%	-8.0%
R1K Value	8.2%	-1.3%
Growth less Value	10.5%	-6.7%
Russell 2000 (R2K)	8.4%	-1.6%
R2K Growth	9.5%	-1.7%
R2K Value	7.6%	-1.3%
Growth less Value	1.9%	-0.5%

First, relative to Stimulus, as we know discussions in Washington DC have slowed to a crawl as we have drawn closer to the election. However, I believe the contention arising around filling the Supreme Court vacancy created by the death of Justice Ruth Bader Ginsburg has the risk of leading not only to the failure to pass another fiscal stimulus package, but the possibility that the FY2021 Budget may be held up. Given the expected impact of a conserative Supreme Court majority on issues such as healthcare, reproductive rights, gun control, business regulation and other issues, the stakes around the upcoming election increased dramatically following Justice Ginsburg’s passing on Rosh Hashanah.

Second, relative to Economic Data, while we wait with interest for the flash PMI releases on Wednesday 9/24, there are clear indications the pace of activity is slowing. Note that with the end of summer and the beginning of the school year some deceleration in economic activity is to be expected. 

With the advent of alternative sources of real-time data, there are more real-time economic indicators available. For example, the New York Federal Reserve Branch’s Weekly Economic Index aggregates daily and weekly data on unemployment insurance claims, Federal tax receipts, retail sales, consumer confidence and gasoline sales, etc.. Back on 3/7/20 before COVID hit, the index was +1.42 before dropping to a 4/25/20 low of -11.45 off the back of lock-downs. Now, the index is at -5.11 with a steady decline from earlier readings (8/29/20 -4.81, 9/5/20 -5.07). 

Separately, the Dallas Federal Reserve Branch publishes a Mobility & Engagement Index for the U.S. as a whole based off data from SafeGraph to track how often, how long and how far cell phone users venture away from home. On 3/9/20, the index was +1.53 before dropping to a 4/10/20 low of -110.21. Now, the index is at -44.43, also declining from earlier readings (9/6/20 -27.86).

The take-away from both real-time measures is that the momentum of recovery is waning, underscoring the need for further support for the economy, something it appears that Congress will not deliver anytime soon.   

Third, relative to The Fed, the press conference by Chairman Powell last Wednesday to discuss the revised Statement of Economic Projections left a poor impression as while the 2020 forecast was increased the outlook for 2021 and 2022 were reduced, not something to underscore the possibility of a strong “V-shaped” recovery. Also, note that The Fed will not have any further meetings until after the election with the next meeting concluding on Thursday 11/5/20. So, with The Fed out of the market for now, this horsemen of the recovery is in the stable, something that may leave the broader market less so.

Fourth, relative to Vaccine, while there are clear political reasons for the incumbent to be talking up the prospects for a vaccine discovery ahead of the election, most informed reasonable minds agree that general vaccine availability lies in 2021 or later. Various scientists within and outside government are stating that for now the best course of action for containing COVID remains wearing masks and continued social distancing. 

Bottom line, momentum for recovery is faltering and uncertainty is rising. We know how much markets abhor uncertainty, so best if cash is raised by taking profits from what has been a stellar run in the markets off the March 2020 lows as the 43 days to the election will be choppy. 

On the positive side, note that there are only 16 trading days until the start of 3Q 2020 earnings season with the release of earnings reports from the likes of JPM and C on Tuesday 10/13/20. In our view, this is likely to be on balance a re-run of the 2Q 2020 earnings season which should provide support for the stock market. That, along with the prospect for low-to-no interest rates from The Fed through 2023, keep us constructive at present.  

Question 2

David, now that football is back and both the Stanley Cup and NBA finals occurring simultaneously, I’d thought we could talk about some “match ups” that our listeners will likely encounter over the next few weeks.

The first is the Tech Sell-off vs. the Bull Market.

Has this short-term dip set the market up to resume its trajectory of the past five months?

Given technology’s hefty gains and extended valuations, alongside the industry’s compelling growth outlook, can tech shares continue to be a leader in both the rallies and the dips ahead?

Rick, with the possibility COVID will continue to force companies to maintain a “work from home” (“WFH”) status for the bulk of their workforce (for example, see the challenges faced by banks J.P. Morgan, Barclays and Goldman Sachs in returning staff to trading desks), the underlying need to rely increasingly on technology to support the economy should lead to continued strong financial results for tech companies and by extension improving valuations for their shares. 

The greatest argument to be made for tech leadership not continuing is the timing of commercial availability of a COVID vaccine to allow for a reversal of WFH operations. Failing the COVID vaccine discovery, the alternative of pushing for herd immunity carries a substantial cost in human terms. 

The minimum herd immunity threshold is thought to be 60%. Apply this to the current U.S. population of 328,000,000 means roughly 197,000,000 COVID infections. With the U.S. COVID mortality rate of approximately 3%, then 5,900,000 deaths would be necessary for herd immunity. With about 200,000 COVID dead now, there are about 5,700,000 more deaths to go to achieve herd immunity in the U.S. under these parameters. Not a price anyone with an ounce of human compassion should want to pay, especially not someone running for elected office.

The second “match up” is COVID-19 vs. Consumer.

As we’ve seen, the pandemic has inflicted significant damage on the economy, and we probably shouldn’t anticipate a return to pre-pandemic GDP levels for some time.  So are you of the mindset that until a vaccine is available for mass distribution, the health crisis will be the prominent headwind, restraining economic growth?

With consumers responsible for the lion’s share of GDP growth in the U.S.  should we expect the pace will be governed by household incomes and confidence?

While overall retail sales have already returned above pre-pandemic levels, the pace of spending growth has slowed, would you attribute that to the fading effects of the initial fiscal-relief package from Washington?

Rick, as I mentioned earlier, it is necessary for investors to be conservative in their assessment of the prospect for further fiscal stimulus ahead of the election. In my view, a renewal of the CARES Act may likely be a Q1 2021 event as the SCOTUS vacancy is crowding out other business before Congress at present. The elimination of the $600 weekly supplement has created a hole in household finances that has not been filled as unemployment remains high. 

In time, this will be seen as a significant element in the slowing of economic activity. Had Congress acted in time, it could have been avoided. However, in an election year, it is not safe to expect that politics and common sense will make good bedfellows. 

And our final “matchup” is the Election vs. Fundamentals.

With election a month and a half away, as the campaigns ramp up, so too will political uncertainties, accompanied by polarizing rhetoric and headlines.  Do you expect market fluctuations to increase as we approach the election, given the political climate and potential policy shifts?

Historically, market volatility has risen in the two months ahead of an election but has subsided by an average of -16% in the month afterward, with smaller post-election fluctuations reflecting reduced political uncertainty regardless of the outcome, but given the possibility of a contested outcome what should investors be prepared for?

History shows that over time market performance is driven principally by fundamentals, not elections. To that end, do you believe the combination of a sustained, but gradual economic expansion, a rebound in corporate profits, and an ongoing monetary-policy stimulus – though not immune to presidential policies – will set the broader course for the markets regardless of the election outcome?

Rick, while this cyclical pattern around elections is true as hopes serve to bolster the market ahead of the actual results in a clear case of “buy the rumor, sell the news,” it may not necessarily apply in 2020 for the reason that the current incumbent has given clear indications that should he not be re-elected it is his intention to contest the results as being fraudulent. In America, democracy has been attended over our history with the peaceful transition of power. We may be at a moment where our history in this vital respect is not honored. Investors should be prepared for this possibility.

Absent the possibility of political chaos around the current election, the elements for an advance to our S&P 500 index target of 3800 remain in place as corporate profits are recovering as costs have been reduced to allow for profit growth to resume, interest rates will remain low and a vaccine will ultimately be discovered. The critical element is going to be fiscal relief and that is where the difficulties being raised in the political environment come into play. It is important for cooler heads to prevail and keep partisanship at bay. Our country and our economy may very well depend on it.

Question 3

David, as we have done so often on “A Brighter Future,” I need to ask you about the Fed.  The market seemed to have a negative reaction this week after their most recent meeting.  In my humble opinion, I didn’t think the Fed came across any less dovish so was it the Chairman Powell’s Press Conference?  While he wasn’t negative he was definitely not as over-the-top dovish in his commentary as he has been previously.

Rick, the point was made earlier that while Chairman Powell has provided great leadership in terms of monetary policy during the COVID crisis, it is now time for The Fed to step out of the public limelight as the election campaign season is in full swing ahead of the November election. So, while Powell has certainly been appropriately dovish, the fact that The Fed is on the sidelines until Thursday 11/5/20 is not leaving market participants with a level of comfort needed to support the market while political partisanship is on the rise following Justice Ginsburg’s untimely demise.

Question 4

David, as we bring this episode of “A Brighter Future” to a close, I would be interested in your perspective on a topic that was discussed this weekend in Barron’s.  In a discussion with Nela Richardson, a strategist I have followed in the past, see shared that the biggest surprise that could happen next year is the Federal Reserve could launch a digital currency in 2021.

Now that the Fed has increasingly embraced a desire to have a closer connection with Main Street—as in the Main Street Lending Facility for midsize firms, and average inflation targeting in order to prioritize its full employment mandate, digital currency could be used as a new policy tool, which could revolutionize the payment system and may even, over the very long term, rival the dollar as the world’s reserve currency. In fact, a digital currency would have made it easier for the Fed to get direct payments to households during the peak of the Coronavirus pandemic.

Given your in-depth knowledge of cryptocurrency, would that work ?

Rick, thank you for raising the topic as it has been interesting to see how central banks around the world have been considering introducing digital currencies, so were The Fed to consider such a move it would likely not be alone. The People’s Bank of China (“PBOC”) started its digital currency project in 2014. 

The PBOC reportedly accelerated its development in 2019 after Facebook unveiled its own digital currency, called Libra. Beijing has kept the initiative largely under wraps. With tensions increasing between the U.S. and China under the current administration, one of the major reasons China is developing its digital currency is to decrease its dependence on the U.S. Dollar. 

China has been expanding its global role, especially in developing countries, but its bilateral trade still relies on the U.S. Dollar. That is a risk for Beijing, considering recent U.S. threats to impose sanctions on China; such moves effectively weaponize the U.S. dollar.

Meanwhile, one of the challenges with digital currencies, or tokens, currently is that spreads remain wide, a disincentive to broader adoption. What is striking about digital currencies is how sophisticated they are becoming. There are now futures and derivatives and lending products and products that pay yield, and decentralized exchanges and innovations in decentralized governance. However, for all the hundreds of tokens listed, one has to determine specifically what purpose each one is for. 

So, the market is evolving clearly, but as we can see geopolitical tensions may very well prove to be the catalyst that will take the digital currency market to the next level. Should the PBOC make a move to displace the U.S. Dollar, we fully expect The Fed will need to act appropriately. This will likely encompass a range of options that will include developing a digital currency. For the PBOC, its next digital currency test is thought to be scheduled around the Winter Olympic Games in 2022, but it may well come sooner. Watch this space.

Episode Title: Episode 26 – September May Be Choppy, But Will There Be An October Surprise?

Hashtags & Stock Symbols: #StockMarket #DJIA #Fed #Economy #COVID $DIA $SPY $QQQ $AAPL

SCRIPT:

Hello and welcome to another episode of “A Brighter Future” Laidlaw & Co.’s Podcast Series.  I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and once again I am joined by David Garrity, Chief Market Strategist for Laidlaw & Co. 

 

David, I hope you had a nice weekend. In most parts of the east coast, the weather was a bit unsettled as the remnants of Hurricane Laura made their way thru, but last week the markets 

were anything but unsettled. We saw markets finish higher, on track for the best August in 34 years, and continuing the rally after the third bear market in two decades. 

The S&P 500 is now up nearly +52% since the bear market bottom on March 23, and is up nearly +8% for the year, posting a new record high of 3,494.

 

Personal spending rose +1.9% in July, the third month in a row showing growth, indicating that the economic recovery is underway and the  Federal Chairman, Jerome Powell, stated that the Fed will let inflation run slightly higher than the traditional +2%, meaning rates will stay lower for longer, which is a tailwind for equities.   

So, David let’s start our discussion here:

Rick, the weekend offered a good chance to pause and reflect again on the apparent disconnection between the ever-elevating financial markets and the COVID-19 Coronavirus (“COVID”)-driven disarray of the global political economy. 

The best response I can offer is that we are seeing old paradigms that are being broken and new frameworks that are being put in place. 

Relative to monetary policy, Federal Reserve Chairman Jay Powell’s speech last week indicated that the Federal Reserve has moved off the anti-inflation policy priority that had been installed 50 years ago by then Fed Chair Paul Volcker who physically passed in December 2019. 

Relative to the stock market we have seen what some have called a bull market for algorithms and a bear market for humans as technology companies with a high ratio of intangible assets per employee have massively outperformed those with a high ratio of physical assets per employee. Clearly, man is no longer the measure of all things that he used to be. 

As to July’s strong Personal Spending growth, we will have to see how well that holds up as fiscal COVID relief programs have run out with little prospect of renewal until the end of September and more likely until after the November election. 

This coming Friday’s August Employment Report will also make for interesting reading, so brace yourself for a not-so-quiet week heading into the summer-ending Labor Day weekend. 

Question 1  

At the annual Jackson Hole policy symposium Chairman Powell announced a shift in the Fed’s approach to achieving its long-term average inflation target. His statement read: “Our revised statement says that our policy decision will be informed by our ‘assessments of the shortfalls of employment from its maximum level’ rather than by “deviations from its maximum level” as in our previous statement. This change may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation,” 

So what does this mean to our listeners David? 

Rick, it has been clear from the Federal Reserve’s monetary policy actions since the onset of COVID that interest rates will likely to remain at a zero level for an extended period of time, perhaps as far out as the next five years given the extent of damage that COVID has wreaked on the global economy’s growth potential. 

In his speech last week, Powell has formally shifted the operational emphasis of the Federal Reserve from an emphasis on the price stability objective in its dual policy mandate over to an emphasis on the employment promotion objective. In short, the Fed is now squarely in a pro-nominal growth policy stance and as indicated earlier former Fed Chairman Paul Volcker’s anti-inflation policies are now clearly a ghost. 

With this move, Powell has taken the fear of negative interest rates out of the market, something clearly reflected in the Fed Funds Futures curve out to July 2022. How soon long-dated Treasuries sell off in expectation of the eventual rise in the inflation rate remains to be seen, but a steepening yield curve is the part of the capital markets picture of the early stages of an economic recovery that has up until now been missing. 

Not sure investors are prepared for the prospect of 2% 10-year Treasury yields, but with last week’s speech the stage is being set for just that possibility.   

Question 2

David, there was some news last week about the Dow Jones Industrial Average getting a revamp.  In the biggest adjustment to the index since 2013, S&P Dow Jones Indices announced that Salesforce.com, Amgen, and Honeywell International Inc. will replace Exxon Mobil, Pfizer, and Raytheon Technologies Corp. effective September 1. 

The addition of Salesforce and removal of Exxon, which was the most valuable U.S. publicly traded company as recently as 2014, is the main headline and was triggered by Apple’s 4-for-1 stock split.

So let me ask you a few questions on this topic:

1. Why did Apple’s decision to split their stock impact the rest of the Dow holdings? 
2. Does being added or removed from an index change the fundamental value of a business? 
3. Does the Dow Jones index really matter anymore?   After all, the S&P 500 is a broader index, and more representative of the U.S. large-cap universe. In fact, I saw a statistic that approximately $28 billion uses the Dow as a benchmark versus over $11 trillion that is benchmarked to the S&P 500! 

Rick, in short, the decision by Apple on a 4:1 stock split prompted a move by the Dow Jones index committee to reconstitute the index as the split would take Apple’s index weighting down from 12% to 3%. The decision by Apple to split the stock was driven by an interest in making it easier for individual investors to purchase a round lot of shares. On its own, a stock split does not change the underlying value of a business. A better signal of underlying value is dividend policy. If a stock split is accompanied with a dividend increase that should be seen as supporting an increase in valuation. Otherwise, the split means little in value terms. 

As you mention, the Dow Jones Industrial Average (DJIA) is a price-weighted index of 30 large-cap companies whereas the S&P 500 is a market-cap weighted index of 500 companies. Most importantly, more investment capital is benchmarked to the S&P 500 than the DJIA. While the changes in the DJIA are significant for the companies involved, the fact that the DJIA is largely insignificant as an investment benchmark means that being excluded or included should have minimal impact on the share performance of the companies involved. What is important here is that even with the changes made to the DJIA the tech sector weighting at 23% post-shift will still lag the 28% tech sector weighting in the S&P 500 index.  

  

Question 3

David, let’s shift gears and talk about a topic that Barron’s wrote about this weekend, the fate of the Municipal Bond Market.  

Many of our listeners have been Muni Bond buyers for years but with yields right now at 0.7% for top-rated 10-year muni a growing number are getting cautious on the market as that yield may not be enough to compensate investors for the risks that many municipalities are set to face.  

With so many businesses closing and so many people either out of work or working from home, revenues from sales and income taxes are way off. Ditto for gasoline taxes, tolls for bridges and tunnels, public transit fares, and airport fees.

In all, states are facing a budget shortfall of $555 billion for the three years through June of 2022 and for cities and towns, it’s an additional $360 billion for the three years through December 2022.  That’s close to a trillion dollars!!! 

So, should we expect that many municipal bond issuers won’t be able to repay on their bonds? Also, what should long time Muni Bond buyers be aware of when evaluating new bond investments? 

Rick, as you clearly spell out, unless the next fiscal COVID relief package includes meaningful aid for state & local governments the capital markets fall out for the municipal bond market could be quite negative as existing debt will need to restructured and new debt issued at much higher interest rates. 

Fed Chair Powell wants to see rates at the long end of the Treasury yield curve rise. With munis priced off the curve, the outlook for a correction in the muni market is growing by the day.

Question 4 

David, as near the end of another episode,  I want to ask you what may seem like a strange question, but what gives with September and the Financial Markets?   

September’s reputation as a poor month for equities is well-known. In fact, since the Dow Jones Industrial Average was created in the late 1800s, the Dow has fallen an average of -1% in September, while it has gained on average +0.7% in all other months.  I have heard lots of opinions, but one of my favorites is that the stock market in September suffers from pent-up selling from investors who are just returning from their summer vacations.  

So, is everyone going to unpack their suitcases after Labor Day and then unload their portfolios? 

Rick, as of last Friday’s close, the S&P 500 was up +13.15% to date for Q3 2020. That is a great deal of return for an environment in which one may argue that a wide variety of risks have not been mitigated. 

Consequently, it is quite possible that as investors awaken from the summer reveries to consider the world in the cold harsh light of September that a certain reassessment of risks & returns should be in order. Right now, the S&P 500 is more extended further above its 200-day average than at any time but one in the past decade. So, no one should be surprised by a pause or sharp pullback for any reason or none at all.

On the other hand, a review of earnings expectations for H2 2020 show that very little, if any, of the substantial Q2 2020 earnings season’s outperformance has been factored in. That said, we should consider that the Q3 2020 earnings season will see something of a replay as companies surprise to the upside. This is likely to be the October Surprise that keeps the S&P 500 index on track to reach our 2020 price target of 3800. 

So, the word for September may be to view the market cautiously, but keep some capital available for October.  

Synopsis: “A Brighter Future”, Episode 25

In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, discusses the 2020 Q3 outlook, the 2020 election season, Tech sector market leadership, the Fed and other developments with Laidlaw & Company Chief Market strategist, David Garrity.

The topics discussed in this episode are: What are final marks for 2020 Q2 earnings season and what now for 2020 Q3 earnings?, What portfolio moves should investors make ahead of the November 2020 election?, Is the Tech sector’s market leadership overdone?, What takeaways are there from Fed’s June 2020 minutes?, and Should silver be in the portfolio and what appreciation potential is there for the S&P 500 for the rest of 2020?

Please tune in for more timely insights.

SCRIPT:

Hello and welcome to another episode of “A Brighter Future,” Laidlaw & Co.’s Podcast Series.  I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co. 

David, I hope you had a nice weekend.  Did you get a chance to do some more fishing with your sons?

Rick, last week we decided to test our fishing fortunes on the open sea. The younger members of the crew caught fluke and sea robin, both of which were enjoyed later for dinner. Me, I caught crabs, who just like the financial markets are showing a great tenacity and staying power.

Question 1  

David, last week the S&P 500 edged past its pre-pandemic record high reached in February.  It was a milestone that marked the roundtrip rally from lows to highs as the fastest bear-market plunge and the second-fastest bear-market recovery in U.S. history. In contrast, the economy has not had a chance to recover as swiftly from the plunge in economic activity in the second quarter as a result of the pandemic and the national and global lockdown measures to contain it. 

The good news is that, after the greatest decline in economic activity since the Great Depression in the second quarter, the economy has shown signs of recovery. The bad news is that with COVID-19 cases still at elevated levels, the momentum of that rebound has softened in August.

So, with most of Earnings Season behind us and in the spirit of “Back To School,” what grade would you give the overall earnings results and what should we expect for the 3^rd Quarter?

Rick, as you may recall the onset of the COVID-19 Coronavirus (“COVID”) pandemic prompted roughly 80% of the companies in the S&P 500 index suspend financial guidance.  You know, in 2020 H1, analysts cut 2020 estimates for S&P 500 index companies by -28.7%, the largest decrease for any H1 since the data was collected starting back in 1996. At the same time, 2021 estimates were cut by -16.9%. With all this being the case, Wall Street was left in the position of preparing for the worst and hoping for the best. 

So, with this kind of a setup, it was not a surprise that 2020 Q2 managed to blow past the massively decreased expectations as 83% of S&P 500 companies reported a positive EPS surprise (+22.4% ahead of forecast) and 64% have reported a positive revenue surprise (+1.6% ahead of forecast). This marks the highest percentage of S&P 500 companies reporting a positive EPS surprise since the data was tracked starting in 2008 and sends the clear message that to handle COVID companies are getting a clear fix on their operating costs so profit margins are much stronger than they were previously feared to be. 

While some observers might claim that company managements were sand-bagging earnings guidance, I would differ and give credit where it is due in recognizing managements’ discipline in battening down the hatches to deal with the demand devastation from COVID. Separately, as discussed in earlier episodes, corporate profits have to now always followed a “V-shaped” path in recovery and 2020 Q2 results clearly serve to underscore to investors this critical point. 

So, where does this leave us in terms of an encore? Off the back of Q2, estimates for both 2020 and 2021 are moving higher. Thus far in Q3, analysts have raised EPS forecasts for 2020 and 2021 by +3.5% and +1.4%, respectively. The path of the EPS and revenue recovery for the S&P 500 is shown in the table below:

Forecast Expectations: S&P 500
Period	Revenues	EPS
2Q 2020	-9.8%	-33.8%
3Q 2020	-4.4%	-22.9%
4Q 2020	-1.4%	-12.8%
1Q 2021	3.1%	12.9%
CY2020	-3.2%	-19.0%
CY2021	8.4%	26.5%

Bottom line, we are encouraged by the strength of corporate performance relative to expectations and are of the opinion this will carry over into 2020 Q3 earnings season which will start in October, being nevertheless mindful of the COVID risks that persist.

Question 2

David, last week the election news cycle kicked into full gear with the Democratic National Convention (held virtually for the first time). This week, the Republican National Convention will take center stage. I am sure we can expect election news will dominate headlines through November, and election uncertainty may cause short-lived market volatility. 

However, stocks have performed well in all types of political configurations, returning +10% on average over the past 100 years regardless of which party occupied the White House or controlled Congress.  What matters more for investor portfolios over the long term are economic and corporate fundamentals that support the rise in stock prices over time.

So in light of that, David, is there an “Election Playbook?”  For example, if Democrats win how should investors position portfolios vs. an outcome that favors Republicans?  

Rick, as much as one might wish there were an “Election Playbook,” for 2020 the impact of COVID on the political economy does not have useful historical parallels. For 1918, it was a midterm election in the U.S. that was affected by the Spanish Flu epidemic. However, one should note that the Bolshevik Revolution in Tsarist Russia unfolded against the backdrop of the Spanish Flu epidemic. Not a political outcome one might want to see in the U.S. this year as revolutions tend be decidedly disruptive.

With the collapse of the global economy due to COVID, it is not surprising to see Trump’s re-election prospects under pressure.

The Republican National Convention kicks off today with the theme “Land Of Promise,” appropriate perhaps since one hopes better days lie ahead should COVID be contained to allow the economy to recover. Of note, as is typical for Trump, the nominee will break from conventional practice by speaking at 10:00pmET every night of the conference rather than restrain himself to one appearance to deliver the acceptance speech on the last night of the convention. The one major development that might change the narrative for Trump is the discovery and commercialization of a COVID vaccine, but on this score time is running short as the fatality count relentlessly rises.

Turning to the prospects for a “Blue Wave” in which the Democrats win both chambers of Congress, the odds as shown by PredictIt are favorable for a Democratic sweep although the odds have tightened over the past month.

Relative to investor positioning for a Democratic sweep, the greatest concern for equities will be an increase in the corporate tax rate to 28% from the 21% rate now that would mute the benefit from the “V-shaped” profit recovery path mentioned earlier. On a positive note, companies positioned to participate in clean-energy infrastructure should be of interest. There are ETFs for the sector (e.g. ICLN, $16.29, $1.2bn market cap, +38.6% for 2020 to date) that are enjoying gains in the run-up to the November election. Also, as new revenue sources are desirable, it is likely that cannabis legalization will spread under a Democratic administration. According to the Institute for Taxation and Economic Policy, there were over $1.9 billion in revenues in 2019 from excise tax and sales tax in states with legal recreational sales. Estimates are that national legalization could produce nearly $130 billion in additional tax revenues and over 1 million jobs nationwide. There are ETFs for the sector (e.g. MJ, $12.40, $542mm market cap, -27.6% for 2020 to date) that have underperformed the broader stock market.

Under a Trump second term with a divided Congress, we expect Defense stocks and Energy stocks should prove attractive in part reflecting an aggressive “America First” foreign policy in addition to regulatory roll-backs.   

Question 3

David, one of the other big market stories from last week was Apple becoming the first company to have a $2 trillion dollar market cap, extending a historical run that’s lasted decades. 

Yet a statistic I heard caught my attention: It took AAPL 39 years (from the IPO in 1980 till October 11, 2019) to achieve a $1 trillion market cap. It took AAPL stock less than a year to go from a $1 trillion market cap to a $2 trillion market cap and that doubling of market cap occurred during the worst pandemic in 100 years.  

Obviously, the surge in AAPL stock price isn’t fundamentally based, the company is doing well, but not that well. Much of that gain has been fueled by liquidity, i.e. investors piling cash into companies that they believe are immune from the negative effects of the coronavirus. Said differently, part of the increase in AAPL market cap is being driven simply by liquidity/asset inflation. The world is awash in liquidity, and investors, both retail and institutional are taking that liquidity/ cash and piling it into assets such as real estate, bonds, and stocks, especially secular growth stocks such as AAPL, AMZN, FB, GOOGL, MSFT, etc.

I think most investors are happy AAPL is a $2 trillion company, as almost everyone invested has exposure to AAPL somehow through index funds or mutual funds and they make fantastic consumer electronics.  But, let’s not confuse the explosion in AAPL shares and other tech giants with similar explosions in revenue or profits. A lot of the gains in 2020 are driven solely by the anticipation of continued and accelerating asset inflation. What does that mean for our listeners?  Is this something we should be concerned about?  

Rick, put succinctly, COVID has provided the Tech sector a window to pursue disruption on steroids. As we have discussed in earlier episodes, COVID in substantially disrupting the global economy has brought forward in time growth opportunities for tech stocks such as Apple. 

For example, Electronics continue to benefit from the pandemic, especially as Americans prepare for the new school year. Most schools and colleges are incorporating some virtual learning. As we can readily see both may get shut down again depending on the virus case count this fall. Google searches for “Macbook” and “HP” continue to climb and are higher than even November 2019 when queries typically spike around Black Friday. On top of that, they are even higher than the levels around the initial COVID outbreak and national lockdowns in April. If you’re wondering why Apple is a $2 trillion market cap company, this graph goes a long way to explaining that remarkable number. 

While one could say that the current demand is not sustainable, bear in mind that as a result of COVID consumers and businesses have become more reliant on technology products and services. In terms of how individuals’ time is spent the shift to “work from home” has resulted in two hours being reallocated as activities such as physically commuting have been lessened. The longer COVID persists, the more these changes in behavior will become engrained. In comparison the “Internet 1.0” and “Y2K” Tech bubble were not founded on sustainable changes in consumer and business behavior. In the case of COVID the shift is founded on new behaviors that are becoming increasingly engrained as society shifts to a new standard.

That said, we are mindful that fiscal and monetary relief to offset COVID will diminish over time, perhaps sooner should Congress fail to act prior to the November election. Diminished liquidity inflows would serve to brake the flywheel that elevated share prices. This is not a market to chase aggressively, but still one to participate in as we expect the averages will grind higher into the end of the year. 

Question 4 

David, it seems like just about every day there is some discussion about the Fed yet typically FOMC minutes are a non-event for the markets, but that was not the case this past Wednesday as the markets interpreted the minutes as “not dovish enough,” and that caused a decline in stock prices and a rally in the dollar and the 10-year Treasury yield (a typically hawkish move). 

So, what did we miss?  I did not read anything in the minutes that appeared hawkish. Is this a case of the market assigning dovish expectations to the Fed and if their future comments are “max dovish” it will be  a disappointment?

Rick, I believe the market was disappointed that in the June 2020 Fed minutes there was no indication of an immediate response to the signs of economic recovery weakening, that the Fed was possibly holding off on making a September 2020 shift to yield curve targeting. This response shifted the burden of market expectations over to the fiscal relief efforts in which Congress appears to be stalled over issues such as relief aid for state and local governments and additional funding for the U.S. Postal Service to support “mail-in” balloting for the November election. 

I would say that investors may have been too quick to judge the Fed as this week will bring the Kansas City Federal Reserve Branch’s economic symposium scheduled for August 27th to 28th which is normally held in Jackson Hole, WY but will instead be held virtually this year. Fed Chairman Jay Powell will have a presentation on Thursday that may prove interesting in terms of previewing the changes the Fed is making in terms of inflation targetting, so stay tuned. 

Question 5 

David, as we bring today’s episode to a close, I thought it would make sense for us to discuss our Investment Committee meeting from the past week, specifically the decision to implement a position in Silver.  As well, give the opportunity to discuss our new 2020 S&P 500 price target and the evidence supporting the decision for the change.  

Rick, we have discussed before the weakness of the U.S. Dollar to other currencies as the pace of recovery domestically has lagged other economies. As then noted, it is a normal pattern seen in previous economic cycles. In such a scenario, alternative U.S. Dollar-denominated commodity investments such Gold and Silver have performed well with Silver outperforming Gold by 55% as shown in the table below.

Historical Performance: Gold and Silver
			Silver/
Period	Gold	Silver	Gold
1976-1980	717%	1063%	1.48
1985-1987	75%	97%	1.29
1992-1996	25%	58%	2.32
2001-2008	289%	383%	1.33
2008-2011	164%	367%	2.24
Average	254%	394%	1.55

With this in mind the Laidlaw Wealth Management Investment Committee has added a position in Silver to that of Gold which has been in the model portfolio since 2019. 

Relative to the price target for the S&P 500 index, when the “Laidlaw 5” was published in December 2019, the 2020 S&P 500 price target was set at 3420, a level now +0.7% above last Friday’s close. We are increasing the 2020 S&P 500 price target to 3800, a level indicating +11.9% appreciation potential, based on the following considerations.

First, the current stock market recovery is tracking closely to the arc of the recovery seen in 2009.

The match is quite close, and 105 days from the 2009/2020 lows the S&P is just slightly better (+2 percentage points) than back in 2009 on the same trading day. That the 2009 experience points to a further gain between now and the end of the year is welcome news.

3 further thoughts on this comparison, both for good and bad –

1) The leadership groups in the 2009 rally were much different than in 2020. In 2009, the Financials doubled from March 9th 2009 to this point in the rally. That move gave investors a valuable signal that perhaps the Financial Crisis was over and that equities were safe to buy again. The narrative in 2020 could not be more different. Big Tech is leadership as it gains consumer and business share of wallet and attention. More on this below.

2) 2009’s rally occurred after a US Presidential election, where 2020’s move is happening just ahead of one. In many ways 2009 was such a good year (+26% for the S&P 500) because 2008 had been so bad (-37%). One reason 2008 was so horrible was the delay in providing fiscal stimulus (ARRA) until February 2009. Lawmakers barely passed TARP in 2008, and with the November 2008 election and change in power there was no consensus about fiscal stimulus until a new President and Congress took office in early 2009. This time around, the S&P 500 is heading into election season at essentially full throttle. Fair enough – it’s logical enough to believe that no matter which party wins White House and Congress there will be further fiscal stimulus. Most importantly, this is clearly different from 2009.

3) The belief in a powerful rebound in corporate earnings is the most important similarity between 2009 and 2020. During the Financial Crisis, S&P 500 annualized earnings went from a trough of $43/share (in Q1 2009) to $57/share at the end of 2009 to $91/share in mid 2011, a new record high. This time around, S&P earnings are troughing at $117/share (in Q3 2020) but analysts expect they will be at fresh record highs ($163/share) by the end of next year.

In summary, the comparison of 2009 and 2020 is ultimately a reminder that A) bottoms occur when government policy responses match the scope of an economic downturn and B) the nature of the market’s recovery will vary by sector, but the aggregate return (driven by a sharp earnings rebound) is closer than one would think likely.

So, how does the S&P get to 3,800 as this is the indication of where the 2009 playbook says it should go by year end? Consider the following:

1) Forget about cyclical rotation driving stocks higher if that means Tech + Google, Amazon and Facebook falter along the way. These stocks are collectively 38% of the S&P 500. Financials and Industrials (together 17.8% of the index) could rally +10%, but if that meant a -5% pullback for Big Tech then the S&P 500 would remain unchanged.

2) We need to see earnings estimates for 2021 continue to rise. An S&P 500 rallying with a 22x multiple means just one thing: investors think 2021 earnings are going to be better than expected. The latest FactSet data (chart below) shows this is happening, but it has to continue. That means a steady drip of better than expected economic data is needed critically.

3) Whatever happens with the November 2020 elections needs to be decisive. Remember the lesson of 2008 from 1) supra: political dead zones hurt stocks if the US economy is on shaky ground.

Bottom line, we remain positive on US equities, but recognize fully the next +10% move for the S&P 500 will likely be a more difficult climb than the last +50%.

SCRIPT:

In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, discusses takeaways from the July 2020 employment report, the run-up to the November 2020 general election, Fed inflation targeting, mega-cap tech stocks and other developments with Laidlaw & Company Chief Market strategist, David Garrity.

The topics discussed in this episode are: Does the July 2020 employment report offer signs of a steady economic recovery?, What portfolio moves should investors make ahead of the November 2020 election?, Are Gold and TIPS the best hedges against inflation? Is the bond market signalling worse times ahead? Is The Fed likely to ease its inflation guideline?, and Does the stock market’s declining breadth signal a market top? 

Please tune in for more timely insights.

Hashtags & Stock Symbols: #StockMarket #NASDAQ100 #BondMarket #Fed #Economy #Election2020 #COVID $SPY $QQQ $AAPL $AMZN $FB $GOOGL $MSFT $SPG

SCRIPT:

 

Hello and welcome to another episode of “A Brighter Future” Laidlaw & Co.’s Podcast Series. I’m Rick Calhoun CEO of Laidlaw Wealth Management and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co. 

 

David, I hope you came through last week’s storms and power outages unscathed. I had some sump pump issues cause a wet basement but luckily our power outage was only a short one.   

Rick, Despite some wild winds, Tropical Storm Isaias left no lasting damage for our area of the country, glad to say. Meanwhile, over the weekend I was battling with the fish with my 13-year old and 10-year old boys which left a need to replenish the tackle box. 

I think, however, that while the fish we caught were small, we landed something more substantial than the executive orders that were issued over the weekend. Our lines might have gotten snarled, but they were more easily sorted out than the economic damage being caused by the delays in fiscal relief to sustain the economy during the Covid-19 Coronavirus (“COVID”) pandemic which continues to plague the country.      

  

Question 1  

David, last week we saw stocks extend the previous week’s gains, while the Nasdaq set another record on better-than-expected economic data and improved trends in U.S. coronavirus cases. Business activity for the services sectors expanded, and the U.S. economy added 1.76 million jobs in July, beating estimates. The continuing, yet moderating, gains in employment show that the recovery in the labor market and the economy is on track, but there is still a long road ahead.

 

So, let’s start this week’s episode with the “Road Ahead” –  the Employment Situation Report can fairly be labeled better than feared given the surprisingly weak ADP Employment Change Report seen earlier in the week. That report estimated that 167,000 jobs were added to private-sector payrolls. The government’s official report indicated that private-sector payrolls increased by 1.462 million in July.

The nonfarm payrolls number was even larger. Some might call it a “big number” at 1.763 million.  If one had to pick some holes in the report, it would be the slight drop in the labor force participation rate and the recognition that the increase in the employed population (1.350 million) was nearly identical to the decrease in the number of people on temporary layoff (1.340 million). This suggests old jobs were restored more so than a lot of new jobs were created.   But in any case, more people working is a good thing, as is the uptick that was noted in average hourly earnings, and the decline in unemployment rates for all ethnic groups.

So with all this data, what’s your thought on the Road Ahead for this economy ?

Rick, on its face, the employment report was encouraging as it did come in ahead of forecasts which led to general commentary that COVID’s resurgence has not as of mid-July slowed the pace of U.S. economic recovery. However, best to put the report in a broader context. 

From February to April 2020 the US economy lost -22.2 million jobs (152.5 million in February to 130.3 million in April) due to COVID business shutdowns. The labor market recovery pace has been choppy. May added back +2.7 million jobs, June added back +4.8 million, and July was +1.8 million. The recouped jobs total +9.3 million which is 42% of the -22.2 million total jobs lost to COVID. 

The present unemployment rate of 10.2% is well in the range of the two worst periods of joblessness since 1948: December 1982 (10.8%) and October 2009 (10.0%). More strikingly, labor force participation is now just 61.4%, the worst level since 1976 and lower than either prior peak for unemployment (December 1982 64.1%, October 2009 65.0%). Clearly, COVID has put a big hole in the U.S. economy and the damage is evident in the labor market as 5.8 million of the Americans who held the jobs lost have left the workforce since February, hence the drop in labor participation. This unfortunately hit college educated workers, something that bodes ill for a recovery in consumer spending. That said, Congress should look deeper into the employment report than the headline number because another COVID relief package is sorely needed as the employment hole will take well into 2021 to fill.

Meanwhile, the stock market will see further earnings estimate increases off the back of the much stronger than anticipated 2Q 2020 earnings season where, with 89% of the S&P 500 index reported, 83% beat EPS estimates (average outperformance +22.4%, a record) and 64% beat revenue estimates (average outperformance +1.6%). Wall Street analysts dramatically underestimated earnings leverage in Q2 and are being very cautious in revising their estimates for the rest of 2020, all of which points to further upside revisions to come. 

Interestingly, the stock market reaction to 2Q 2020 has been to narrow the margin by which Growth has been outperforming Value and to support better performance from smaller market cap shares as investors have been encouraged by the economic data, the likelihood of further fiscal relief to limit further damage from COVID and the possibility of COVID vaccine candidates successfully completing trials.

 

Growth vs. Value: 2020 Performance By Quarter
	1Q20	2Q20	3Q to date	YTD
Index	Change %	Change %	Change %	Change %
S&P 500	-20.0%	20.0%	8.1%	3.7%
S&P 500 Growth	-14.8%	25.7%	9.6%	17.5%
S&P 500 Value	-26.0%	12.4%	6.4%	-11.5%
Growth less Value	11.2%	13.3%	3.3%	29.0%
Russell 1000 (R1K)	-20.6%	21.2%	8.3%	4.2%
R1K Growth	-14.4%	27.4%	10.1%	20.1%
R1K Value	-27.3%	13.6%	6.9%	-11.8%
Growth less Value	13.0%	13.9%	3.2%	31.9%
Russell 2000 (R2K)	-30.9%	25.0%	8.9%	-6.0%
R2K Growth	-26.2%	30.8%	9.2%	5.4%
R2K Value	-36.2%	18.8%	8.9%	-17.4%
Growth less Value	10.0%	12.0%	0.2%	22.9%

  

So, Rick, the road ahead remains rocky with a number of unknowns to be resolved, not the least of which is how well the upcoming school year begins. Should COVID infections rise with schools reopening, the knock-on effects to the U.S. economy will be material. However, we are of the opinion that the “V-shaped” recovery in corporate profits will continue to sustain the stock market, although volatility is likely to remain pronounced.

Question 2

David, let’s go back to one of our Laidlaw 5 topics, The Election.  With less than 100 days to go before this year’s U.S. elections, anything could change, from voter sentiment to the candidates’ standing to the trajectory of the coronavirus pandemic, which has sickened millions, killed more than 150,000, and driven the nation’s economy into the worst downturn since the Great Depression. All the more reason, then, for investors to hedge their bets on the election results, preparing for several possible outcomes—each with different implications for policy, the economy, and financial markets.

So, given what we know, how would you suggest clients be positioned as the election begins to come more into focus? For example, I know portfolio decisions will be different if the Republicans maintain the White House vs. The Democrats taking the White House and possibly a “Blue Wave”   

Rick, the coming election will be a referendum on just how willing the U.S. electorate is to ignore the devastation a fragmented response to COVID has brought to the country. Given the perilous state of the economy are voters willing to put the interests of party ahead of country? The fortunes of the GOP hang in the balance.

Meanwhile, Napoleon once said, “never interrupt your enemy when he is making a mistake.” In that spirit, Democratic Presidential candidate Joe Biden is benefitting every day as the Trump Administration blunders continually in dealing with the COVID pandemic. The failure to move forward the necessary COVID fiscal relief threatens only to worsen the economy by removing the necessary social safety measures, something that will most likely serve to stir further unrest in the run-up to the election on Tuesday November 3rd. 

With that kind of political turbulence in store, investors may look to lower duration investments as a means to limit portfolio risk. To that end, note that the recent 2Q 2020 earnings season’s performance has had a positive impact on bond spreads as both investment grade (“IG”) and high yield (“HY”) spreads are clearly improving, they are still appreciably higher than their mid-February lows (IG: +136 basis point (“bp”) versus +102 bp; HY: +506 bp vs. +356 bp). If compared to the stock market, the corporate debt market more closely resembles the Russell 2000 (-7% away from its February 2020 highs) than the S&P 500 (-1% away from its February highs). Consequently, taking gains from stocks and adding to HY debt may be an appropriate strategy in the run-up to the election. 

Question 3

David, over the weekend, Barron’s published a discussion on why Gold and TIPS (i.e. Treasury Inflation Protected Securities) are the best protection for a falling stock market.  While we have covered Gold in past Episodes and the fundamental backdrop of a falling dollar and declining real rates continue to support the bullish case for gold, we have not spent a great deal of time on TIPS.  Could you offer our listener’s a bit of education on TIPS and whether you agree with Barron’s assertion that inflation-sensitive assets such as Gold and TIPS could be better hedges against an equity portfolio than the traditional 60/40 allocation?

Rick, back in “A Brighter Future” Episode 12 (5/12/20) we discussed inflation hedges as highlighted in an analysis published in early May 2020 by the well-known investor Paul Tudor Jones wherein he stated that the best inflation hedges were #1 Gold, #2 The Yield Curve (long 2-year bonds, short 30-year bonds), #3 The NASDAQ 100, and #4 Bitcoin. 

Investors should understand that TIPS are a way of measuring market expectations with regard to what inflation will be in the future as they are a Treasury bond that is indexed to an inflationary gauge to protect investors from the decline in the purchasing power of their money. The principal value of TIPS rises as inflation rises while the interest payment varies with the adjusted principal value of the bond. The breakeven rate, or expected inflation rate, equals comparable U.S. Treasury yield minus TIPS real yield. Real yield on TIPS equals comparable U.S. Treasury yield minus breakeven or expected inflation rate.

To the extent TIPS could be considered as a proxy for #2 The Yield Curve, we are glad to see Barron’s echo Jones’ conclusions. With future inflation well below the Federal Reserve’s +2% target rate, we would favor Gold as an inflation hedge as the current monetary policies from the Fed will likely keep interest rates at depressed levels for the foreseeable future. As such, the opportunity cost of funding a position in Gold is negligible. 

Question 4 

David, in past episodes we have discussed the importance of the Bond Market (it is significantly larger than the Equity Market) as well as keeping an eye on the Yield Curve and we have all heard the saying that history doesn’t repeat itself perfectly in markets, but it does tend to rhyme and right now the broad markets fairly strongly resemble the late 1990s.

In saying that, what I mean is the dynamics of the yield curve continue to resemble the period in the late 1990s when a 10s-2s inversion in 1998 was followed first by a run to new highs in

stocks, only for the S&P 500 to reverse back lower by more than 22% in just three months. Then in late ’98, the index recovered to new all-time highs and continued higher for 18 months, registering trough-to-peak gains of nearly 70% into the frothy top of the dot.com bubble in 2000.

So, is the Bond Market telling us the “light ahead” we all want to see as our Brighter Future, might be a “Freight Train” instead?

Rick, to your point, the bond market is the dog that wags the stock market’s tail and a yield curve inversion is something all investors should pay attention to since the inverted yield curve has consistently predicted a recession each of the 5 times it has inverted over the past 50 years. However, although a recession follows inversion, the timing is uncertain. On Friday March 22, 2019, the yield on the U.S. Treasury 10-year dipped below the yield on the U.S. Treasury 3-month for the first time since 2007. Clearly, as precipitated by COVID, we are now in the recession that was then indicated. In answer to your question, COVID drove the freight train into town.

Relative to stock market parallels with the late 1990s “Internet 1.0” and “Y2K” period, I would offer that COVID provides a far better-founded case for technology adoption as the social-distancing strictures it has forced upon the world are likely to prove to be permanent.

Right now, the Nasdaq 100’s price-earnings ratio of 36x compares with a 10-year average of 22x. If we assume technology shares remain unchanged, it would take roughly three years’ worth of almost +20% annual earnings growth to get multiples back to the long-run average.

As such, the stock market is more than just adjusting for a brutal, but brief, economic interruption. Instead, this valuation level reflects a more profoundly altered reality. Namely, a world in which the urge to limit human interaction squeezes the old economy mercilessly, while hastening the ascent of a digital and mostly automated new one.

Granted the successful commercialization of a COVID vaccine could limit how long such a shift might last and that in part is what appears to lie behind the improved stock market performance of late for Value and Small Cap shares.

Question 5 

David, as has become a tradition on “A Brighter Future” I want to turn our attention to the Fed.    Last week, CNBC ran an article that suggested the Federal Reserve might announce a change to its policy-setting framework, shifting to an “average inflation” target. This change, it was said, could be announced before, or at, the September FOMC meeting. Since inflation has been running below the 2.0% target for some time, the implication is that the Fed would be comfortable allowing inflation to run above 2.0% to achieve an average inflation rate of 2.0%.   According to the article, the Fed would likely signal to the market that it isn’t going to raise the fed funds rate until it has met its inflation and employment targets. Considering the current unemployment rate of 10.2% is still above the peak rate seen since the Great Recession, it’s going to take a whole lot of hiring activity and probably a good bit of time before the employment target is hit. 

So, David, do you see inflation ever getting back to the Federal Reserve’s 2.0% longer-run target on a sustained basis?

Rick, as we have discussed before the amount of monetary stimulus provided to offset COVID along with the disruption to global supply chains stemming from the trade wars waged by the Trump Administration are serving to put in place the pre-conditions for a substantial increase in inflation rates. 

With the Fed prior to COVID appearing to be more focused on pursuing its employment support mission as opposed to its inflation containment objective, it is not surprising there is speculation on possible relaxation of the Fed’s 2% inflation guideline. While it will not be held in its usual Jackson Hole, WY setting, the upcoming Kansas City Federal Reserve Branch economic symposium scheduled for August 27th to 28th will likely provide a forum for discussion around relaxation of inflation targeting by central banks more broadly. Bottom line, the Fed moving to be more relaxed on price stability does increase the likelihood inflation will rise over time.

Meanwhile, it is good to keep an eye on Fed Funds Futures as a forecast of future interest rates. It appears that the Fed easing the 2% inflation guideline has served to take speculation regarding negative interest rates off the table. On Friday 8/7/20, for the first time in almost 2 months, Fed Funds Futures are pricing in positive policy rates all the way through 2021. 

Note that negative rates had been priced into the December 2021 Fed Funds Futures contract since Thursday 6/18/20. With Fed Funds Futures being a good leading indicator of rate market sentiment for several years, investors should be aware that they are signaling a possible backup in interest rates in the near term.   

Question 6

David, as we bring today’s episode to a close, I wanted to discuss the continued incredible  outperformance of “Big Tech.” On last week’s episode, we talked about incredible earnings of MSFT, APPL, AMZN and FB and how these market leaders have been powering this market higher for a long time. The distance between the generals and the soldiers, once thought to portend a market top, is as wide as it has ever been.

  

So, at this point any chatter about lousy breadth sounds like the boy who cried wolf, but what happened last week is truly remarkable. The Nasdaq Composite (CCMP) closed up +1.49%, while the Nasdaq A/D line was -971. To put that in perspective, since 2004 (as far back as there is data) there has only been one other day where the CCMP was up at least +1.49%, and there were more decliners than advancers. That was 4/16/20 which was +1.66% with the A/D line -319.

Looking at it the other way, there have been 645 days since 2004 when the CCMP had at least 971 net decliners. Prior to Friday, the best performance for the CCMP on those days was +0.67% on 6/10/20. The 2nd best day was +0.53% on 7/9/20.  Which means the top three most lopsided breadth/performance days in the last 16 years have come in the last 7 weeks!

Paradoxically, this was more concerning on the way up than it is today, since now that the big five are such a large percentage of the market, it hardly matters what the rest of the stocks are doing. For example, the top three names in the NASDAQ-100, Apple, Amazon, and Microsoft, are equal to the bottom 87 stocks in the index.

So, have we reached a point with the mega-cap tech names that until they begin to breakdown a bit, it’s difficult to call a top and breadth divergences are less and less meaningful? 

Rick, signs of a narrowing advance in the stock market have historically been taken as indicating an approaching market top. Certainly, the $2.9 trillion in additional market valuation garnered by the NASDAQ 100 since the onset of COVID is an impressively larger number that one might think sufficiently captures the magnitude of the economic shift in their favor. 

That said, it is staggering to consider the shifts that are occurring during COVID. For example, the Wall Street Journal is reporting that Amazon is reportedly in talks with the biggest mall-owner in the U.S. to turn former department stores into fulfillment centers. Simon Property Group could lease vacant spaces that were J.C. Penney or Sears stores to Amazon, which would use them as distribution centers that would get products to customers faster. Another example, in the U.K. internet sales now make up around one third of total retail spending, up from a fifth pre-pandemic as many Britons are switching to shopping online, hitting sales at high streets, retail parks and shopping malls. Note that COVID is driving similar changes across the world.

Shifts of such magnitude offer market share gain opportunities to those companies with the resources and capabilities needed to capitalize on them. To this extent, we are not surprised that the mega-cap tech names have widened out their stock market leadership. 

As we discussed in the run-up to 2Q 2020 earnings season, the mega-cap tech names were essentially trading in line with their 2021 EPS growth rates. A Price-to-Earnings Growth (“P-E-G”) ratio of 1.0-1.5x is not excessive by historical standards. With their results largely coming in well ahead of expectations, it is understandable their shares have traded higher.

It is entirely possible that the successful commercialization of a COVID vaccine could forestall the underlying shifts in the global economy that mega-cap tech stocks appear to indicate. However, as that discovery is very much a matter of speculation, the fact remains that larger market share of the world economy is being gained by these companies every day as COVID persists.

SCRIPT:

Episode Title: Episode 23 – 2Q 2020 Results Bring Estimate Increases, But Can The Fed Inoculate The Economy?

Synopsis: “A Brighter Future”, Episode 23

In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, discusses takeaways from the 2Q 2020 earnings season, the ongoing complications from COVID and other developments with Laidlaw & Company Chief Market strategist, David Garrity.

The topics discussed in this episode are: With 2Q 2020 results prompting analysts to raise estimates, are stocks still attractive?, Are management share sales a red flag for stocks? Can The Fed fully offset COVID’s economic impact?, How might investors capitalize on the weakening U.S. Dollar?, and How should investors best operationalize “Quality” in portfolio construction? 

SCRIPT:

Hello and Welcome to another episode of “A Brighter Future” Laidlaw & Co.’s Podcast Series. I’m Rick Calhoun CEO of Laidlaw Wealth Management and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

David, I hope you had a nice weekend and were maybe able to take in a little basketball as another professional sport returned to action in the “Bubble” down at Disney.
Rick, The example of the halting start to the shortened 60-game MLB season from Covid-19 coronavirus (“COVID”) outbreaks among various teams travelling across the country to play in empty stadiums does serve to underscore the need to change the approach to organized activities, sports or otherwise.

Let’s hope that the bigger season coming up, namely the beginning of the new school year, is handled more appropriately. With the clear and present risk of COVID infection, it is quite likely that schools will see staggered start dates as administrators, teachers, staff, students and families find the best way to move forward while emphasizing “Safety First.”

Question 1

David, we saw stocks escape a busy week of earnings, economic data reports, and the Federal Reserve’s policy meeting unscathed, finishing modestly higher and adding to the biggest four-month gain in the S&P 500 since 2009. At the same time, nervousness about the negotiations over the next round of fiscal relief, along with concerns about the sustainability of the rebound, pushed the 10-year yield to its third-lowest closing level on record and the five-year yield to a new record low. GDP growth data showed the sharpest quarterly downturn on record, however, it was better than expected which lent to stocks finishing the week slightly higher on positive earnings news.

But I think most people would say the big story last week as “Big Tech” with FB, AMZN and AAPL reporting results that were significantly better than expected. So with about half of the S&P 500 companies having reported quarterly results, 84% of the companies have exceeded analyst estimates. Is that an indication of a “lower bar” or an example of the stock market isn’t the economy?

Rick, As we have noted previously, the financial markets have in many ways become a liquidity-driven flywheel powered by the cumulative effect of the monetary and fiscal COVID relief efforts unleashed across the globe. Hence the importance of the COVID relief negotiations now underway in Washington, DC. Nevertheless, while it is true that the stock market is not the economy, it still remains anchored in the economy.

One of the major reasons the 2Q 2020 earnings season has been so much stronger than expected is that with the onset of COVID up to 80% of companies in the S&P 500 index suspended forward financial guidance. As such, the financial analysts took a conservative approach of presuming the worst while crossing their fingers that it would not come to pass as stock prices rebounded sharply from the March 2020 lows.
From an earnings season standpoint, the score is reassuring as we now have 63% of the companies in the S&P 500 index that have reported 2Q 2020 results with 69% beating revenue expectations by +2.4% and with 84% beating EPS expectations by +21.8%, both record performances in data series going back to 2008. At the sector level, the Information Technology (94%), Materials (94%), Health Care (92%), and Industrials (91%) sectors have the highest percentages of companies reporting earnings above estimates, while the Energy (63%) and Real Estate (63%) sectors have the lowest percentages of companies reporting earnings above estimates. Overall, 2Q 2020 with a -36% year/year EPS decline is coming in far better than the worst quarter of the Great Recession when in 4Q 2008 EPS fell by -69% year/year.

On the tail of the positive 2Q 2020 performance relative to expectations, we are starting to see analysts raising quarterly S&P 500 EPS estimates, something that has not happened since 1Q 2018 and which will likely serve to support current valuation levels. The forward 12-month P/E ratio for the S&P 500 is 22.0x. This P/E ratio is above the 5-year average (17.0x) and above the 10-year average (15.3x).

So, Rick, while the stock market may not be the economy, the economy as represented by the companies making up the S&P 500 index actually outperforming Wall Street’s worst fears by a record margin. Note that this serves to support a point we have made before, namely that corporate profits are likely to have a “V-shaped” recovery even though the shape of the broader economy’s recovery may be a more sluggish “W.”

Question 2

David, over the weekend, I read an interesting post from a financial writer, who wrote:

Tech stocks are going crazy? Check
IPOs are on fire? Check
Retail day-trading is going bananas? Check
People are proclaiming we’ve entered a “new” economy? Check
Warren Buffett is getting mocked relentlessly? Check
Investors are throwing money at unproven business models with no profits? Check
Value stocks are getting crushed by growth stocks? Check
Small cap stocks are getting left in the dust by large cap stocks? Check
This is a description of what went on during the insanity of the late-1990s dot-com bubble…and what’s happening in 2020.

I mention this because another strategist we both admire, Tobias Levkovich, is saying something similar but through his Panic/Euphoria Model, which is generating a reading of “Euphoria,” signifying investors might be a bit “too bullish” right now.

Couple that with corporate insiders, whose buying correctly signaled the bottom in March, now being mostly sellers. As almost 1,000 corporate executives and officers unloaded shares of their own companies last month, outpacing insider buyers by a ratio of 5-to-1, according to data compiled by the Washington Service. And I think you can see where I’m going with this question –

What should the average investor trying to read this market be doing now?

Rick, while the prospect of continued liquidity being provided by way of COVID relief should be understood to support a more euphoric level of market sentiment, we do consider managements’ stock activity to be an important indicator as to the potential for the further appreciation of their own companies’ shares.

If there is any subset of investors who have access to proprietary information, it is management when it comes to assessing the relationship between their company’s valuation and underlying economic performance. So, managements shifting their stance to become net sellers is a warning sign to which we pay close attention as it more indicates a market more likely to churn, not soar, higher from current levels.

That said, we would do best to get some more granular detail as to the sectors where the shift has taken place. Note, as discussed previously, that COVID has brought about a world in which the pace of technological disruption is occurring at an accelerating pace. Last week’s results from AAPL, AMZN, FB & GOOGL by and large blew by expectations in a reflection of just this acceleration.

With that in mind, it would make perfectly good sense that the managements of companies who are being disrupted would be net sellers of their shares. The thing to watch for when it comes to management sales is whether it is stock from the disruptors as opposed to from the disrupted companies that is coming to market.

Question 3

David, let’s spend a few minutes on the Fed. If there was any doubt about the Fed’s commitment to support the economic recovery, last week’s statement provided yet another clear signal that the committee is going to do everything in its power to help fill the economic hole left by the pandemic. Using Chairman Powell’s words in June and reiterated again last week, the Fed is “not even thinking about thinking about raising rates,” which strongly suggests that rates and credit costs will stay low for longer, reducing some of the market downside risk that would have been more pronounced without the Fed’s backstop.

So, while it’s great that the Fed is still fully engaged, when the coronavirus started to take hold of the U.S. economy, there was an article that said neither economists nor columnists could predict the virus’ impact on growth. That’s still as true as ever. No one really knows where this recovery—which started earlier and more strongly than expected—is going. In fact, Chairman Jerome Powell said as much on Wednesday, repeatedly stressing that the U.S. economy is at the mercy of the coronavirus.

So while we have seen great earnings, as discussed earlier, can the Fed alone save the economy?

Rick, much as we would like to ascribe extraordinary powers to Federal Reserve Chairman Jerome Powell, he is only human just like the rest of us. To that end, while the Fed is clearly committed to “doing whatever it takes” to offer monetary accommodation in the time of COVID, the fact remains that the pandemic is stubbornly persistent in the face of containment efforts and a commercially available vaccine remains months off.

We all know the data in terms of infections and death rates from COVID is sobering. Over the weekend, South Africa surpassed 500,000 cases. It has the fifth-heaviest caseload in the world, including most of Africa’s confirmed infections. Australia, an early success story, had to toughen up a lockdown of Victoria, its second-biggest state. Meanwhile India recorded 50,000 new cases a day for six days, taking the country’s total to over 1.75 million. Latin America collectively has nearly 5 million; 30% of the world’s total despite being home to just 8% of its population.

With this, the Fed is playing a major role, but ultimately it will not be the one that is determinative. As such, time to keep our eyes on what Dr. Anthony Fauci has to say in terms of bringing COVID under control.

Question 4

David, we don’t talk about it a lot but the U.S. Dollar Index weakened to a two-year low. The dollar has been in a fairly steady downtrend against other major currencies, namely the euro, since mid-May. Last week, the U.S. Dollar Index slipped to 92.54, which was its lowest level since May 2018.

The weakness in the dollar has been attributed to various influences like:
-Concerns about the widening budget deficit and rise in national debt
-The strengthening of the euro, which coincided with EU leaders taking an important step toward a stronger fiscal union with the agreement on the European Recovery Fund
-The resurgence of coronavirus cases in the U.S., which have exposed better containment efforts abroad that have created better potential for a faster recovery period.
-Interest rate suppression in the U.S.
-Worries about increased volatility in the U.S. market as the presidential election draws closer.
-An unwinding of carry trades as foreign currencies strengthen against the greenback.

Beyond the obvious, what should our listeners know about this weakening and how can impact their portfolios?

Rick, the fact that the U.S. Dollar is weakening relative to other currencies is not surprising in light of how poor COVID containment is leading the pace of the U.S. economic recovery to lag that of other regions globally, something that will likely be confirmed by PMI and employment data over the course of this week. Important that investors should appreciate that the U.S. Dollar saw a spike earlier in 2020 as part of a global flight to safety with the spread of COVID.

Relative to the stock market, investors should know that the S&P 500 index companies receive 40% of revenues from non-US sources, but the proportion varies widely by industry group. While Materials (57% of sales are non-US) and Energy (41%) have +40% non-US revenues, their combined weighting in the S&P 500 index totals only 5%. On the other hand, for Information Technology (56%), Staples (44%) and Communications Services (40%), their combined S&P 500 index weighting totals 45%. So, a weaker U.S. Dollar is one more investment positive for Big Tech.

In a historical context, the U.S. Dollar has depreciated in previous economic recoveries. After its March 2009 highs, the U.S. Dollar weakened by -16% in the next 2 years. We believe it is reasonable to expect this will happen again during 2021 and 2022 as the global economy slowly recovers from the crisis of COVID. That would take the Trade Weighted Dollar Index back to a level of 106-107, essentially where it was in early 2018.

Question 5

David, as we bring today’s episode to a close, I’d like focus on something that we have been talking about for some time – Quality.

Over the course of this year, we have been recommending that investors focus on quality in the various asset classes where we allocate funds. So that would logically mean companies featuring a low amount of leverage (debt) and lots of cash on the balance sheet along with growing revenues that can weather economic uncertainty and produce attractive profit margins. But in terms of equities and sectors, just what does quality mean and what are some names to consider?

Rick, the forcing function that COVID has delivered in accelerating technology’s disruption of the global economy is most likely the major differentiator for investors to consider when it comes to constructing portfolios for 2020 and beyond. As the table below shows, Large Cap Growth has been the major out-performer in 2020, showing gains during the time of COVID.

To the point that you raise, Rick, of the need for investors to choose “Quality” in building portfolios for long-term capital appreciation, we consider not just the financial position as being important but also how well the management team performs in dealing with a range of constituencies from customers to employees to communities to society and the world at large that ultimately determine long-term performance. We agree with this approach because in the long run, “quality” will serve to distinguish great companies from the merely good.

As you know, the rise of Environment, Social & Governance (“ESG”) approach towards investing reflects these concerns’ increased importance. One firm that provides a readily accessible ranking of roughly 1,000 U.S. public companies along these broader parameters is Paul Tudor Jones’ JUST Capital.

While technology firms are prominently featured in the top 10 companies from the 2020 ranking (e.g. MSFT, NVDA, AAPL, INTC, CRM, GOOGL, PYPL, VMW), names such as ANTM and PG are well placed. For investors wishing more information, please find the ranking here: https://justcapital.com/rankings/.

Overall, while we noted earlier that “Safety First” is a watchword for the present as COVID is not yet contained, we stress that for superior long-term performance investors do need to put a high priority on “Quality.”

SCRIPT:

Episode Title: Episode 22 – Solid 2Q 2020 Earnings May Say Rotate To Value, But Are The Supporting Factors Fully In Place?

Synopsis: “A Brighter Future”, Episode 22

In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, discusses the strengthening 2Q 2020 earnings season, the likely sizing of further COVID relief support by Congress and the Fed and other developments with Laidlaw & Company Chief Market strategist, David Garrity.

The topics discussed in this episode are: With 2Q 2020 results strengthening, is now the time to rotate into Value?, Does COVID accelerating Tech disruption continue to favor Growth? Just how big should the next COVID fiscal relief package be?, Is now a good point to add to stock positions?, and Will the U.S./China relationship be calmed by a return to a focus on trade? 

Please tune in for more timely insights.

Hashtags & Stock Symbols: #StockMarket #SP500 #Economy #COVID #China #Election2020 $SPY $AAPL $AMZN $DELL $FB $GOOGL $HPQ

SCRIPT:

 

Hello and Welcome to another episode of “A Brighter Future” Laidlaw & Co.’s Podcast Series. I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co. 

 

David, I hope you had a nice weekend and were able to enjoy a little baseball as “America’s Pastime” returned to the field albeit with cardboard cut-outs instead of fans, soundtracks for crowd noise and possibly one of the worst first pitches ever by Dr. Fauci .

Rick, this weekend I had the chance to enjoy two national treasures: baseball and Walden Pond. On baseball, while the shortened 60-game season is now 5% over, it has had its share of unusual aspects such as the cardboard fans accompanied by recorded crowd sounds, a sight which is just bizarre. However strange, it still gives rise to philosophical ponderings such as whether the female Dodgers fan whose cut-out was hit in the face by Will Smith’s pinch-hit homer in 9th inning of Saturday’s 4-5 loss to the San Francisco Giants should as a courtesy receive the ball in question. Talk about a loss of face if the Dodgers get this one wrong. Perhaps time to call in Dr. Fauci as he, apart from his pitching, generally gets things right more often than not. 

On Walden Pond, I had the chance to beat the 90-degree heat by hiking around to a shaded spot where I put my feet in the water and coached a 10-year-old boy in his effort to catch minnows in the lake’s clear waters. Try as we might, bits of bread and potato chips were but poor bait for the task at hand. As consolation we were treated to wild blackberries growing on the shore while being serenaded by the cries of the loon that caught the fish which eluded us. I like to think that perhaps Thoreau had similar challenges during his time on Walden Pond. Next time I will come better equipped. 

In any event, Rick, it was all in all a great break from a week in the market that left us metaphorically hit in the head and wondering at events that to us seemed as crazy as a loon.        

  

Question 1  

David, we saw stocks decline modestly last week, while long-term bond yields retreated to near record lows. The S&P 500 turned briefly positive for 2020 before pulling back on concerns over escalating Chinese/American tensions. 

On the economic front, U.S. initial jobless claims increased last week for the first time since March, raising worries that the economic recovery is beginning to stall, but on the positive side, EU leaders agreed on a landmark stimulus package to help member states mitigate the economic downturn.  Oh, and if that wasn’t enough, we had over 330 companies report earnings, with 20% of them being in the S&P 500.  So what was your take on the week that was?   

Rick, it was like going to see a play at Ford’s Theater in that you like the performance, but you’re not so sure about the ending. Namely, as the number of confirmed COVID cases globally hit 16m, with nearly 650,000 fatalities, the WHO warned that there will be no return to the “old normal”. In a sign that COVID’s spread of the disease is accelerating, more than 1mm new infections were reported in just four days. Over the weekend, almost 40 countries reported record single-day increases in COVID cases. 

From an earnings season standpoint, the score was reassuring as we now have 26% of the companies in the S&P 500 index that have reported 2Q 2020 results with 71% beating revenue expectations by +3% and 81% beating EPS expectations by +11%. This offers encouragement on two fronts: 1) companies are doing a better job than anticipated in driving revenues and controlling costs so profit margins are holding up better than feared, and 2) the likelihood that estimates for the second half of 2020 and full-year 2021 will be increased, barring further economic deterioration from the Covid-19 Coronavirus (“COVID”) pandemic. 

Interestingly, this led to an outperformance by Value stocks last week with a +0.16% gain for the S&P 500 Value ETF (ticker IVE), extending the Value run seen so far in 3Q 2020.

Growth vs. Value: 2020 Performance By Quarter
	1Q20	2Q20	3Q to date	YTD
Index	Change %	Change %	Change %	Change %
S&P500	-20.0%	20.0%	3.7%	-0.5%
S&P500 Growth	-14.8%	25.7%	3.8%	11.2%
S&P500 Value	-26.0%	12.4%	4.0%	-13.5%
Growth less Value	11.2%	13.3%	-0.2%	24.7%
Russell 1000 (R1K)	-20.6%	21.2%	3.9%	0.0%
R1K Growth	-14.4%	27.4%	3.8%	13.3%
R1K Value	-27.3%	13.6%	4.2%	-14.0%
Growth less Value	13.0%	13.9%	-0.4%	27.3%
Russell 2000 (R2K)	-30.9%	25.0%	1.8%	-12.0%
R2K Growth	-26.2%	30.8%	2.1%	-1.4%
R2K Value	-36.2%	18.8%	3.3%	-21.7%
Growth less Value	10.0%	12.0%	-1.1%	20.4%

While there have been calls made for a rotation out of the Tech mega-caps that have to date been leading the markets higher off the 3/23/2020 bottom, I think this may be premature in that there is insufficient visibility around whether the pace of economic recovery will slow in the face of resurgent COVID infection globally, especially should fiscal relief efforts diminish. 

Note that the economy is in more precarious financial shape now than in 2008. To that end, credit rating agency Moody’s has stated that 414 companies are close to defaulting, a number that is +42% above the peak reached during the 2008 financial crisis. 

This is the second consecutive quarter that a record number of companies made Moody’s list which includes companies in the three lowest ratings tiers before default. The list also featured companies in the four tiers above default that have risk of a downgrade, meaning they’re on watch for a ratings cut. Most of the companies were in the consumer and business services sector. Companies added to the list include video game retailer GameStop and fast-food chain Wendy’s.

 

Now, granted, Growth has massively outperformed so far in 2020 and at some point relative valuation differentials may appear to be too extreme, but it is important for investors to understand that what has occurred and will continue to occur under COVID is redistribution of consumer time and attention to the Tech sector’s product and service offerings as COVID is accelerating the Tech sector’s disruption of the global economy. 

Meanwhile, a sustainable Value rally needs a global economic “re-opening” that is on firm ground with continued fiscal & monetary relief provided and a clear view as to when COVID vaccines will be distributed. Until then, investors should keep Growth names as a core holding with the Tech mega-caps as part of that allocation. 

Question 2

David, let’s stay on the earnings discussion b/c many believe the coming week will be a big test for the biggest names on Wall Street.  Google parent Alphabet, Amazon, Apple and Facebook  will all report calendar their second-quarter earnings within 24 hours of one another on Wednesday and Thursday.  Which is only part of the busiest week of this earnings season, as another 180 companies in the S&P 500 are also scheduled to reveal how the COVID-19 pandemic has affected their finances.

What are your expectations for “Big Tech” both this week and longer term?  

Rick, as mentioned earlier, COVID is providing the Tech sector a window to pursue disruption on steroids. 

For example, e-Commerce share of U.S. retail sales has grown more in the past 12 weeks than it did during the last 10 years, rising to 27% of U.S. retail sales in 2020 from 16% in 2019. Meanwhile, amidst signs COVID resurgence is underway, US households are going through their largest and quickest hardware upgrade cycle ever, first after lockdowns and now as families get ready for back to school and work in the fall. Over half (55%) of consumers expect both K-12 and college students to take at least some of their classes at home in the fall, while just over a quarter (26%) think most or all classes will take place in-person. Aggregate spending for both K-12 and college is forecast to top $100 billion for the first time, or $101.6 billion, more precisely, a gain of +25.9% compared to $80.7 billion in 2019. Bottom line, moves of this magnitude taking place in the midst of the COVID pandemic serve to underscore Tech’s immediate necessity for consumers and businesses alike. More names than just Apple, Dell and Hewlett-Packard will benefit here, so the comments coming from the managements of Alphabet, Amazon, Apple, Facebook and others on their results conference calls will be telling.

 Separately, investors may have noticed that the U.S. Dollar has been weakening steadily against other currencies in part reflecting its weaker economic recovery on a relative basis. To the extent that the Tech sector has roughly 60% of its revenues from overseas markets, a weaker U.S. Dollar actually has a positive translation impact on the sector’s financial performance.

Away from the relatively positive fundamentals for the Tech sector, this week will bring testimony before Congress from leaders such as Amazon CEO Jeff Bezos in his first D.C. appearance as they are questioned on competitive practices in the sector. 

With the Tech mega-cap names trading in line with their underlying EPS growth rate, we are prepared to take the risk from possible regulation in stride as the imposition of such will take time and the companies have had the opportunity to organize an effective lobbying effort to shape the form such regulation may eventually take.

Question 3

David, let’s move to a more macro discussion,  we are seeing COVID-19 outbreaks in Florida, Texas and other emerging hotspots that are slowing reopening efforts in those regions. As a result, if cases continue to rise and if there is another shutdown what impact will that have on the economy and on a related note, what can the federal government do to keep the economy going?   

Rick, the fact that 31 states are now required to restrict travel to New York State will certainly serve to dampen the pace of interstate commerce. Note that the NYC Metro area represents 10% of U.S. GDP. If we fail to bring NYC back on-line, the U.S. will have a 90% economy. To that end, we believe that any extension of COVID relief efforts being debated in Congress this week should have measures targeting state & local governments. 

On the broader question of how large the CARES Act renewal will need to be to offset the pernicious effects of COVID on the U.S. economy, there was a survey conducted last month prior to COVID’s resurgence that asked economists how much additional stimulus spending would be appropriate this year. The median answer: $1.75 trillion. It estimated that the minimum needed to support demand is $1 trillion. 

That COVID’s resurgence can reasonably be expected to make the demand support need greater, it is more than likely the responses will have trended higher to a median of $2 trillion and minimum of $1.25 trillion. On the Democratic side, the HEROES Act proposal of $3.5 trillion appears to be more than adequate while the Senate GOP proposal of $1 trillion is coming up short. Meeting in the middle at $2.25 trillion will meet the need, but how soon it is delivered and its composition will be critical. 

To that end, the relief program needs to offer three elements: 1) a new round of direct payments, especially for those with low income; 2) some extension of extra unemployment benefits; and 3) a sizable chunk of aid to state and local governments, which were neglected in the CARES Act. 

One of the lessons of the Great Recession is that belt-tightening by state and local governments can blunt the effects of fiscal and monetary stimulus. In the last downturn, states & municipalities cut 720,000 jobs over four-plus years, according to Moody’s Analytics, something that meaningfully slowed the recovery. 

This time around, in just three months, states & municipalities have already cut about 1.5 million workers, with more cuts expected. Aside from the impact on policing, infrastructure upkeep, and a whole range of critical services, this will place an overall drag on spending and growth. Also, more aid to states & municipalities could also help them open schools safely, which would benefit working parents and the businesses that need them. 

  

Question 4 

David, more than likely the worst quarter of economic contraction in this short-but-deep recession is now in the rear view mirror. In fact,  when second-quarter GDP is reported at the end of this month, the economy will likely have contracted at an annualized rate of nearly -30%, even worse than any single quarter during the Great Depression in the U.S. 

This unprecedented COVID-19-related economic turmoil has kept the Fed in a major monetary stimulus mode. That likely will not change any time soon.  Historically, easy money policies from the U.S. central bank have supported higher-than-average valuation multiples.  But I need to ask you a question that I as well as our advisors have been asked many  times recently – With stocks having recovered so much since the March sell-off, should I wait for equities to drop again before I invest?

Rick, I’m not inclined to be very short-term with investment recommendations, but investors should be aware of a long-standing market pattern, namely “The Fed Drift” which is a well-documented phenomenon where the S&P 500 index rallies from the open of a Fed meeting through the day after its conclusion. 

The Fed’s own work on the topic shows that from September 1994 to March 2011 (+17 years) the entire move in the S&P 500 index occurred in the 3 days around meetings of the Federal Open Market Committee (FOMC), most specifically FOMC meetings where an updated Staff Economic Projection (SEP) was offered. 

With Fed Chairman Jay Powell set to give a press conference at 2:30pm Wednesday 7/29/20, investors may wish to not lighten up until after the market has had the chance to digest the latest Fed meeting. 

Away from the Fed, we earlier discussed that 2Q 2020 corporate results have been coming in stronger than expected, something that should bolster confidence levels around second half 2020 and full-year 2021 prospects. Still, in light of COVID’s resurgence, continued COVID relief on both the monetary and fiscal fronts will prove necessary to support further equity appreciation. There is no doubt that the Fed will act appropriately, but Congress with its proclivity towards brinksmanship will likely prompt volatility until the final package is determined. If the compromise is at or above $2 trillion, we expect markets to rally on the news. If less than $1.25 trillion, look for a 5-10% correction.

Bottom line, politicians like to stay in office, so with that the Senate should move in the right direction. As such, investors may take this opportunity to add selectively to positions. Note that with our S&P 500 index target of 3,420, expected appreciation potential is +6.4%.

Question 5 

David, as we near the end of today’s episode,  I think our listener’s would be interested in your thoughts on one non-COVID-19 risk that caught the market’s attention last week and that was the rise in U.S./China diplomatic tensions.  

The U.S. closed a Chinese consulate in Houston on spying and intellectual-property theft concerns. China reciprocated by shutting one of five U.S. consulates in China in the city of Chengdu. The concern is that a rise in diplomatic tension might negatively impact commitments made by the two countries in the U.S./China Phase 1 trade agreement struck early this year, which prevented a rise in new tariffs.  It would seem to me that despite heightened diplomatic concerns, both countries have an incentive to keep the trade deal intact in order to encourage continued trade.  Does that make sense or am I missing something?

Rick, while commercial realities would hopefully lead to a more positive focus on maintaining trading relations and as such have both sides move forward with the implementation of the U.S./China Phase 1 trade agreement, investors may need to appreciate that there are political considerations at play on both sides of the U.S./China relationship.

As we know, Trump is lagging badly in the polls based on the failure to contain COVID in the U.S., resulting in the removal of the U.S. economy’s performance as a basis for re-election. With COVID headwinds growing, Trump has given the China hawks in his administration to drive policy and thereby position Trump as a champion of Western values and democracy in the hopes that he can thereby immunize his re-election prospects. 

For People’s Republic of China President Xi Jinping, 2020 poses no immediate internal political challenge. However, he does need to be mindful of what is coming with China’s own leadership contest in 2022, when a once-in-five-year gathering is expected to take place to pick the Communist Party’s top leaders and set policy priorities. While the country’s 1.4 billion citizens do not get a vote, public sentiment still matters when it comes to how much support Xi Jinping can muster from senior party leaders for his indefinite rule.

A crucial pillar of that support has been Xi Jinping’s personification of standing “tall and firm” in the world, an image he has brandished by strongly asserting claims in the South China Sea, spending billions to upgrade military hardware and tightening Beijing’s grip over Hong Kong. While that has generated nationalist fervor that has buoyed his support and in the process helped to make Xi Jinping the most powerful leader in China since Mao Zedong, it has at the same time also set China on a collision course with the rest of the world.

With this dynamic in place, for Xi Jinping to shift his efforts towards resuming trade may be inconsistent with his desire to be perceived as standing “tall and firm”. As we know, while it takes a big man to cry, it takes a bigger man to laugh at the big man crying. With all this, Xi Jinping has put himself in a position where doing anything to diverge from this path of outward aggression is likely to result in a loss of face. As such, returning to a focus on trade alone will not be a home run, something that for Xi Jinping, just as for the L.A. Dodgers last Saturday, could well result in a critical loss of face.

SCRIPT:

Episode Title: Episode 21 – 2Q 2020 Earnings Season Begins Well, But Will Congress Play Ball?

Synopsis: “A Brighter Future”, Episode 21

In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, discuss the strong start to 2Q 2020 earnings season, the chances for further COVID relief support by Congress and the Fed and other developments with Laidlaw & Company Chief Market strategist, David Garrity.

The topics discussed in this episode are: While 2Q 2020 results looking good, what are bonds telling investors?, What is the “Fed Put” and should it exist?, Time to look at bank stocks?, Was it QE that brought about depressed capacity utilization?, and chances for a “Blue Wave” in November, does the market yet care?

Please tune in for more timely insights.

Hashtags & Stock Symbols: #StockMarket #SP500 #Economy #COVID #China #Election2020 $SPY $IBM $TXN $SNAP $MSFT $TSLA $TWTR

SCRIPT:

Hello and Welcome to another episode of “A Brighter Future” Laidlaw & Co.’s Podcast Series.  I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

David, I hope you had a great weekend and you were able to stay properly hydrated as the “Heat Dome” descended upon us .

Rick, I managed to defeat the heat this last weekend by going offshore to Martha’s Vineyard where the temperatures were a good 20 degrees Fahrenheit less than the mainland. With my toes in the sand and a drink my hand I was on top of the world, thank you for asking. With limited internet connectivity, it was a good chance to sit back to consider the issues we are discussing now.

Question 1  

David, last week we saw stocks finish higher for the third consecutive week on coronavirus-vaccine optimism and positive economic data. U.S. retail sales jumped +7.5% in June, and industrial production increased the most since 1959, both surprising to the upside. Following a two-month rebound, retail sales are almost back to their pre-virus levels, largely helped by the direct support and fiscal transfers from the government to consumers. As the expanded unemployment benefits are due to expire at the end of the month, expectations are that Congress will manage to reach a deal on a new aid package, which is much needed to support the economic recovery. Oh and we started Earning Season – WOW there was a lot going last week!!  So, let me make this a two part question:  1) What were your thoughts after the first week of earnings, and 2) There is no rest for the weary, as this week we have 337 companies scheduled to report, 20% of them representing the S&P 500. As well as important economic data being released including existing home sales on Wednesday, leading economic indicators on Thursday, and July’s preliminary Purchasing Managers’ Index on Friday?

Another WOW week !!

Rick, Last week did kick off 2Q 2020 earnings season and so far 9% of the companies in the S&P 500 index have turned in results that surprisingly have been quite good with 78% of  companies reporting better-than-expected revenues by an average of +3.5% more than forecast and 73% reporting better-than-expected EPS by an average of +6.3% more than forecast.

In terms of profit margins, the sector that continues to have the highest is IT forecast at 19.2% for 2Q 2020 (five-year average 20.2%). The next closest sector is Utilities at 12.5% (five-year average 11.9%). While investors may take issue with the Tech sector’s valuation, it is clearly one where there are relatively resilient fundamentals offering support as for all other sectors the outlook with the Covid-19 Coronavirus (“COVID”) still uncontained is contingent on robust fiscal and monetary stimulus continuing. Tech earnings will start coming out this week with IBM (Mon 7/20), Snap (Tues 7/21), Texas Instruments (Tues 7/21), Microsoft (Wed 7/22), Tesla (Wed 7/22), Intel (Thurs 7/23) and Twitter (Thurs 7/23).

Away from the stock market, last week was encouraging as it saw high-yield (“HY”) bond spreads tighten relative to Treasuries from +615 basis points (“bp”) over the curve to +576bp at the end of the week. Note that when HY spreads stopped tightening back in early June 2020 that coincided with the end of the “reopening” equity trade with the S&P 500 index topping out at 3232.39 on 6/8/20. With the S&P 500 Friday 7/17/20 close of 3224.73, it appears HY spreads tightening off the back of decent economic reports and a good start to 2Q 2020 earnings season may position the market to move higher.

A note of caution, however, is that investors should know inflation-adjusted Treasury yields have been heading lower for the past 6 weeks. Ten-year real yields, considered a better read on growth since they strip out inflation, are down to -0.85%. The Treasury market is charting its path based on the resurgent coronavirus and expectations that the Federal Reserve will push even harder on the monetary gas pedal, allowing inflation to run above its 2% target in the process. That has real rates, as measured by the yield on 10-year Treasury Inflation-Protected Securities (“TIPS”), on course to possibly slide to as low -2% in the years ahead.

With the next FOMC meeting scheduled for Tuesday 7/28 and Wednesday 7/29, the Fed is going into a black-out period ahead of time so no Fed Governors are scheduled to speak. Meanwhile, look to the Thursday 7/23 auction of $10bn in 10-year TIPS as litmus test of how bullish investor sentiment is on inflation’s upward trajectory, something that may prompt action in the gold market.

Meanwhile, with Congress back in session this week, all eyes will be on whether the Senate will take steps to sustain the economy will the battle to contain COVID rages on in the U.S.. Clearly, with 40 states seeing increased infection levels, the economy’s reopening prospects are becoming more uncertain and there is growing anxiety about how children will be going back to school over the next two months. Time to act now if the GOP wants a shot at winning at the polls in November.

Question 2

David, in keeping with what has become a bit of a “tradition” with “A Brighter Future” I want to ask you a question about the Fed.  If you have been somewhat paying attention to the financial media, you have likely heard the term “Fed Put” used over and over again—not only in recent months but for the bulk of the last 10-year economic expansion that ended earlier this year. But just what does this term mean?

Also, could a “Fed Put” be a headwind for future growth and innovation if the Fed is providing a permanent crutch that does not allow an occasional mild recession?

Rick, it’s often been said that “price leads policy” inasmuch as the financial market’s price action drives the Fed’s monetary policy actions and Congress in its fiscal policy actions. Certainly, this was proven conclusively in March 2020 when both the Fed and Congress responded vigorously to the devastation created by COVID in the financial markets.

The notion, however, of a “Fed Put” has been around since the time when Alan Greenspan was Federal Reserve Chairman and in essence its contention is that the Fed will bail out financial markets by taking steps following a correction to limit the possibility of an economic recession. As a result, investors have become conditioned to “buy the dip” and one might say that over time position risk controls have become more lax and that as a result markets are not accurately reflecting the level of systemic risk because the Fed is seen as being ultimately accommodative and that as such risk is perhaps mispriced.

Let me just stop here for a moment to say that a real central banker like Paul Volcker would never for a second have tolerated such an idea as the “Fed Put” since the effective exercise of monetary policy in controlling financial markets depends on the Fed retaining the ability to take unexpected actions. Markets are not supposed to be able to game the Fed, something which is the case with the “Fed Put.”

That said, with COVID still running rampant across the world, there is clearly a need for the Fed to remain accommodative as to withdraw support now would have catastrophic effect and likely unleash a wave of bankruptcies that would take years to clear and a permanent increase in unemployment levels in its wake.  

Question 3

David, as mentioned at the beginning today, we saw earnings last week from some of the biggest banks in the country and as many of them have been so beaten down, we have gotten a lot of inquiries about whether now is the time to be investing in banks.

If you don’t mind, I’d like to do this as a multi-part question:

First, do you have any specific bank stock’s you like?

Second – of the three (3) primary types of banks in the U.S. (Commercial, Investment and

Universal banks) which do you believe will fare the best coming out of this crisis?

Third and finally, there a lot of metrics used to analyze a potential investment in any company, evaluating things like Price-to-book (P/B) value,

Return on equity (ROE) and Return on assets (ROA).   But in looking at Bank stocks there is a unique analysis called the Efficiency ratio.  Could you share with listeners why this is so important in evaluating a bank stock investment?

Rick, early in my career I was fortunate to be in the corporate financial management training program at American Express when Jamie Dimon was the assistant to then American Express President Sandy Weill.

 Needless to say, I have followed Jamie Dimon’s progress since and so favor JPMorgan in considering bank stocks. That Dimon has taken the management approach of capitalizing JPMorgan with a “bullet-proof” balance sheet strikes me as being a necessary and commendable approach for the current state and expected future for the global economy. The “bullet-proof” balance sheet is necessary as the chances of the feared wave of corporate and consumer defaults grows greater the longer it takes to contain and eradicate COVID. This is not the time in the economic cycle to bet on a bank that has not taken the full amount of reserves needed to address the credit write-offs that will inevitably occur.

In looking across the three types of banks mentioned, I believe that universal banks will likely fare best to the extent that they have a clear understanding of the wants and needs of capital market, institutional, corporate and consumer clienteles and have developed the cost-effective means of delivering the products and services tailored to each clientele.

As you mention, the efficiency ratio is an important measure to consider when investing in bank stocks as it shows whether the bank is earning more than it is spending, the essence of profitable growth. Specifically, the efficiency ratio is calculated by dividing the bank’s noninterest expenses by their net income. Banks strive for lower efficiency ratios as a lower efficiency ratio indicates that the bank is earning more than it is spending. A general rule of thumb is that 50% is the maximum optimal efficiency ratio.

Question 4

David, let’s talk about Macro-Economics for a moment.  Robert Kaplan, President of the Federal Reserve Bank of Dallas and a voter on the FOMC said in an interview with Reuters last week, that he thinks there will be “disinflation for some period of time until we get rid of this excess capacity.”

That statement came after commenting on the decline in producer prices seen in June. His view stands in contrast to a parallel market narrative that talks about the prospect of inflation picking up appreciably on account of the policy largesse provided by fiscal and monetary authorities in the U.S. and around the world.  I think we can see why Mr. Kaplan is thinking what he is thinking.  Industrial capacity utilization in June was just 68.6%, which is 11.2 percentage points below its long-run (1972-2019) average and the objective truth of the matter is that capacity utilization has been running below its long-run average since the financial crisis.

Coincidentally, the year-over-year change in the PCE Price Index has been running below the Fed’s longer-run inflation goal most months since then as well.  Which is noteworthy, because it speaks to the point that the Fed’s initial jaunt down the road of quantitative easing didn’t have the ominous effect on inflation rates that many feared it would when the Fed launched its QE program to help stem the deflationary effects of the financial crisis.

That plan, however, looks like small potatoes compared to what the Fed has undertaken in response to the COVID crisis.  So did the QE efforts of the FED, well before the current crisis, have the intended effect or did they exacerbate the “Excess Capacity” problem we have today?

Rick, in considering the issue of capacity utilization it is important to pose it in a global context in which trade flows are factored in.

While it may appear that previous Fed monetary policy through the use of Quantitative Easing (“QE”) might have allowed inefficient producers to remain in operation longer than desired thus resulting in a gradual increase in underutilized capacity, it also important to consider on a sector-by-sector basis how the implementation of globally distributed supply chains has resulted in lower capacity utilization rates domestically and higher capacity utilization rates internationally as the companies managing these supply chains have sought to provide consumers with the highest quality product at the lowest competitive price. While the outcome of this process of globalization may be lower domestic capacity utilization, it does also result in lower price inflation and greater consumer choice.

Theoretically, the growth in international trade stemming from the implementation and expansion of globally distributed supply chains was to be a major driver in raising living standards around the world and in many cases performed appropriately. However, at the same time, we know that countries such as China have sought to exploit the trading system for its own gains in seeking access to other countries economies while barriers in access to its own markets.

As such, declining domestic capacity utilization cannot be laid solely at the Fed’s doorstep, one must consider the motivations of the various actors involved in international trade.

Question 5

David, as we near the end of today’s episode,  I’d like to go back to one of our Laidlaw Five topics – The Election and get your thoughts on why it seems the Market doesn’t care about the Election Yet?

While the election, and more specifically the current state of the presidential polls, is becoming a more popular topic many are wondering if the markets are ignoring the potential consequences of a Biden administration.  Or, is it that the market doesn’t believe a “blue wave” where the Democrats take the House, Senate and the White House is a reality?

Rick, the incumbent in The White House appears to be increasingly divorced from the everyday reality that Americans are now living. COVID is far from contained, the economy is on a knife edge dependent on the next fiscal relief program, and families don’t know how safe it will be for their children to return to school in the next two months. As we can easily agree, these are real problems that voters need to have resolved now, not in November. That said, the tide is favoring a change from what we have now.

So, why aren’t financial markets taking more notice, you ask. Based on data from PredictIt.org they should be as the tide has certainly swung in favor of the Democrats in taking the Presidency (62% vs. 50% in mid-April), the Senate (62% vs. 43% in mid-April) and the House of Representatives (86% vs. 72% in mid-April). However, it is clear that due to COVID the 2020 election is going to be unlike any other in living memory as traditional means of campaigning have been for all intents and purposes eliminated. We believe that the Tech sector is going to play a far greater role in the election campaign shapes up in areas such as:

•   Virtual meetings and events
•   Virtual “get out the vote” rallies and live-streamed candidate meet-and-greets
•   Online seminars on how to vote by mail and contacting voters to apply
•   Virtual volunteer training sessions
•   Urging people to vote through phone calls, texts, e-mails and physical mail
•   Social media outreach and digital/TV ads
•   Videoconferences for fundraising

To this end, it will be interesting to see what Snap and Twitter managements have to say on the above topic during their earnings conference calls this week.

Relative to the bigger question of why markets don’t appear overly concerned, the most plausible answer lies in plain sight, namely that there are enough questions of equal, if not greater, importance around issues such as whether fiscal and monetary relief efforts will continue to be concerned about the outcome of events in early November 2020, a date in time that by the pace of current events lies well into the future. The time will come to discount the expected election results, but we are not there yet.

SCRIPT:

Hello and welcome to another episode of “A Brighter Future,” Laidlaw & Co.’s Podcast Series. I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

David, I hope you had a great weekend and the storms didn’t wreak too much havoc in your area.

Rick, despite battening down the hatches in anticipation, the weekend here was left untouched by Tropical Storm Fay which, as with the Covid-19 Coronavirus (“COVID”), nevertheless wrought havoc further South.

In these times, we all do best to keep a weather eye out as events are fast-moving and we must stay ahead because as we know in the race between the quick and the dead there is no pardon. Not every hand we get to play in life comes up trumps, you know. Only a stone-cold fool would think otherwise, I expect.

Question 1

David, stocks finished modestly higher last week, led by technology and long-term growth stocks. The tech-heavy Nasdaq index has gained +18% this year, after practically ignoring the explosion of Covid-19 cases in places like Florida and Texas. It ended the week with three consecutive highs, and for good reason: The index is composed of the kinds of companies that can not only survive, but thrive, in a world where going about your normal, everyday business could get you sick. The other side of that though, is the valuations on Tech Stocks seem to be in what Ed Yardeni referred to this week as “The Twilight Zone”. So, David, is the “Pain Trade” in Tech higher?

Rick, as we have discussed in earlier episodes, COVID has brought about a world where a decade’s worth of technology adoption has taken place in as many weeks, something that favored tech sector incumbents with the products, services and capital allowing them to fully exploit this opportunity.

From a valuation standpoint this served to bring forward out-year earnings much closer in time to the present. With the drop in interest rates attending the sudden recession and the concomitant central bank monetary intervention, the discounted value of these earnings expectations has supported the increase in tech mega-cap share prices.

As shown in table below, the tech mega-caps are trading at 40x forecast 2021 EPS. With the 2021 EPS growth expected to be +39% on revenue growth of +17%, the implied price-to-earnings growth ratio (PEG) is roughly 1.0x. Historically, growth stocks have traded in a PEG range of 1.0-1.5x. So, by this measure of value relative to growth, tech mega-caps do not appear to be over-priced as of yet.

Question 2

David, last week we saw the non-manufacturing Purchasing Managers’ Index, a measure of business conditions, post its biggest monthly gain and move back into expansion, adding to the string of positive economic surprises. In fact, practically every U.S. economic data release over the past month has surprised to the upside. But now, the days of nothing but the latest coronavirus or economic data swinging the entire market in one direction or the other might be ending as this week begins second-quarter earnings season. The current consensus is for a -12% year-over-year drop in revenue and a -44% plunge in earnings for S&P 500 companies. It seemed like companies got a “free pass” when they announced earnings with little to no “guidance” in April and May, but can we assume investors won’t be as forgiving this quarter?

Rick, last week we mentioned that roughly 80% of the companies in the S&P 500 index had suspended financial guidance as COVID set in.

With that investors will be closely scrutinizing 2Q 2020 results both for signs as to how well management teams have performed in the short-term adjustments necessary to cope with the rapid onset of recession as well as for indications as to what plans are in place to return to growth and profitability. Investors know that what they saw in the rearview mirror was bad enough, they want to have more comfort that nothing similar will be coming through the windshield next.

Although consensus expectations for the S&P 500 are severe, the analyst estimates for 2Q 2020 at $23.27/share are well ahead of the -$0.08/share seen in 4Q 2008, the bottom of The Great Recession. This indicates S&P 500 earnings power is in better shape this time around and in fact is not far off (-7%) the S&P 500’s average quarterly operating earnings from 2010-2015 of $24.91/share.

Separately, analyst confidence in the corporate operating income outlook is improving as estimates for 3Q 2020 ($31.80/share, +$0.02 from last week) and 4Q 2020 ($36.60/share, +$0.07 from last week). In this regard, note that Goldman Sachs just increased its S&P 500 estimates for 2020 ($115/share, +$5.00) while holding steady on 2021 ($170/share). Off the 2021 estimate, the index is trading at 18.7x, a relatively full valuation predicated on profit recovery not being derailed by COVID.

Question 3

David, I want to ask you may seem like a weird question – Are the markets already warning us on future economic growth? As I said, that may sound like an odd question given the S&P 500 is so resilient in the face of surging coronavirus
cases and the potential stall of the economic recovery. But I think it’s a legitimate question, because the number of non-tech stock dominated indices that are warning on growth is growing. Case in point, last Thursday the 10- year Treasury yield closed at its lowest level since April, and threatened to break below 60 basis points. That should not be happening if the bond market is optimistic about the economic recovery.

Rick, to paraphrase Oscar Wilde, with COVID we are all lying in the gutter, but the market is looking at the stars. While overall market averages are swayed by the tech mega-caps given that they now comprise roughly 23% of the total S&P 500 index market capitalization, the equal-weighted S&P 500 (ticker: RSP) tells a different story.

Off the 3/23/20 low, both the S&P 500 (+42.35%) and the equal-weighted S&P 500 (+43.04%) have performed well. However, as we know, the COVID re-opening trade stalled out from 6/8/20 as indications grew that infection rates were accelerating in the South and West. Since then the S&P 500 has retreated -1.46% while the equal-weighted S&P 500 is off -9.37%. Take away the tech mega-caps and, yes, the stock market is clearly signalling a push-out in the resumption of economic activity post-COVID.

To our view, the equal-weighted S&P 500 weakness and the continued decline in long-term interest rates are reflections of real-time traffic patterns around the world that show consumers are reluctant to go out and resume historical levels of activity until such time as greater protections from COVID are available. In this case, sad to say, it is COVID’s world and we are just living in it.

Question 4

David, let’s stay on the Interest Rates topic but with a different twist – the U.S. Housing Market. The “American Dream” of a house in the suburbs with a yard and 2.5 kids – still don’t get that part – seems like it could be making a comeback. Mortgage rates are searching for a historic bottom. Home prices are inching up toward record highs. Home shoppers are looking for deals. Homeowners are weighing selling versus refinancing. A lot is going on in the U.S. housing market on the backdrop of an even messier national state of affairs. After an unprecedented first half of 2020, what could the next six months bring?

Rick, the move to create distance in an effort to protect against the spread of COVID is playing itself out both in the workplace and at home.

Historically, it was commonly accepted that one’s quality of life was inversely related to the distance one had to commute. The less far one had to go, the more time was available for other life activities.

With the COVID-driven shift to a distributed workforce model, the need to live close to work, often in a densely populated urban environment, was removed. So, it’s not surprising to see the move to the suburbs as everyone wants to get to a safe distance.

With COVID infection rates on the rise, consumers are nervous about prospects for 2H 2020 and 2021. Consequently, we expect the move to the suburbs will be sustained until COVID can be contained. Still, the contrarian may be tempted to pick up a New York City pied-a-terre in the midst of all this as panicky owners make for fast sellers in the rush to head for the hills.

However, with COVID uncontained the question remains whether cities will enjoy the same range of activities going forward as they once did. Clearly, consumers are voting with their feet and their wallets and are prizing personal safety over urban convenience as COVID changes the calculus of our daily living.

Question 5

David, as we near the end of today’s episode, I’d like to get your perspective on a topic I know you are well versed in – China. It seems not a day goes by without a story related to U.S. /China Relations and the country first hit by the coronavirus pandemic will this week have a clearer picture of its progress on nursing the economy back to health.

China reports second-quarter gross domestic product later this week on Thursday, along with monthly readings for industrial output and retail sales. An easing of lockdown measures plus a modest amount of policy stimulus should be enough to post a positive growth rate, after the historic -6.8% collapse in the first quarter.

While we can learn a lot from their rebound from the pandemic, we also need to remember China is the world’s manufacturing hub and I think we need to figure out how to work with them. What are your thoughts?

Rick, investors would do well to remember that PRC Premier Xi Jinping rose to power in 2012 with the well-enunciated view that China no longer needed to conceal its global ambitions. This was supplemented by programs such as China 2025 when the country would no longer depend on foreign countries for the technologies needed to advance its economic and geopolitical ambitions.

Funny, how sometimes it’s only when moving further past a point in time that the handwriting then on the wall becomes more clearly read. Such is the case with China now as it moves to crush the “one country, two systems” arrangement put in place at the 1997 handover of Hong Kong. China is clearly intent on using its position to bend the world to its will.

So, how best to address such a present threat? To some extent, moves are already underway to reconfigure global supply chains so as to reduce dependence on China as a manufacturing base for critical product categories such as pharmaceutical inputs, medical equipment and supplies.

We know that Democratic Presidential candidate Joe Biden had a major economic policy statement late last week in which he called for selective re-shoring of manufacturing and critical supply chain elements. That said, whatever the outcome of the November 2020 election, there will be efforts made to move away from reliance on China as a manufacturing base.

Near term, while China’s 2Q 2020 GDP data may indicate a resumption of manufacturing activity, the suppressed character of consumer demand globally may see this resumption only support a build-up of inventories as the world is not taking what China is making. There is in all this unfortunately the rise of a new cold war, a development that will serve to undermine the globalism that has served to sustain economic growth since the end of World War II.

SCRIPT:

Hello and Welcome to a special episode of “A Brighter Future” Laidlaw & Co’s Podcast Series. I’m Rick Calhoun CEO of Laidlaw Wealth Management and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

David, I hope you had a fantastic 4th of July holiday and enjoyable vacation.

As I said, today’s episode is a special one as we will do a Mid-Year Checkup on our “Laidlaw 5” Predictions as well as look ahead to what we think the rest of 2020 could look like.

Question One:

David, before we get into “Laidlaw 5,” it’s hard to believe that we’ve reached the halfway mark in 2020. If you’d glanced at the stock market on January 1st and then not again until June 30th, you’d see it was down a modest -4%.

But, as we are all well aware, that doesn’t even begin to tell the story of the first six months of this year. The first half of 2020 contained an all-time high for stocks, a global pandemic, the deepest recession since the 1930s and the sharpest bear market drop on record, followed by a market rally that included the fifth-strongest quarterly gain in the postwar era. So, with all of that packed into the first half of the year, what do you do for an encore?

Rick, it would indeed be fortunate if after all that has transpired so far in 2020 we could just declare victory and go home, but clearly the fight against Covid-19 (“COVID”) is far from over in terms of containment, first, and development and commercialization of a vaccine, second.

As we can see, the COVID containment struggle is setting up to be protracted effort as moves to re-open local economies without implementing adequate testing, tracing, social distancing practices and healthsystem capacity have shown without fail a relapse to rising infection rates. So, patience and persistence are the watchwords as impatience only serves to unmask the danger COVID presents.

With that, the prospects for further stock market gains from here depend primarily on what further fiscal programs governments around the world can provide to support economic activity while the top priority of COVID containment is pursued. In this regard, note with interest J.P. Morgan Chase comments that global debt issuance in 2020 will rise $16 trillion to bring combined private and public sector issuance to a record of more than $200 trillion with the main implication being that this will be positive for equity markets as most of the additional liquidity is expected to find its way into stocks.

As a fine example of government-directed asset inflation, note that China’s CSI 300 Index has now added +14% in five days, the most since December 2014, following influential state media pushing for a “healthy” bull market, a move most likely followed by state-controlled funds helping to drive prices higher.

Bottom line, with near-term private sector earnings prospects uncertain as 80% of the S&P 500 index members have withdrawn guidance, government fiscal programs will continue to be the source of liquidity needed to power the equity market flywheel. With the November 2020 U.S. general election coming up fast, we expect another program on the order of the $3 trillion passed in March 2020, this should provide a level adequate to keep the S&P 500 index moving steadily higher towards our “Laidlaw 5” 2020 target of 3,420, up +9% from the Thursday July 2nd close.

In looking for the next move, good to check stock market performance since 2/19/20.

Clearly, Growth is massively outperforming Value across the various market cap categories as investors remain uncertain about the prospects for economic recovery with COVID outbreaks recurring around the world. With Growth being seen as offering clearer prospects, it has become the “go-to” choice for investors and in the process more than recovered its February 2020 level. For Value to outperform, COVID containment must be achieved so as to provide greater certainty the economic recovery will be uninterrupted.

Question Two:

David, as I mentioned at the outset, today’s episode will be a “Check Up” on our “Laidlaw 5” 2020 Outlook. So, let’s get into it and tackle one of the traditional “third rail” topics, Politics. At the time we rolled out the “Laidlaw 5” in December 2019 it was a very different world and we thought the U.S. Presidential contest could be between Donald Trump (GOP) and Michael Bloomberg (Democratic), but we also talked about the potential of a “brokered” convention. Six (6) months and a Black Swan, Pandemic later things look a little different. History shows us that elections tend to be short-term catalysts for volatility as opposed to a long-term determinant of market performance, but the polarized political environment seems likely to prompt episodes of market indigestion as we progress toward November. The market appears rather complacent on the election uncertainties for now, so what are your thoughts as people start to focus more on November?

Rick, Not wishing to strike only one note here, but it appears that the November 2020 election will follow the COVID tune. To this end, we see Trump’s approval rate is slipping fastest in the 500 counties in the U.S. where COVID deaths have exceeded 28 per 100,000 people, according to Pew Research polls. Older voters who typically trend conservative are abandoning him.

As COVID’s persistence is prompting firms such as Goldman Sachs to cut economic growth forecasts lower (i.e. 2020: -4.2% to -4.6%), the prospects for GOP re-election may likely hang on moves such as limiting “vote-by-mail” since they are unable to run on a record of strong, sustainable economic growth thanks to COVID.

On this point, while the June employment report was a pleasant surprise with a gain of +4.8 million jobs, the spread of COVID in the South and West has served to dampen the rise in foot traffic following local moves to reopen the economy. COVID outbreaks represent a well-defined speed bump for the U.S. economy on its road trip to recovery. With the $600 weekly unemployment supplement scheduled to end on July 25th, COVID outbreaks suppressing consumer activity comes at a very bad time for the +20% of the population that relies on consumer discretionary spending to employ them and pay their wages. There are still 31 million under- and unemployed Americans, so in an election year more fiscal stimulus is certain, but whether it will be sufficient to prevent massive GOP losses in November is unclear.

Meanwhile, despite the announcement over the July 4th weekend via Twitter of the dark-horse Presidential candidacy of Kanye West, the 2020 Presidential race is between the incumbent Donald Trump and former Democratic Vice President Joe Biden. While Biden has a history of making unfortunate gaffes while coping with a life-long stuttering issue, his legislative and policy experience along with his moderate position within the Democratic Party should serve to pave his way to The White House in the November election.

Kanye West notwithstanding, the surprise development we may see is an August 2020 announcement by Donald Trump that he will not accept the GOP nomination and withdraw from the 2020 Presidential race. Over the past two years the president’s re-election effort has raised more than $947 million, and has about $295 million cash on hand. Being President has been remunerative for Trump Inc. Assuming a deal can be struck to limit prosecution for Trump once he leaves office, a withdrawal decision is likely assuming that COVID containment efforts continue to fall short and poll results deteriorate concomitantly.

Question Three:

The next topic from the “Laidlaw 5” was the Macro-Economy. At the time, we felt the global macro-economy was likely subdued as major events such as the U.S.-China trade tariff confrontation and the distinct possibility of a hard “Brexit” by the U.K. from the E.U. remain unresolved. We also thought there was the possibility of an exogenous shock, with an increase in oil prices to the $75/barrel, of course the exogenous shock was a virus from China. With this as back-drop, what are your thoughts on the Macro-Economy?

Rick, starting from the baseline of the IMF forecast calling for a -4.9% contraction in the global economy, the real forecasting question is what are the prospects for 1) rebound in 2H2020 and 2) real recovery in 2021.

While some gauges of manufacturing and retail sales in major economies are showing improvement, hopes for a V-shaped rebound have been shattered as the reopening of businesses looks shaky at best and job losses risk turning from temporary to permanent. Note that true recovery means you are at least as well off as you were before the crisis started and from all available data it is apparent that we are a long way off that thanks to COVID.

As such, COVID holds the upper hand not just in the U.S., but worldwide. The IMF estimates that by the end of 2020 170 countries, almost 90% of the world, will have lower per capita income. This marks a complete reversal from January 2020, when the IMF predicted 160 countries would have bigger economies and positive per capita income growth.

Bottom line, the prospects for 2H2020 rebound depend on sustained fiscal and monetary support along with successful COVID containment. Together, achieving these two milestones along with a COVID vaccine being developed would lay the foundation for recovery in 2021.

Question 4:

The next topic was a call, and a great one, on both Interest Rates and Staying Invested as we said with rates continuing to drop the idea of “TINA” or There Is No Alternative to the equities would become even more important. With the Fed signaling a Zero Interest Rate policy until 2022, how should investors be positioned?

Rick, while our discussion to this point underscores how the equity market is the primary beneficiary of the liquidity provided by fiscal relief programs, investors need to address first the asset allocation decision as that is the greater driver of long-run investment returns. We think equities should represent 50-55% of overall portfolios with an emphasis on Growth over Value until there are clear indications that COVID containment efforts are sustainably working at which point Value could be over-weighted.

Relative to fixed income, U.S. 10-year Treasury yields have tumbled by more than 100 basis points this year to around 0.67%. The prospect of negative interest rates, however undesirable to Fed Chairman Jerome Powell, offers some chance of further interest rate declines. Globally, monetary relief efforts will continue as the COVID crisis is far from over. Morgan Stanley predicts $13 trillion in cumulative central bank balance-sheet expansion from the U.S., euro region, Japan and U.K. through the end of 2021. Bottom line, our view is fixed income should receive a 35-40% allocation with yield-oriented investors looking to have corporate or high-yield issues represent 55-60% of the fixed income allocation.

The balance of the portfolio allocation of 5-15% should go into a mix of inflation hedges such as gold, commodities and real estate. We note that the longer interest rates are at a zero bound and the prospects for liquidity-driven inflation grow, gold looks to appreciate from current levels. For commodities, producers in the energy and metals sectors have brought in production levels sufficiently to allow prices to remain stable and possibly rise as economic growth resumes. For real estate, while COVID driving a distributed workforce model does not favor higher occupancy rates, low interest rates do allow for a higher present value for the portfolio of long-term lease agreements that real estate represents.

Question 5:

Finally, we talked about the potential of profit margins depressing for Alphabet and Facebook but due to greater regulation not a boycott by advertisers. Despite the problems Facebook is facing right now though, Tech is “on fire” During the first half of 2020, the Nasdaq 100 rallied almost +17%, sprinting past the S&P 500 index, which fell -4%. The numbers look even better for a broader basket of tech companies. Barron’s this weekend ran a report showing tech stocks with market values of more than $5 billion—a group of 200 —and found an average first-half return of nearly +26%!! So you do investors just need to “close their eyes” and buy a Tech ETF?

Rick, when it comes to how the Tech sector has been revalued during COVID, we need to appreciate that developments that were expected to take 10 years to unfold have been accelerated in as many weeks. As such growth has been brought forward. A review of how more time has been re-allocated to Tech-based activities serves to drive this point home.

Before COVID, Americans spent almost an hour commuting and a similar amount of time shopping every day. With “work-from-home” (WFH) still prevalent across the U.S., that amounts to almost 2 hours up for reallocation. The winners of this time-grab have been everything from social media to hardware suppliers to exercise platforms. As long as WFH persists these sorts of names will continue to take market capitalization from companies “losing time”.

That said, buying an ETF comprised of the companies that are “time takers” and shorting an ETF comprised of companies of “time losers” would be a sensible investment strategy as the trends unleashed by COVID appear to be sustainable.

Bonus Question:

What is one thing you think we could see in the second half of 2020 that no one else is focusing on?

Rick, I’m tempted to go with Kanye West becoming President of the United States as the wild card on this one. However, there is one development possibly occurring in China that could be quite a surprise, namely an earthquake-induced collapse of the Three Gorges Dam on the Yangtze River.

A major piece of infrastructure that when constructed in 2006 was the largest dam in the world, the Three Gorges Dam created an immense deepwater reservoir allowing ocean-going freighters to navigate 2,250 km (1,400 miles) inland from Shanghai on the East China Sea to the inland city of Chongqing.

Following steady rainfall in the Yangtze River basin over the past month, there have been within the past week earthquake-induced landslides upriver from the dam’s location. Note that the Three Gorges Dam sits on two major fault lines, the Jiuwanxi and Zigui-Badong, and that massive changes in water pressure in the dam’s reservoir due to flooding could lead to earthquakes, a phenomenon known as reservoir-induced seismicity, which in turn would lead to landslides that would at the very least exacerbate the flooding in the area and potentially threaten the integrity of the main dam.

A failure of The Three Gorges Dam would be a catastrophic tragedy that would most likely drive China further into recession as its ability to support global supply chains from the Yangtze Basin interior manufacturing base would be severely compromised.

That said, Rick, we remain for now a bull, albeit in a china shop.

In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, recaps the markets and discusses the investment outlook with Laidlaw & Company Chief Market strategist, David Garrity. The topics discussed in this episode are macro level issues such as how stock market volatility signals need for further fiscal & monetary relief, Fed Chair Powell’s Humphrey-Hawkins testimony to Congress, prospects for the new bull market, how COVID crisis recovery may involve infrastructure spending and whether globalization has ended. 

Please tune in for more timely insights.

Episode Title: To Fuel The New Bull Market, Congress Should Turn Towards Low-Carbon Infrastructure Spending.

Hashtags & Stock Symbols: #StockMarket #Economy #ClimateChange #SP500 $IVW $IWD

SCRIPT:

Hello and welcome to another episode of “A Brighter Future”, Laidlaw & Co’s Podcast Series.  I’m Rick Calhoun CEO of Laidlaw Wealth Management and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co. 

David, great to be with you again after another eventful and volatile week in the markets.  So let’s get into it.  

 

Question One 

Last week, we saw stocks log their worst weekly declines since March as fears of a second wave of infections and doubts about a speedy economic recovery dampened investor sentiment.  The Federal Reserve indicated that rates are likely to remain near zero until 2022 and issued a cautious economic outlook.  The Fed’s cautious tone, in combination with news of an acceleration in new infections and hospitalizations in certain states as well as concerns about the speed of the rebound in stocks, triggered some profit-taking.  So, was it just that, David, profit-taking after a great run from the lows or should we be worried?    

Rick, Despite last Thursday’s violent -5.9% sell-off in underwhelmed reaction to Fed Chair Jay Powell’s press conference on Wednesday afternoon, the S&P 500 index at 3,041.31 closed the week and is still up +35.9% from the March 23rd low, although with a decided tilt towards Growth (ticker IVW $200.78, +39.9% vs. 3/23/20) over Value (ticker IVE $109.19, +31.6%) as the broader global macroeconomy remains plagued by the COVID-19 Coronavirus (“COVID”) pandemic.  This still leaves room for a further -5% correction from current levels to trade in the 2,800-3,000 range considered “fair value” for the S&P 500. 

Apart from profit-taking spurred by Powell’s tentative remarks, the news of renewed COVID outbreaks globally along with rising civic unrest, the fact that last week saw the return of the “-5% daily move” in the S&P 500 index prompts a quick review of the significance of this kind of volatility. 

Since it was formed in 1957 the S&P 500 index has had only 27 days when it has fallen by -5% or worse.  As the average daily change in the S&P 500 index is less than 1%, this indicates that a move of -5% or worse in a single day lies more than 5 standard deviations (“sigma”) from the average.  Based on the principles of probability, such a move should only occur once every few thousand years or so, not something that can or should be attributed to normal profit-taking.

Over the span of the S&P 500 index’s history, the greatest cluster of “-5% daily moves” was 12 days during the Financial Crisis & Great Recession of 2008-2009.  With the Thursday 6/11/20 decline marking the 5th day of such negative volatility during the current downturn, the COVID crisis is now ranked #2 in terms of equity market volatility. So, what does this all mean?

To our view, such volatility is a clear and unequivocal signal that government fiscal and monetary policy is lagging economic reality, something that is troubling as one might expect with a general election less than 6 months from now that politicians would rather put themselves ahead of the curve than to run so disastrously behind it. 

While there have been and still are hopes for a “V-shaped” recovery (e.g. see Morgan Stanley on the side of the “V-shaped” recovery, J.P. Morgan on the side of something more modest), the evidence is that until such time as consumers feel economically secure and physically safe the pace of recovery will be measured.  Consequently, time for Congress to stop dithering and get on the ball in passing the next fiscal COVID relief package.  As it is, with November fast approaching, their jobs are at stake.  

Question Two 

David, not a week has gone by since the beginning of this pandemic where we have not discussed the Fed in some way.  Last week, many felt that Thursday’s “sell off” was directly related to Federal Reserve Chairman Powell’s comments in his Post FOMC Press Conference. 

Powell essentially said: The economy is a disaster and we don’t see any signs of an imminent rebound, but the Fed will be here to do whatever it takes to support the economy until it gets better.  Which to me says the “Fed Put” is in play and reminds me of your past comments of the Fed (and the trend) is your friend.  What is more worrisome though,  is that the FOMC and Powell made virtually zero mention of a sustainable economic rebound.   

What are your thoughts from a Macro perspective on how we can achieve that sustainable economic rebound? 

Rick, When the COVID crisis is finally resolved, I fully expect there will be a re-make of the 1999 film “Being John Malkovich”, but this time it will be titled “Being Jay Powell” as clearly everyone is trying to get inside the mind of the Fed Chairman. Meanwhile, your guess on which actor will be cast for the leading role is as good as mine. 

That said, Jay Powell this week has the opportunity to clarify his macroeconomic thoughts not only once, but twice, as part of the semi-annual Humphrey-Hawkins testimony before Congress on Tuesday 6/16 and Wednesday 6/17 in which he will explicate the Federal Reserve’s Monetary Policy Report that was submitted last Friday. So, stay tuned on this front for Jay Powell to have the chance to be more definitive in his words regarding the macroeconomic outlook.

Meanwhile, with the Federal Reserve acting to back-stop the credit markets and so helping to tighten the spreads over Treasuries for investment grade (IG) and high-yield (HY) issues, last week did see something of a reversal as spreads widened out a bit. Nevertheless, corporate bond spreads were more resilient than stocks during Thursday’s risk asset selloff. Although so far in June the S&P 500 is lower, IG spreads remain lower by 17 basis points and HY by 14 basis points as of Thursday. 

What may be interesting in Jay Powell’s upcoming testimony, among other topics, is the possibility the question may be posed of whether the Fed has considered extending support to the equity market. Equities don’t have that backstop now and last Thursday was a 5-sigma down day. Bonds do have the Fed back-stop, so while spreads widened last week, fixed income price action was nowhere near as dramatic as what was seen in stocks. Just saying.

Meanwhile, for thoughts on ways in which to achieve a more sustainable economic rebound we offer some fiscal policy considerations later in the discussion in the context of considering not just recovering from COVID, but in putting in place the energy infrastructure needed to transition to a less carbon-intensive economy.

Question Three

David, let’s turn our attention back to the markets.  Last Thursday’s -1,800-point drop in the Dow brought back memories of the dramatic swings that were prevalent through February and March. Although the market declined -5% last week, it should not be lost that it is still +36% higher since late March and just -10% from its all-time high.  I did a little homework this weekend and history shows that the initial stages of new bull markets are typically characterized by strong gains.

 

Stock Market Performance

Bear market low	1 month	3 months	12 months
1974	19%	13%	38%
1982	19%	36%	58%
1987	14%	19%	23%
2002	14%	19%	34%
2009	27%	39%	68%
2020	25%	36%*	?
Source: Bloomberg, S&P 500 price return. *3/23/20-6/12/20. Past performance is not a guarantee of future results

According to Bloomberg, in the postwar era, every instance in which the stock market rose more than +30% from a bear market low turned out to be the beginning of a new bull market. So, in your opinion, could this be the beginning of a new Bull Market?

Rick, From the standpoint of textbook definition, any -20% retrenchment, or bear market, offers the chance to bring about a new bull market. With the S&P 500 index falling -33.9% from the high on 2/19/20 to the low on 3/23/20, the first condition of having a bear market has been met. Also, as you indicate, the +35.9% return from the low does show the second condition for the consideration of a new bull market has been met. 

However, given the tsunami of liquidity that has been unleashed as governments around the world have sought to mitigate the impact of the COVID pandemic, is it fair to say that this a bull market as its economic underpinnings are uncertain and the possibility that at some point the relief injected will likely be withdrawn?  Such circumstances could just as easily be termed an asset bubble wherein expectations have been floated while the economy remains on the rocks.  

Nevertheless, I am inclined to see that we are indeed in a new bull market, but one that will need to find its footing and as such is likely to be more of a grind higher from here than a continuation of the rocket ride from the March 2020 lows. 

In this context, it may be best for investors first to build core positions in solid Growth names prior to expanding into more economically exposed Value names until the desired firmer economic footing becomes clearer.

Growth vs. Value: Performance from 2/19/20 Peak
	2/19 – 3/23	3/23 – 6/12	2/19 – 6/12	Recover %
Index	Change %	Change %	Change %	Of Peak
S&P500	-33.9%	35.9%	-10.2%	89.8%
S&P500 Growth	-31.4%	38.9%	-4.7%	95.3%
S&P500 Value	-36.8%	31.6%	-16.9%	83.1%
Growth less Value	5.5%	7.3%	12.2%	12.2%
Russell 1000 (R1K)	-34.7%	37.4%	-10.3%	89.7%
R1K Growth	-31.5%	40.3%	-4.0%	96.0%
R1K Value	-38.4%	34.0%	-17.4%	82.6%
Growth less Value	6.8%	6.3%	13.4%	13.4%
Russell 2000 (R2K)	-40.8%	38.4%	-18.0%	82.0%
R2K Growth	-38.5%	41.9%	-12.8%	87.2%
R2K Value	-43.1%	34.1%	-23.7%	76.3%
Growth less Value	4.6%	7.8%	10.9%	10.9%

Question 4

David, there is a quote attributed to Aristotle – 

“It is the mark of an educated mind to be able to entertain a thought without accepting it.” 

I mention that because I recently read the headline, “Renewables surpass coal in U.S. energy generation for first time in 130 years.” 

The headline, while impressive, gave the impression that renewables had made a large, unexpected, leap forward versus coal and other fossil fuels.  Globally, our lives revolve around energy use, and lots of it.  Fossil fuels (such as coal, oil, and natural gas) generate most of that energy today.  Recent progress in renewables (like wind, solar, and hydropower) has been made, and I have no doubt that renewables are the future.  But do you see fossil fuel use on the verge of collapsing?  

Rick, While there was certainly a great deal of furor and speculation around the oil price crash and OPEC+ production cut pact earlier this year and the commodity’s subsequent price rebound, gasoline demand is beginning to recover in part due to people deciding to drive their own cars rather than run the risk of COVID infection by taking public transportation and, no, fossil fuel use is not collapsing.  Note that in 2019 global oil consumption was running at a rate of roughly 100mm barrels per day, not something that is about to disappear overnight. 

However, there is an opportunity in the COVID crisis to stimulate economic growth by public and private sector investment in climate-friendly infrastructure that will serve to create new jobs and position the global economy to address the longer run challenge of climate change. 

Note that neither COVID nor greenhouse gases care much for borders, something that makes both challenges global.  Furthermore, the two crises do not just resemble each other, they interact as shutting down the global economy has led to huge cuts in greenhouse-gas emissions.  However, on a global basis, there is still more than 90% of the necessary decarbonization left to do to get on track for the Paris Agreement goal of a +1.5 degree Celsius increase in temperature levels.

This leaves open a significant opportunity to not only stimulate economic growth, put in place pricing and tax frameworks to promote the use of less carbon-intensive energy sources and produce the revenues necessary to pay for the fiscal stimulus employed to offset COVID. In this way, policy can be both penny-wise in the short-term and avoid being pound-foolish by not taking advantage of currently lower opportunity costs to put the global economy’s energy infrastructure on better footing climate-wise for the long term.  

Question 5 

David, as we near the end of today’s episode I’m interested in your thoughts on the pandemics effect on Globalization.  

We are now seeing that the fallout from the coronavirus pandemic has capped growing disenchantment with globalization that we have observed over the past decade.  Fragile supply chains worldwide have been exposed by competition for essential medical and food supplies.  Unilateral export controls have been imposed to ensure availability of goods for the local market.  That has compounded the pandemic’s damaging economic effects, atop the human tragedy, adding to protectionist pressures to sustain U.S. living standards. 

Recent developments follow a long “hollowing out” of manufacturing and loss of high-paying blue-collar jobs, aggravating politically sensitive income inequality in the U.S. and abroad. Even The Economist sounded globalization’s death knell in a recent cover story referring to as Slowbalization!!  

David, could the pandemic’s economic and human toll bring an end to globalization?

Rick, While there was already consideration of the need to re-engineer supply chains away from following the strict rule of finding the lowest price available, something in part prompted by the U.S.-China trade war, the impact of COVID has been to accelerate the implementation of these nascent plans into action. 

Companies are learning from the COVID crisis to insure themselves against supply chain disruption through steps such as having at least two suppliers of every component or raw material.  Until now, logistics and supply chains may have been very fragmented and very vulnerable since the overriding goal of finding the cheapest global provider led companies to overlook the value of the provider who was just around the corner.

Yet it is not just supply chains that are being reconfigured, it is the entire social and political economy that has been underpinned by globalization.  As the world reopens from COVID, activity may recover, but we cannot expect unfettered movement and free trade to return.  As can be seen, COVID is politicizing travel and migration and entrenching a bias towards self-reliance.  To our view, this process of turning inward will undermine the economic recovery and thereby likely promote geopolitical instability.Consequently, it is critical for efforts to be made to reach an over-arching consensus to support an open global economy or face costs that may be greater than simply having to pay a higher price for imported products.  To find a way forward from COVID, I believe it better to have agreement around resilience than a divided self-reliance. As Ben Franklin once said, “We must, indeed, all hang together or, most assuredly, we shall all hang separately.”

In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, recaps the markets and discusses the investment outlook with Laidlaw & Company Chief Market strategist, David Garrity. The topics discussed in this episode are macro level issues such as how stock market volatility signals need for further fiscal & monetary relief, Fed Chair Powell’s Humphrey-Hawkins testimony to Congress, prospects for the new bull market, how COVID crisis recovery may involve infrastructure spending and whether globalization has ended. 

Please tune in for more timely insights.

Episode Title: To Fuel The New Bull Market, Congress Should Turn Towards Low-Carbon Infrastructure Spending.

Hashtags & Stock Symbols: #StockMarket #Economy #ClimateChange #SP500 $IVW $IWD

SCRIPT:

Hello and welcome to another episode of “A Brighter Future”, Laidlaw & Co’s Podcast Series.  I’m Rick Calhoun CEO of Laidlaw Wealth Management and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co. 

David, great to be with you again after another eventful and volatile week in the markets.  So let’s get into it.  

 

Question One 

Last week, we saw stocks log their worst weekly declines since March as fears of a second wave of infections and doubts about a speedy economic recovery dampened investor sentiment.  The Federal Reserve indicated that rates are likely to remain near zero until 2022 and issued a cautious economic outlook.  The Fed’s cautious tone, in combination with news of an acceleration in new infections and hospitalizations in certain states as well as concerns about the speed of the rebound in stocks, triggered some profit-taking.  So, was it just that, David, profit-taking after a great run from the lows or should we be worried?    

Rick, Despite last Thursday’s violent -5.9% sell-off in underwhelmed reaction to Fed Chair Jay Powell’s press conference on Wednesday afternoon, the S&P 500 index at 3,041.31 closed the week and is still up +35.9% from the March 23rd low, although with a decided tilt towards Growth (ticker IVW $200.78, +39.9% vs. 3/23/20) over Value (ticker IVE $109.19, +31.6%) as the broader global macroeconomy remains plagued by the COVID-19 Coronavirus (“COVID”) pandemic.  This still leaves room for a further -5% correction from current levels to trade in the 2,800-3,000 range considered “fair value” for the S&P 500. 

Apart from profit-taking spurred by Powell’s tentative remarks, the news of renewed COVID outbreaks globally along with rising civic unrest, the fact that last week saw the return of the “-5% daily move” in the S&P 500 index prompts a quick review of the significance of this kind of volatility. 

Since it was formed in 1957 the S&P 500 index has had only 27 days when it has fallen by -5% or worse.  As the average daily change in the S&P 500 index is less than 1%, this indicates that a move of -5% or worse in a single day lies more than 5 standard deviations (“sigma”) from the average.  Based on the principles of probability, such a move should only occur once every few thousand years or so, not something that can or should be attributed to normal profit-taking.

Over the span of the S&P 500 index’s history, the greatest cluster of “-5% daily moves” was 12 days during the Financial Crisis & Great Recession of 2008-2009.  With the Thursday 6/11/20 decline marking the 5th day of such negative volatility during the current downturn, the COVID crisis is now ranked #2 in terms of equity market volatility. So, what does this all mean?

To our view, such volatility is a clear and unequivocal signal that government fiscal and monetary policy is lagging economic reality, something that is troubling as one might expect with a general election less than 6 months from now that politicians would rather put themselves ahead of the curve than to run so disastrously behind it. 

While there have been and still are hopes for a “V-shaped” recovery (e.g. see Morgan Stanley on the side of the “V-shaped” recovery, J.P. Morgan on the side of something more modest), the evidence is that until such time as consumers feel economically secure and physically safe the pace of recovery will be measured.  Consequently, time for Congress to stop dithering and get on the ball in passing the next fiscal COVID relief package.  As it is, with November fast approaching, their jobs are at stake.  

Question Two 

David, not a week has gone by since the beginning of this pandemic where we have not discussed the Fed in some way.  Last week, many felt that Thursday’s “sell off” was directly related to Federal Reserve Chairman Powell’s comments in his Post FOMC Press Conference. 

Powell essentially said: The economy is a disaster and we don’t see any signs of an imminent rebound, but the Fed will be here to do whatever it takes to support the economy until it gets better.  Which to me says the “Fed Put” is in play and reminds me of your past comments of the Fed (and the trend) is your friend.  What is more worrisome though,  is that the FOMC and Powell made virtually zero mention of a sustainable economic rebound.   

What are your thoughts from a Macro perspective on how we can achieve that sustainable economic rebound? 

Rick, When the COVID crisis is finally resolved, I fully expect there will be a re-make of the 1999 film “Being John Malkovich”, but this time it will be titled “Being Jay Powell” as clearly everyone is trying to get inside the mind of the Fed Chairman. Meanwhile, your guess on which actor will be cast for the leading role is as good as mine. 

That said, Jay Powell this week has the opportunity to clarify his macroeconomic thoughts not only once, but twice, as part of the semi-annual Humphrey-Hawkins testimony before Congress on Tuesday 6/16 and Wednesday 6/17 in which he will explicate the Federal Reserve’s Monetary Policy Report that was submitted last Friday. So, stay tuned on this front for Jay Powell to have the chance to be more definitive in his words regarding the macroeconomic outlook.

Meanwhile, with the Federal Reserve acting to back-stop the credit markets and so helping to tighten the spreads over Treasuries for investment grade (IG) and high-yield (HY) issues, last week did see something of a reversal as spreads widened out a bit. Nevertheless, corporate bond spreads were more resilient than stocks during Thursday’s risk asset selloff. Although so far in June the S&P 500 is lower, IG spreads remain lower by 17 basis points and HY by 14 basis points as of Thursday. 

What may be interesting in Jay Powell’s upcoming testimony, among other topics, is the possibility the question may be posed of whether the Fed has considered extending support to the equity market. Equities don’t have that backstop now and last Thursday was a 5-sigma down day. Bonds do have the Fed back-stop, so while spreads widened last week, fixed income price action was nowhere near as dramatic as what was seen in stocks. Just saying.

Meanwhile, for thoughts on ways in which to achieve a more sustainable economic rebound we offer some fiscal policy considerations later in the discussion in the context of considering not just recovering from COVID, but in putting in place the energy infrastructure needed to transition to a less carbon-intensive economy.

Question Three

David, let’s turn our attention back to the markets.  Last Thursday’s -1,800-point drop in the Dow brought back memories of the dramatic swings that were prevalent through February and March. Although the market declined -5% last week, it should not be lost that it is still +36% higher since late March and just -10% from its all-time high.  I did a little homework this weekend and history shows that the initial stages of new bull markets are typically characterized by strong gains.

 

Stock Market Performance

Bear market low	1 month	3 months	12 months
1974	19%	13%	38%
1982	19%	36%	58%
1987	14%	19%	23%
2002	14%	19%	34%
2009	27%	39%	68%
2020	25%	36%*	?
Source: Bloomberg, S&P 500 price return. *3/23/20-6/12/20. Past performance is not a guarantee of future results

According to Bloomberg, in the postwar era, every instance in which the stock market rose more than +30% from a bear market low turned out to be the beginning of a new bull market. So, in your opinion, could this be the beginning of a new Bull Market?

Rick, From the standpoint of textbook definition, any -20% retrenchment, or bear market, offers the chance to bring about a new bull market. With the S&P 500 index falling -33.9% from the high on 2/19/20 to the low on 3/23/20, the first condition of having a bear market has been met. Also, as you indicate, the +35.9% return from the low does show the second condition for the consideration of a new bull market has been met. 

However, given the tsunami of liquidity that has been unleashed as governments around the world have sought to mitigate the impact of the COVID pandemic, is it fair to say that this a bull market as its economic underpinnings are uncertain and the possibility that at some point the relief injected will likely be withdrawn?  Such circumstances could just as easily be termed an asset bubble wherein expectations have been floated while the economy remains on the rocks.  

Nevertheless, I am inclined to see that we are indeed in a new bull market, but one that will need to find its footing and as such is likely to be more of a grind higher from here than a continuation of the rocket ride from the March 2020 lows. 

In this context, it may be best for investors first to build core positions in solid Growth names prior to expanding into more economically exposed Value names until the desired firmer economic footing becomes clearer.

Growth vs. Value: Performance from 2/19/20 Peak
	2/19 – 3/23	3/23 – 6/12	2/19 – 6/12	Recover %
Index	Change %	Change %	Change %	Of Peak
S&P500	-33.9%	35.9%	-10.2%	89.8%
S&P500 Growth	-31.4%	38.9%	-4.7%	95.3%
S&P500 Value	-36.8%	31.6%	-16.9%	83.1%
Growth less Value	5.5%	7.3%	12.2%	12.2%
Russell 1000 (R1K)	-34.7%	37.4%	-10.3%	89.7%
R1K Growth	-31.5%	40.3%	-4.0%	96.0%
R1K Value	-38.4%	34.0%	-17.4%	82.6%
Growth less Value	6.8%	6.3%	13.4%	13.4%
Russell 2000 (R2K)	-40.8%	38.4%	-18.0%	82.0%
R2K Growth	-38.5%	41.9%	-12.8%	87.2%
R2K Value	-43.1%	34.1%	-23.7%	76.3%
Growth less Value	4.6%	7.8%	10.9%	10.9%

Question 4

David, there is a quote attributed to Aristotle – 

“It is the mark of an educated mind to be able to entertain a thought without accepting it.” 

I mention that because I recently read the headline, “Renewables surpass coal in U.S. energy generation for first time in 130 years.” 

The headline, while impressive, gave the impression that renewables had made a large, unexpected, leap forward versus coal and other fossil fuels.  Globally, our lives revolve around energy use, and lots of it.  Fossil fuels (such as coal, oil, and natural gas) generate most of that energy today.  Recent progress in renewables (like wind, solar, and hydropower) has been made, and I have no doubt that renewables are the future.  But do you see fossil fuel use on the verge of collapsing?  

Rick, While there was certainly a great deal of furor and speculation around the oil price crash and OPEC+ production cut pact earlier this year and the commodity’s subsequent price rebound, gasoline demand is beginning to recover in part due to people deciding to drive their own cars rather than run the risk of COVID infection by taking public transportation and, no, fossil fuel use is not collapsing.  Note that in 2019 global oil consumption was running at a rate of roughly 100mm barrels per day, not something that is about to disappear overnight. 

However, there is an opportunity in the COVID crisis to stimulate economic growth by public and private sector investment in climate-friendly infrastructure that will serve to create new jobs and position the global economy to address the longer run challenge of climate change. 

Note that neither COVID nor greenhouse gases care much for borders, something that makes both challenges global.  Furthermore, the two crises do not just resemble each other, they interact as shutting down the global economy has led to huge cuts in greenhouse-gas emissions.  However, on a global basis, there is still more than 90% of the necessary decarbonization left to do to get on track for the Paris Agreement goal of a +1.5 degree Celsius increase in temperature levels.

This leaves open a significant opportunity to not only stimulate economic growth, put in place pricing and tax frameworks to promote the use of less carbon-intensive energy sources and produce the revenues necessary to pay for the fiscal stimulus employed to offset COVID. In this way, policy can be both penny-wise in the short-term and avoid being pound-foolish by not taking advantage of currently lower opportunity costs to put the global economy’s energy infrastructure on better footing climate-wise for the long term.  

Question 5 

David, as we near the end of today’s episode I’m interested in your thoughts on the pandemics effect on Globalization.  

We are now seeing that the fallout from the coronavirus pandemic has capped growing disenchantment with globalization that we have observed over the past decade.  Fragile supply chains worldwide have been exposed by competition for essential medical and food supplies.  Unilateral export controls have been imposed to ensure availability of goods for the local market.  That has compounded the pandemic’s damaging economic effects, atop the human tragedy, adding to protectionist pressures to sustain U.S. living standards. 

Recent developments follow a long “hollowing out” of manufacturing and loss of high-paying blue-collar jobs, aggravating politically sensitive income inequality in the U.S. and abroad. Even The Economist sounded globalization’s death knell in a recent cover story referring to as Slowbalization!!  

David, could the pandemic’s economic and human toll bring an end to globalization?

Rick, While there was already consideration of the need to re-engineer supply chains away from following the strict rule of finding the lowest price available, something in part prompted by the U.S.-China trade war, the impact of COVID has been to accelerate the implementation of these nascent plans into action. 

Companies are learning from the COVID crisis to insure themselves against supply chain disruption through steps such as having at least two suppliers of every component or raw material.  Until now, logistics and supply chains may have been very fragmented and very vulnerable since the overriding goal of finding the cheapest global provider led companies to overlook the value of the provider who was just around the corner.

Yet it is not just supply chains that are being reconfigured, it is the entire social and political economy that has been underpinned by globalization.  As the world reopens from COVID, activity may recover, but we cannot expect unfettered movement and free trade to return.  As can be seen, COVID is politicizing travel and migration and entrenching a bias towards self-reliance.  To our view, this process of turning inward will undermine the economic recovery and thereby likely promote geopolitical instability.Consequently, it is critical for efforts to be made to reach an over-arching consensus to support an open global economy or face costs that may be greater than simply having to pay a higher price for imported products.  To find a way forward from COVID, I believe it better to have agreement around resilience than a divided self-reliance. As Ben Franklin once said, “We must, indeed, all hang together or, most assuredly, we shall all hang separately.”

Hello and Welcome to another episode of “A Brighter Future” Laidlaw & Co’s Podcast Series. I’m Rick Calhoun CEO of Laidlaw Wealth Management and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

Good Morning David another beautiful weekend here on the East Coast so I have to ask, any special items on your bbq menu this weekend?

Rick, with beaches reopening, this weekend was a chance to get some sun, enjoy the frigid ocean waters and pick up some fresh shellfish – clams, mussels, oysters, so the grill got a break as the diet, like the economy, began to expand beyond its recent constraints.

As I sat down to put together today’s episode I was reminded of my Econ 101 Class in College where the Professor told us the stock market is a leading indicator and it will start to react to data before you get the data. Which I think in part, explains why the Dow climbed 1727.87 points, or +6.8% last week while the NASDAQ rose +3.4% to 9814.08 and the S&P 500 gained +4.9% to 3193.93.

David – those numbers would be an incredible week in any year but when you consider we have riots, disease, joblessness and widespread despair and the S&P 500 just closed the books on its best 50-day stretch ever it doesn’t make sense, but maybe it doesn’t have to anymore?

Is this retail investor FOMO taking over?

Rick, as a summer intern in Salomon Brothers equity research department during graduate school, I had the opportunity to make a presentation to Peter Lynch and several other portfolio managers at Fidelity Investments. Coming out of the conference room, the salesman who arranged the meeting thought it was well-received as orders had already been called into the trading desk and the shares of the companies discussed were moving higher. It was a thing of beauty, the salesman said, to watch “billions of dollars chasing an idea.”

While the stock market put up a compelling performance last week off the back of the massive upside surprise in the May employment report, we have noted previously that it is the flood of liquidity from central banks and fiscal relief programs that has been lifting all asset prices.

To your question of whether it is retail investors chasing the market higher, there have been strong indications that with the shutdown of other traditional speculative activities (e.g. casinos, sports betting), there has been a flood of individuals into the market as they have the time given their underemployment and the money given the relief funds they have received. Consequently, we can say the flood of liquidity has brought about a frothy market.

Talk about billions of dollars chasing an idea, namely the hopes for economic recovery. To see how this has played out across the stock markets segments such as Large Cap, Small Cap, Growth and Value, the table below shows that Value and Small Cap have been the laggards from the 2/19/20 market peak and have since mid-May 2020 been rallying hard.

Note that the Small Cap sector has benefitted from high yield spreads tightening.

David recently as I drove into the office in the early morning hours, there has been some heavy fog. Driving through fog is difficult. It’s hard to see the road and even harder to see the destination. As I drove through it though, I thought about the connection to our current situation, as we try to navigate a path from recession to recovery.

As the economy emerges from the lockdowns, investors continue to look for signs that the recovery is going in the right direction. In a week when civil protests were widespread in cities across the U.S. and geopolitical tensions between the U.S. and China continued to be elevated, the market kept its focus on economic and corporate drivers of long-term equity performance and that focus, as we discussed, was rewarded.

The S&P 500 is now just -6% from the February record high and has risen +43% from the March lows. Though the path between the strength of the equity rally and the current weakness in the underlying fundamentals is still foggy, I think three positive indicators are beginning to slowly clear the way and I’d like to get your thoughts on each:

First the Labor Market – Do you see “Green shoots” in the recovery from the reopening of the global economy?

Rick, the May 2020 Employment report offered indications that lower-skilled, lower-wage sectors have been seeing recovery. The table below offers a breakdown of the job gains seen in May with a contrast to the total number of jobs lost in March-April.

While some portion of the jobs gain reflects relief funds being spent to sustain employment, this does represent a major “green shoot” of recovery.

Next, Central Bank Stimulus – Can better credit conditions due to aggressive actions by central banks offset by high corporate debt?

Rick, the fact that the Fed has moved to backstop the corporate bond market has served to tighten yield spreads relative to Treasuries. With the Fed’s FOMC meeting this week, we expect to have further pronouncements underscoring the central bank’s credit market support extending into 2021.

Finally, Corporate Earnings – Will corporate earnings benefit from a sustained improvement in economic conditions, like the stronger-than-expected job gains posted for last month?

Rick, while the economic downturn from the COVID-19 Coronavirus (“COVID”) pandemic has been swift and severe, the interesting thing to note is that 2Q20 S&P 500 earnings at $23.67/share will actually out-earn its 2006-2007 peak operating earnings run rate (average quarterly earnings of $22 – $23/share over this time). Furthermore, Street estimates for Q3 ($32.01/share) and Q4 ($36.72) mirror 2017 and early 2018 S&P 500 earnings power. If those come to pass, they will serve to validate the recent rally.

David our Chief Investment Officer recently brought to my attention the impact the almost silent slide in the US dollar has had recently. In fact, some see it as one of the most ignored devaluations in history. Retail Investors might not have noticed but the slide by the U.S. dollar should get some of the credit for the stock market’s stunning rally.

Can you explain why that’s the case?

Rick, for the S&P 500 index roughly 40% of its earnings come from non-US sources. As such, a weaker U.S. Dollar will result in foreign currency earnings being translated back into more U.S. Dollar-denominated earnings per share. Last week’s aggressive fiscal and monetary actions in Europe served to raise the prospect of gradual improvement unfolding in the EU economy, something that helped weaken the U.S. Dollar as currencies tend to trade on GDP growth and interest rate differentials.

David – many of our listeners are already in or nearing retirement and considering their income options from their portfolios. A decade ago, investors were complaining about a 3.8% yield on the 10-year Treasury, because a decade before that, they were yielding 6.4%.

Recently though, 10-year Treasury was yielding 0.88% and as a result investors have gone further out on the risk curve, allocating larger portions of their portfolio to high-yield, emerging-market debt, and bank-loan funds.

That risk taking hurt badly in the coronavirus market rout between Feb. 19 and March 23 when we saw some Fixed Income ETF’s like HYG a High Yield Corp Bond fund plunge 22% and PFF a Preferred and Income Securities fund lose 27% !!

So David with rates so low, do income investors need to rethink Bonds?

Rick, while Treasuries meet the Will Rogers’ investment test of providing greater certainty as to the return of capital, you properly identify the present problem of being one of return on capital.

The need for better return rates on fixed income allocations has forced investors to look at either high-yield fixed income or possibly convertible preferred markets as a means of meeting their income generation targets.

Clearly, reaching for yield has required going out the risk spectrum. That said, with the Fed backstopping credit markets and corporate issuance being at record levels, investors have both some level of assurance and greater selection to consider.

David as we near the end of another Episode, I’d to again discuss what many consider the “real Hero” of the current markets – The Federal Reserve.

Since the beginning of Coronavirus Crisis, the Fed has taken a multitude of actions including:

• Two (2) separate emergency cuts in the federal funds rate’
• Massively increased repurchase agreement facilities
• Announced an unlimited quantitative easing (QE) bond purchase program
• Expanded dollar swap lines with other major central banks.
• Reintroduced the money market liquidity facility
• Reintroduced the term asset-backed securities loan facility
• Announced the primary market corporate credit facility
• Announced the secondary market corporate credit facility
• Announced the municipal liquidity facility
• Announced the paycheck protection program lending facility
• Announced the main street lending program

David, two of the recurring questions I hear from clients, are 1) is the Fed just creating money? And 2) What do these high debt levels and the Fed’s actions imply for investment performance?

Rick, one of the benefits of the Fed being the central bank for the leading global reserve currency is that it offers some flexibility and discretion to be used in times of global crisis such as COVID.

While there will eventually need to be a withdrawal of the surplus liquidity that has been provided to sustain the global economy and thereby prevent a catastrophic crash into a period of prolonged deflation, the Fed is doing what is absolutely necessary at the present time to forestall the clearly more undesirable possibilities. As such, the Fed and other central banks are clearly intent on inflating financial markets so that companies and governments can refinance, extend debt maturities, and take other measures necessary to strengthen balance sheets and otherwise avoid catastrophic failure.

That said, I fully expect the stock market to run up to, if not through, its previous highs before seeing a pullback. We are investing in interesting times and it is important to recognize the Fed is doing what it can to support a “risk on” investment environment. As such, investors should at least remain at a “Hold” at the present time.

Hello and welcome to another episode of “A Brighter Future” Laidlaw & Co’s podcast series. I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

Good Morning, David, I hope you had a nice weekend and we’re able to take advantage of the beautiful weather.

Rick, the hot weather rolled in late last week, so on Saturday I installed room A/C units. It was a bit of heavy lifting and a chance to break out the power tools. Meanwhile, like the market and geopolitics these days, things are running hot and we need to cool it down. 

David, I think it was a Beatles lyric that said “I have to admit it’s getting better (better) a little better all the time.” This week we saw stocks cap the month of May with back-to-back weekly rallies as optimism surrounding re-openings outweighed rising geopolitical tensions between the U.S. and China. 

 Additionally, continued positive developments on a possible COVID-19 vaccine and economic data showing signs of bottoming in April further bolstered sentiment. Meanwhile, WTI crude had its best monthly performance in 40 years.

Last week we talked about whether the market had moved “too far, too fast” but this week I want to ask should investors think “all clear” or stay clear?

Rick, the news last week on the monetary and fiscal policy front was uniformly positive with Fed Chair Powell stating on Friday that further relief will be provided until the economy is normalized. Even Senate Majority Leader Mitch McConnell chimed in to say Congress would decide whether to pass a “final” coronavirus relief package in about a month. That, along with the announcement of fiscal relief programs in the EU ($826 billion) and Japan ($1.09 trillion), served to give markets a clear view that the liquidity tide remains at flood stage. 

As a rising tide lifts all boats, it was not surprising that the market sectors that have lagged to date played some catch up with cyclical stocks and Value outperforming.

Overall, performance for the month of May was quite solid with regions announcing large relief programs showing strong performance in anticipation of the news. Growth holds the upper hand with a positive return year to date.

With the stock market resembling a liquidity-driven flywheel, the news flow has been positive to the extent that it has become divorced from the underlying economic realities where as long as the impacts of the COVID-19 Coronavirus (“COVID”) pandemic do not worsen in an unexpected manner the prospects for positive returns to investors remain intact.

Relative to valuation, the FactSet consensus 2020 S&P 500 earnings estimate is now $128/share, so the S&P 500 index at its March 2020 low of 2,237 traded at 17.5x trough earnings. With the S&P 500 index ending May 2020 at 3,044, the main questions to address are: 1) what are the 2021 earnings being discounted?, and 2) what can the S&P 500 earnings reasonably be in 2021? 

Note that the S&P 500 has a 35% weighting in Tech, so a 20x P/E multiple on 2021 earnings appears appropriate which implies EPS of $152/share. This would represent +19% growth from 2020 trough earnings while being -9% under the 2019 EPS of $163/share. Past recoveries off cyclical lows have seen earnings growth easily surpass +20% (e.g. 2001-2002 +20%; 2009-2010 +92%) which would result in 2021 S&P 500 of $154/share. Bottom line, the stock market is not anticipating anything that past history cannot support. 

That said, there are clear risks to the outlook ranging from further COVID outbreaks limiting economic recovery to China testing geopolitical limits with its suppression of Hong Kong and territorial incursions throughout Southern Asia to the outbreak of civil unrest in a populace grown weary of COVID and increasingly aware of the failings that have become apparent in government at multiple levels. Overall, there has been a critical loss of momentum in the global economy that has put the world at a threshold where the risk of things coming apart has to be taken into consideration.  

David, in each episode we talk about numerous factors that can influence the movement of the markets, but late on Friday we got a potentially major market mover with what appears to be an escalation of the “Cold War” with China. While the anti-Beijing and Wuhan animus seems to grow each day, I think the feared impact on our markets might not be realized. 

Meanwhile, on Sunday, the Federal Reserve Bank of New York released a study that showed the billions in tariffs have reduced the market value of U.S.-listed companies by $1.7 trillion during the course of the 2-year-old trade offensive. 

The study model found that policy announcements lowered U.S. equity prices in a 3,000-company sample group by a total of six percentage points. Those 3,000 companies represent a combined $28 trillion market capitalization, so the six-percentage-point fall wiped away $1.7 trillion. Which is the equivalent to the combined total of the national GDPs of Russia, Canada and South Korea.

David, we have not spoken about the tariffs on past episodes, so can I ask you to address the topic and what the direct and indirect impact could be on the markets?

Rick, as you are aware the impact of tariffs is borne not by the producers of the goods in question, but instead by the consumers of the tariffed items in the form of higher prices. 

In bringing a trade war against China, the Trump Administration chose to attack the globalization of the world economy that has relied on complex and extended supply chains that had to date served to deliver American consumers a greater range of goods at increasingly affordable prices. 

Companies were negatively affected by tariffs in that the trade war served to disrupt sourcing decisions that had been made to leverage the China market both in terms as a source of supply, but also as a source of demand. To this extent, companies both experienced higher costs and lower revenues as a result of the Trump tariffs. 

Not only that, but the attack on globalization served to create uncertainty as to long-term investment planning for companies as setting in place supply chains is a multi-year effort, one that in no small part relies on a stable and predictable trade policy regime. Important to also consider the distinct possibility that in time a de-globalized economy may very well lead to a more dangerous world as there are fewer ties that would serve to bind countries together and thereby restrain geopolitical adventurists.  

David, it appears as if the markets have become addicted to stimulus and, while having states reopen and the trillions of dollars paid out from Washington has been beneficial, the Federal Reserve has been the most crucial element lifting stocks. 

While the path of the virus is unknown. Could there be a second wave in the fall?  Can a vaccine succeed and how long will it take for an effective one to be found?  It seems as investors we need to be asking two important questions:

A) How long will the Fed provide the level of support that it has and… 

B) How long can the Fed continue to provide the level of support?

Rick, while investors may be justified in criticizing the Administration’s COVID response, the one part of the U.S. government that has been a stand-out performer in the current crisis has been The Federal Reserve under the leadership of Chairman Jay Powell. 

In remarks last Friday, which were his last prior to the next FOMC meeting on 6/9-10, Powell expressed his concerns as to the potential for a second COVID outbreak to limit the prospects for economic recovery and reiterated his promise to keep monetary policy loose until the recovery is well on its way and the U.S. unemployment rate – widely expected to surpass 20% in 2Q20 – has returned to healthy levels. With this the Fed’s intent is clear, now to determine its capacity. 

The Fed has ballooned its balance sheet, which it had been trimming before COVID, to a record-setting level of over $7 trillion. The Fed may need to do more before the crisis is over, to keep borrowing rates low even as the economic recovery takes hold. Powell has indicated the Fed has limits in that “the balance sheet can’t go to infinity, but there are limited risks based on what the Fed is doing right now to inflation or to financial stability.”

Bottom line, Rick, on Wall Street the trend is your friend and for now The Fed is clearly setting that trend. 

David, let’s head overseas, where on Wednesday last week the European Commission, which runs the entire EU, agreed to borrow €750 billion to provide a combination of grants and loans to southern EU countries (Greece, Italy, Spain) that have seen their budgets destroyed by the pandemic. 

Based on the research I have read, the EU, has always resisted issuing common debt—i.e. debt that all the EU countries have to pay back. Instead, individual countries issue their own debt (German bunds, Italian BTPs, etc.) with varying interest rates.  

David, if the EU embraces a common bond, over time could it pull demand for U.S. Treasuries and help the euro challenge the dollar’s status as the world’s reserve currency? 

Rick, while the EU at 741 million people has a larger population than the US at 327 million people, the US GDP at $20.5 trillion is still larger than the EU GDP at $15.9 trillion.

Moreover, within the EU there is only now emerging a consensus to allow for joint financial obligations which are not necessarily matched by unified taxation authority to ensure the servicing of such debt. 

Away from fiscal and governance structures, the global economy is fairly substantially U.S. Dollar denominated in terms of how a range of goods and services are priced and traded. 

This EU bond offering is an interesting and promising first step, but it will have to be stress-tested before it could be scaled to a point where the Euro could be considered an effective reserve currency alternative to the U.S. Dollar.

In his book “The Tipping Point”, Malcolm Gladwell points out that tipping points can be hard to spot in advance, but when they happen things can move fast. David, it looks as though the market is at or approaching a tipping point.

Market sentiment is starting to feel a little stretched. The percentage of bearish respondents in the American Association of Individual Investors survey fell to a 12-week low and Wall Street’s measures of sentiment reveal almost no bearishness at all. 

Citigroup’s Panic/Euphoria index, for instance, entered euphoria territory on Tuesday, while Société Générale’s sentiment indicator experienced its quickest shift from extreme risk-off to extreme risk-on in its history.

At the same time, others like noted market historian John Authers, see many “green shoots.”  

David, as a Market Strategist where do you see the next move from here? 

Rick, as we discussed earlier, at current levels the stock market is discounting 2021 earnings growth that is in line with previous economic recovery cycles. Meanwhile, the Fed is clearly indicating that further monetary relief will be made available to counteract the economic fallout that might attend further COVID outbreaks. The market as a liquidity-driven flywheel is set to show further gains and as such investors should anticipate appreciation. 

We note with interest that Goldman Sachs has withdrawn the 2,400 price target it had set for the S&P 500 index as it has broken through the technically significant 3,000 level. Looking back to when the Laidlaw Five 2020 Outlook was published in December 2019, we set a 3,420 price target for the S&P 500 index. Off the 2021 estimate of $154/share, the implied P/E valuation of 22.2x is high but in our view supported by what will be an accomodative monetary policy. That said, there is a potential +12.3% gain ahead to realize the Laidlaw Five 2020 Target. 

Hello and Welcome to another episode of “A Brighter Future” Laidlaw & Co’s Podcast Series. I’m Rick Calhoun CEO of Laidlaw Wealth Management and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

Good Morning David – another beautiful spring weekend. What was on the bar b que menu?

It was indeed a beautiful May weekend and the menu offered up a mixed grill of sausages, steak and swordfish along with asparagus, Brussel sprouts, corn on the cob, roasted garlic and potatoes across three dinners – good eating.

David – we had a tough week in the markets and the economy. On the markets front, we saw the Dow lose -2.7% for the week, the S&P 500 fell -2.3% and the Nasdaq declined -1.2%. In fact, it was the worst weekly performance the S&P 500 has had in the past nine weeks!

On the economic front, compliments of COVID-19, nearly 3 million additional people filed for first time jobless claims, while retail sales suffered the largest plunge on record, and industrial production cratered. As if that wasn’t enough, Federal Reserve Chairman Powell threw the stimulus ball back into Congress’s court and they “dropped the pass” while tensions are rising again between the U.S. and China.

Can you help our listeners sort some of this out?

Like the weekend menu, Rick, last week was mixed indeed.

To our view, on the negative side the stand-out item was the warning and admonition from Federal Reserve Chairman Powell last Wednesday that Congress best provide more fiscal relief being met with a shrug by Senate Majority Leader McConnell and a statement that criticized Powell for not saying when the aid was needed. Unfortunate words indicating a tone-deaf disengagement from the plight of American voters. You know with Powell indicating that the U.S. economy is poised to contract by more than -30% on an annualized basis in 2Q20, McConnell should have the sense to stop playing politics at a time like this. Talk about fiddling while Rome burns.

On the positive side, there have been indications that economies overseas have begun the slow pace of re-opening after putting in place measures necessary to contain the COVID-19 coronavirus (“COVID”), something that is also starting to happen in the U.S.. We are in a grindingly slow process, but one that is an upward progression economically from which investors should take heart.

Meanwhile, looking specifically at how companies are faring, we note with interest the lead article in today’s WSJ headlining that as companies have suspended financial guidance it has left investors at a crossroads.

With 90% of the companies in the S&P 500 having reported 1Q20 results, we are now getting a clearer read on how 2Q20 results are likely to unfold as analysts have had a better chance to digest company data. Here are the 2020 quarterly breakdowns with a comparison to where numbers stood two weeks ago when 55% of 1Q20 S&P 500 results were in:

1Q20: -13.8% (-13.7%) on +0.7% (+0.7%) sales
2Q20: -41.9% (-36.7%) on -11.3% (-9.5%) sales
3Q20: -23.8% (-21.0%) on -5.5% (-4.3%) sales
4Q20: -11.6% (-9.4%) on -1.2% (-0.5%) sales

Putting this on an annualized basis for 2020, the S&P 500 EPS is tracking at $129/share. Note that this is greater than the trailing 10-year average S&P 500 EPS of $122/share. As such, it would appear that the massive monetary & fiscal response to COVID has succeeded in keeping the earnings power of the companies in the index intact as it has backstopped aggregate corporate profit margins & liquidity and access to capital and solvency.

From a market valuation perspective this has clearly been significant. At the 3/23/20 low of 2237 the S&P 500 was trading at 17.3x its trailing 10-year EPS. Back at the March 2009 low, the S&P 500 was trading at 10x, now that was a point where investors had given up on America.

Now, as the market is clearly heavily dependent on monetary & fiscal relief, it is not surprising that the S&P is trading off -3.1% since 4/29/20 as the economic data from the March-April 2020 timeframe have come in decidedly negative from COVID lockdown thereby highlighting the need for further relief funding. Within the market we can see that the weakness is concentrated in Value as that market segment is down -6.6% while Growth is basically flat, only being off -0.1%. The longer the U.S. Senate dithers over the next fiscal relief package, the more likely the pull-back in Value is poised to accelerate.

So, here we are at the crossroads as the market debates the view on the S&P 500 EPS outlook for 2021. If we consider 2010 when U.S. unemployment stood at 9%, a range of $80-90/share is possible for next year and the market would be now valued at 33.7x earnings, a rich valuation by most standards. If the upside case is like 2014 when U.S. unemployment stood at 6%, a range of $130-140/share is likely and the market valuation at 21.2x earnings, above the 15.8x trailing 10-year average P/E multiple, but acceptable if viewed in the context of a post-COVID global economic recovery.

Time to put in a call to Senator McConnell’s office and let him know it’s time to get on board with moving more fiscal relief forward.

David, when the economy slips into a recession and the stock market tanks, investors are naturally inclined to sell bank stocks. After all, during the last recession and bear market in 2008, bank stocks were the biggest losers, with some bank stocks ultimately going to zero.

So it should be no surprise that bank stocks have been taking a beating with many down 25% or more YTD. But, all recessions and bear markets are not the same, and this isn’t 2008.

Everything I have read says Banks are in much better financial position than they were in 2008. So, is this an opportunity for our listeners to get some great companies
“On Sale?”

With recent 1Q20 results for the banking sector showing prudent steps to bolster loan-loss reserves and the fact that major financial institutions have been subject to annual stress tests since the 2009 Great Financial Crisis, Rick, I would agree that this is an area for investors to go bargain-hunting. Note that while Warren Buffett’s Berkshire Hathaway pared its stakes in GoldmanSachs and JPMorgan, it did increase its holding in PNC Financial. It will be interesting to see how PNC decides to redeploy the capital raised from the recent paring down of its stake in BlackRock.

Still, investors need to be aware of where major risks may lurk in the bank stocks. Back in 2009, the risk lay in collateralized debt obligations (CDOs). Since 2009, we have seen the rise of collateralized loan obligations (CLOs), a market that totaled $1.4 trillion in 2019.

In September 2019, The Bank for International Settlements (BIS) published a paper discussing CLOs and the potential risk they pose that noted, “the deteriorating credit quality of CLOs’ underlying assets; the opacity of indirect exposures; the high concentration of banks’ direct holdings; and the uncertain resilience of senior tranches, which depend crucially on the correlation of losses among underlying loans” are all risks that investors can expect to be tested by during the current downturn.

With that caveat made clear, it can nevertheless be tempting for investors to consider bank stocks, especially when names such as Wells Fargo are sporting +8% current dividend yields.

David, let’s pivot and talk about a topic that as part of our Laidlaw Five we believed would impact the 2020 Markets and that’s the Presidential Election. However, I want to look at it through a different lens – Advertising.

As campaigning for the 2020 presidential election heads into its final months, you and I recently discussed that political ad spending will hit an all-time high. The highly partisan political environment is driving more Americans to donate money to their preferred candidates than in past election seasons, which in turn is funneling more money into advertising. In fact, total political ad spending in the 2019/2020 election cycle is expected to reach $6.89 billion, and I know you believe that creates some opportunities for investment.

Please share your insights.

As we know, Rick, 2020 is an election year and elections have over time only become more expensive. For example, back in June 2019, Group M, a prominent ad agency, estimated spending for political ads in 2020 will reach $10 billion, an increase of +59% from the 2016 election year when an estimated $6.3 billion was spent.

With the onset of COVID, the level of digital engagement by the U.S. population has increased substantially, something seen in the 1Q20 results for Alphabet, Facebook, Snap and others providers.

The net result is the distinct possibility that digital is set to gain a substantial reallocation of the 2020 election ad budget, something that will serve to boost 2H20 results for these companies as well as Verizon (parent of Yahoo! and AOL), Comcast and AT&T.

Among the constituencies likely to prove critical to the 2020 election outcome, Millennials will be an area of focus. In this regard, Snap is of particular interest as evidenced by the following:

“Snapchat is a hot battleground in the 2020 election. Meme-like videos have helped Trump nearly triple his following to more than 1.5 million in about 8 months, far exceeding Joe Biden’s audience. But Biden is wising up as he is giving interviews on Snapchat’s political news show, Good Luck America. Millennial and Gen-Z voters make up 35% of the U.S. electorate, and Snap says the app reaches 75% of them a day.”

Bottom line: Investors should consider holding a basket of stocks leveraged to the rise in 2020 election cycle spending which should support, if not improve, their relative performance over the next 6 months.

David, I want to ask you a more Macro, “Big Picture” question around the potential for Prolonged Recession, something raised this week in a speech given by Fed Chairman Powell.

Obviously, that would not be good for stocks as a prolonged recession would depress earnings and the market multiple, bringing back memories of recent “prolonged recessions,” like 2009-2010 and 2001-2002, where stocks traded horribly. But I want to believe the Fed is going to make a big difference, especially when you consider in the last two months the Fed balance sheet has increased from $4.1 trillion to $6.7 trillion. That’s $2.6 trillion in two months!

David, can the Fed be our savior or could we be in for another 2009-2010?

Rick, as discussed in our opening response, the Fed has the wherewithal to have a considerable impact in denting the economic blow from COVID, but in our view monetary relief alone will prove to be insufficient. The Fed cannot do it alone. Congress needs to act. Otherwise, we could be looking at 2021 S&P 500 EPS of $80-90/share, down -34% from the 2020 run-rate of $129/share. Markets can look through earnings declines when the path forward to recovery is clear, but right now there are still too many unknown unknowns such as the probability associated with COVID Wave 2 and perhaps even COVID Wave 3.

As mentioned earlier, Fed Chair Powell sees the U.S. economy shrinking at a -30% annual rate in 2Q20. This is based on a number of near-term economic forecasting models developed by regional Federal Reserve branches. For example, the NY Fed’s “NOWCAST” model as of Friday 5/15/20 calls for a -31.1% rate of decline as negative surprises from retail sales and industrial production data mostly offset positive surprises from a regional survey and international trade data. The Atlanta Fed’s “GDPNow” model sees a -42.8% rate of decline with 2Q20 real personal consumption expenditures growth and real gross private domestic investment growth decreased to -43.6% and -69.4%, respectively.

Rick, these are clearly not numbers to write home about or to tell anxious voters. Hello, Senator McConnell, it’s America calling. Time to put down your fiddle.

David, as we near the end of another great episode, I thought maybe we could talk about a topic that might benefit our listeners as they watch the markets on a daily and weekly basis and that’s Technical Analysis.

As a backdrop, Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. So, you’ll hear people reference things like 50 Day Moving Average, Trading Ranges, Support, Resistance and even crazy terms like “The Death Cross”

I know I was taught that any good portfolio manager uses both fundamental analysis and technical analysis, and this past week there was a lot of talk about the Trading Range for the S&P 500 as well as the resistance it might hit at 2950.

So, David, do you follow Technical Analysis and are there any “Tricks of the Trade” that could benefit our listeners?

Rick, as we highlight that the market is at a crossroads as investors consider the prospects for the balance of 2020 and the outlook for 2021, it is helpful to consider insights from a range of disciplines. This is especially true when we are faced with the fact that from 3/23/20 low, the S&P 500’s top 5 stocks (i.e. Alphabet, Amazon, Apple, Facebook and Microsoft) have comprised more than 25% of the +28% gain since then. In the past, such concentrated rallies have not lasted. A study of instances where the S&P 500 set a 52-week low and then rallied over the next 35 days showed that in the 8 times when the top 5 stocks provide over 20% of the gain, each time the rally fails.

While technical analysis tends to focus on relatively short-term price trends over 5-day, 10-day and 50-day trading day windows and considers the 200-day average to be a key level of support or resistance, I have looked at longer term averages such as the 400-day as providing the baseline of support for a market upturn or downturn.

Right now, the 400-day level for the S&P 500 stands at 2893, a level just +1% above the Friday 5/15/20 close of 2864. While the 200-day average at 2998 may represent overhead resistance for the market until economic fundamentals become more clear, we are encouraged that the recovery from the 3/23/20 low has brought the S&P 500 index back to a level we consider the bedrock for the market’s recovery from the March 2009 lows. Not in any way a guarantee of smooth sailing, but a sign that the technical damage done by the sell-off from the 2/19/20 peak has been to some extent limited.

That said, for now, call your Senators and go with Growth.

Hello and Welcome to another episode of “A Brighter Future” Laidlaw & Co’s Podcast Series. I’m Rick Calhoun CEO of Laidlaw Wealth Management and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

Good Morning David – I trust you had a nice weekend although you needed your bar b que more for warmth than cooking. Snow in May, very odd.

Rick, not exactly the time of year for a polar vortex, but then we live in interesting times. Nevertheless, the outdoor grill was manned and ready for the Mother’s Day cookout, thank you for asking.

Odd is also a good way to characterize the markets this past week. We had bad economic data and mediocre earnings —and the stock market just kept going higher. The Dow Jones Industrial Average rose 608 points, or +2.6%, to close at 24,331. The S&P 500 index rose +3.5%, to 2,930. The Nasdaq Composite beat both its peers, rising +6% to close at 9,121, cracking the 9,000 barrier again. The Nasdaq, amazingly, is up on the year, having tacked on almost 2,500 points, or +38%, from the March lows. Not bad, considering the damage that Covid-19 has wrought on the economy. David, what’s your take on what’s going on?

Rick, there is a saying on Wall Street that you go with what is working. This is the primary insight behind the “momentum” style of investing which draws on the first law of Newtonian physics, namely that an object remains in motion unless acted upon by a force. As we know, the COVID-19 Coronavirus (COVID) pandemic has been met with a record level of fiscal & monetary stimulus which while it has not prevented a record level of unemployment as indicated by the April 2020 Employment Report released on Friday 5/8 it has nevertheless served to provide the liquidity necessary to propel stock prices as measured by the S&P 500 index to a +31% recovery from the 3/23/20 low.

Within the stock market, growth stocks have led the recovery with a +33% gain while value stocks have posted a more modest +27% rise. This is not a function of growth performing worse than value in the S&P 500’s -34% sell-off from the 2/19/20 peak in which growth declined -31% as value plummeted -37%. With the S&P500 now off -13% its peak, investors should note that growth is down only -9% while value is still -20% down. Put it this way, if investors were long growth and short value from the peak to now, they would be +11% ahead. So, clearly growth is working in both down and up markets as shown in the table below.

The reasons supporting growth’s outperformance are relatively clear in that the shift to the COVID work-from-home (WFH) economy has made our society increasingly dependent on the technology companies who comprise a significant proportion of the growth stock index. The tech sector’s recent 1Q20 results have demonstrated continued revenue and profit growth in the face of a shrinking economy. With the likelihood that the WFH economy will persist as the return to the office will be gradual and likely not to return to pre-COVID levels, we have witnessed what perhaps should be considered an enduring repricing of the tech sector.

Bottom line, the pace of recovery is clearly uncertain and I expect that for the stock market to continue its recovery from the 3/23/20 low that further fiscal and monetary relief will be necessary. To that end, it will be critical to investors to see how Congress performs in this regard since with the upcoming general election in November 2020 the window of opportunity may be limited as campaigns get underway over the summer. Hopefully the politicians will understand that an employed constituent is a likely supporter and take the necessary actions. Meanwhile, although it has not re-covened, the U.S. House of Representatives is expected to hold votes as early as this week on a massive economic aid package for state and local governments.

David, let’s unpack the markets a little bit and talk about an area where I know you focus a lot of research – Technology. You were recently on Bloomberg Radio talking about names like GOOGL, AAPL, AMZN etc. and a few moments ago we referenced the move the NASDAQ has made off the March 23rd low but something that has become a bit distressing is the concentration of capital in what are being called “The Big 5” – GOOGL, MSFT, AAPL, AMZN & FB.

While the Nasdaq is now positive for the year, roughly 75% of the stocks in the index are down. But the Nasdaq, like the S&P 500, is weighted by market capitalization, and larger companies count for more. As of Friday’s close, the top 10 stocks, which include tech names like AAPL, AMZN, and MSFT, account for about 44% of all the value in the 2,700-stock index and those stocks aren’t cheap. On average, they trade for about 47x estimated 2020 earnings.

While the outsize weighting of major tech names fueled the Nasdaq’s bounce-back, should investors be worried?

As we have discussed previously, the present is an economic environment where the strong can rapidly become much bigger while the weak will be killed and eaten. Companies such as the “Big 5” have not only the resources needed to survive, but to thrive during COVID. Put more formally, Rick, last week noted value investor Clifford Asness published a piece defending value investing titled “Is (Systematic) Value Investing Dead.” In his analysis, “investors are simply paying way more than usual for the stocks they love versus the ones they hate (and measured using our most realistic implementation this is the clear maximum they’ve ever paid) and doing it in a highly diversified way up and down the cross section of stocks.”

The piece covers 50 years of stock market history going back to 1965 in its analysis, an impressive span of time that lends Asness’ conclusion substantial weight. However, it is interesting to note that in 1965 Gordon Moore published a paper with an insight that became known as “Moore’s Law,” which accurately predicted that computing speed/dollar would double every 2 years or so.

It is good for investors to consider that this growth in computational productivity has supported the difference we are seeing in today’s market as there is a clearly evident divide between those companies that leverage Moore’s Law and the companies that are being disrupted by it.

The period since 1965 has seen change unfold at an accelerating pace and perhaps the post-COVID WFH economy should be considered a tipping point. All I can tell you is that value investors need to be aware of how the underpinnings of our economy are shifting in making appraisals of value and allocations of capital. Otherwise, they risk coming up a dime or more short. Bottom line, if investors want more, they better get Moore.

David, let’s move to something that many veteran market watchers paid close attention to, but I don’t think the average investor did and that was when late last week, federal-funds futures began to indicate that the Federal Reserve’s key policy interest rate would fall below 0% by late this year.

While negative interest rates have been imposed by other central banks, notably the European Central Bank and the Bank of Japan, Fed officials have indicated on several occasions that they don’t favor a similar policy. While it’s still possible that we could see negative yields on U.S. Treasuries, the yield on the 2 year turning negative isn’t the same thing as the Fed “going negative”

So let me ask this as a two part question David:

First, I have read that “negative rates” is a term that’s used to describe a phenomenon that can have different meanings, can you elaborate on that for our listeners?

Rick, negative rates generally mean that a bank will charge you a storage fee for holding your cash rather than offer interest as an incentive for saving. As such with negative interest rates holding cash balances for investment purposes is discouraged and instead cash should be used for consumption because otherwise the holder of cash in penalized. With negative rates the greatest value of cash is the present. To hold it for future periods is to receive lesser value. That is the best definition of negative rates that I have.

Second, could we see negative rates in the U.S. like we’ve seen in Europe and Japan and if so, does that sentence the U.S. economy to future slow growth like we’ve seen in Japan and the EU?

Rick, the use of negative rates as a monetary policy tool has been when deflation is a significant concern. In recessions, people and businesses tend to hold on to their cash while they wait for the economy to improve. But this behavior can weaken the economy further, as a lack of spending causes further job losses, lowers profits, and prices to drop—all of which reinforces people’s fears, giving them even more incentive to hoard. As spending slows even more, prices drop again, creating another incentive for people to wait as prices fall further.

With the U.S. unemployment rate now at 14.7% and official views that the unemployment rate may rise to 20-25% before a gradual recovery unfolds paced by COVID containment measures, the U.S. economy is clearly at risk of experiencing deflation as incomes and consumer spending contract sharply. The April Employment Report presented a statistical oddity as average hourly earnings rose. This was due to how the job losses were so overwhelmingly concentrated among lower income, service industry workers.

One important point to note here is that lower income households have a higher propensity to consume, if for no other reason than they have less savings to fall back on. As mentioned earlier, Congress needs to act to provide further fiscal relief to support incomes otherwise the U.S. economy will face a significant risk of deflation among other possible negative consequences from the COVID depression. Deflation follows in the footsteps of the demand destruction pandemics such as COVID cause.

At present the Bloomberg Global GDP Tracker is indicating a -4.8% contraction in 2020. On a global basis it is estimated that a -20% contraction of income and consumption could push 524mm people into poverty (i.e. surviving on less than US$5.50/day (roughly $2k/year)). Even assuming a -10% contraction would result in an additional 249mm people living in poverty. With the COVID depression it is important for investors to consider the possibility that poverty will become more widespread in the U.S.

I want to make a 180 degree turn here David and talk about something that has been sort of forgotten and that’s Bitcoin. It was announced last week that billionaire investor Paul Tudor Jones one of the first well-known hedge fund managers, having started Tudor Investment Corporation in 1980 at the age of 25, believes that Bitcoin, the controversial digital currency, reminds him of gold in the 1970s, and may be the best hedge against inflation in the age of coronavirus.

Paul Tudor Jones is definitely someone we should pay attention to, he made a name for himself and a lot of money for investors by correctly calling the 1987 crash. He also shorted Japanese equities a couple of years later just before that market collapsed and then most recently he made a call on gold in June of 2019 that has played out almost exactly as predicted. So, as someone who knows a great deal about Bitcoin, is he right?

Rick, while we earlier discussed the risk of deflation from demand destruction in the wake of the COVID pandemic, we have to consider that assuming the tsunami of fiscal and monetary relief works in serving to stabilize the global economy and putting it on a path towards recovery there will be a distinct possibility inflation returns.

To that end, Paul Tudor Jones co-authored a paper published last week titled “The Great Monetary Inflation” in which he notes, “in a world that craves new safe assets, there may be a growing role for Bitcoin.” Jones offers this insight in the knowledge that monetary aggregates such as M2 are growing at the fastest rate since the end of WWII when annual M2 growth peaked at almost +27%. As the Federal Reserve is primarily focused on the employment support element of its mandate, Jones notes that “any (interest rate) hiking cycle is likely to be delayed and unambitious.” Separately, Jones sees in the COVID pandemic inflationary developments as “a breakdown in global supply chains spills overs to goods prices, undoing two decades of disinflation attributable to globalization.”

Against this analytical backdrop Jones offers a roster of likely inflation hedges in which Bitcoin ranks #4 after #1 Gold, #2 The Yield Curve (long 2-year bonds, short 30-year bonds) and #3 The NASDAQ 100. No wild-eyed cryptocurrency libertarian, Jones is just a seasoned successful investor “who wants to capture the opportunity set while protecting my capital in ever-changing environments.”

For Jones, Bitcoin represents “the only large tradeable asset in the world that has a known fixed maximum supply.” In a world where currencies are being devalued through massive monetary stimulus, assets that have a relatively fixed supply such as Bitcoin and gold are effective hedges against the anticipated inflation to follow.

David, as we wrap another episode this week, I thought maybe we could look ahead a little bit. Last week Professor Jeremy Siegel from the U of PA said “we’ve seen the lows in March and we will never see those lows again” expressing optimism about the path forward for the U.S. stock market, despite a historically bad jobs report. However, it’s his final statement that I’d like to focus: “I think 2021 could be a boom year, with the liquidity that the Fed is adding it could be a really good year.”

Do you agree?

Rick, focusing on Siegel’s point relative to liquidity, I agree that the March lows are unlikely to be re-tested on the conditions that Congress acts to provide further fiscal relief and that measures to contain a second wave of COVID infection prove effective.

On the first qualification, we noted earlier that the U.S. House of Representatives will likely act this week to provide further relief, but this is no guarantee that the U.S. Senate will approve, especially as Majority Leader Senator McConnell has taken the view that states should be allowed to declare bankruptcy to restructure obligations such as public sector pensions. To our view, such a political exercise would be akin to playing a game of musical chairs on the decks of the S.S. Titanic.

As to whether COVID containment measures will prove effective, we note that infection rates in the U.S. outside of New York City have remained high. Consequently, it is possible that with at least 10 states moving to re-open without meeting CDC guidelines a spike in infection rates may occur in June.

Consequently, we are at a delicate point, but I remain cautiously optimistic that the market will continue to grind higher from here as Congress moves to provide further liquidity and COVID is contained. That said, go with what is working, go with growth.

NOT AVAILABLE

Hello and welcome to another episode of “A Brighter Future” Laidlaw & Co’s Podcast Series. I’m Rick Calhoun CEO of Laidlaw Wealth Management and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

Good Morning, David. Thank you again for joining me this morning.

Rick, It’s great to be back with markets rising overseas following last Friday’s rally on Wall Street and news, on balance, is good. Data over the weekend showed COVID-19 Coronavirus (“COVID”) deaths slowed the most in more than a month in Spain, Italy and France, and all three countries have signaled tentative moves to open up their economies.

Meanwhile, there is a lot on deck for investors to consider this week with the Fed, BOJ and ECB all due to announce policy decisions as the battle against the COVID pandemic continues. Several major economies will release GDP numbers, while corporate earnings will keep coming in, including results from names such as Amazon, Barclays Plc, Facebook and Samsung Electronics, among others.

David, a few episodes ago, you referenced the famous Chinese curse “May you live interesting times” for the events we were living through and last week I referenced the quote from Dickens’ Tale of Two Cities, “It was the best of times, it was the worst of times” as a way to define the week.

I think the best way to sum up this week is – Bizarre. We had the oil market in such a pricing collapse due to lack of storage space you could possibly have gotten paid you to store it in your swimming pool and we had a jobless claims report that now shows over 26 million Americans have filed for unemployment benefits in the past five weeks yet the Energy Sector finished up almost 2% for the week while the S&P & Dow were each off less than 2% and the NASDAQ was flat.

Wasn’t this week the type of week that should have scared the hell out of people?

I fully expect investors to have picked more than a few gray hairs of late and last week was no exception, especially when focusing on the energy market where oil prices went to negative levels last Monday. Prior to the COVID crisis, daily world oil consumption was about 100mm barrels. Demand now, however, is somewhere between 65-70mm barrels per day. So, worst-case, roughly a third of global output needs to be shut-in. With WTI now trading at $14.50/barrel, at least we can say prices are positive compared with a week ago, but the dislocations in the market are just beginning to be factored in.

What began as a fight for global oil market leadership between Russia and Saudi Arabia has ended up taking U.S. producers out of the market as they have already started to move to shut-in production ahead of the 9.7mm barrel per day OPEC+ cut coming Friday 5/1. Meanwhile, investors should understand that the break-even oil price for most U.S. shale oil producers is around $45/barrel and Saudi Arabia needs $80/barrel to make its budget, so there is just a sea of red ink sloshing around the oil sector right now. Domestically, major shale oil producing states such as North Dakota are already seeing a rapid retrenchment in production. Oil producers there have already closed more than 6,000 wells, curtailing about 405,000 barrels a day in production, or about 30% of the state’s total volume. Going downstream, U.S. oil refiners processed just 12.45 million barrels a day on the week to April 17, the lowest amount in at least 30 years and looking ahead to May 2020 global refineries could halt as much as 25% of total capacity.

Globally, there is a greater likelihood of Middle East conflict in this environment. Though badly afflicted by COVID, Iran shows no sign of reducing its operations in Iraq, Syria, Yemen and elsewhere. Meanwhile Israel could soon start annexing the West Bank. All in all, the chances of a regional blowout, which America will either be drawn into or castigated for neglecting, are rising again. This is not something investors can disregard as the decimation of America’s shale-oil firms now underway could eventually lead to a renewed dependence on Saudi oil.

Apart from that and the fact that 26mm Americans are filing for unemployment benefits, things are not that bad from a market perspective. Thanks to the massive and relatively rapid monetary and fiscal policy response, COVID has not taken the S&P 500 down as much as the 2008 Financial Crisis did. At this point in the 2008 experience (start the sequence with 9/29/08, the first -5% move for the S&P), the index was down -17.6%. Now, (start with 3/9/20, the first -5% “crash” day), the S&P 500 is actually up +3.3%. So, based on the valuation for U.S. large cap stocks, this indicates a market view that the worst outcomes are off the table.

As such, the stock market believes the US economy will not be shut down again as testing, contact tracing and social distancing successfully contain COVID until better therapeutics and a vaccine arrive. This is underpinned by a view that monetary and fiscal authorities will remain on guard, ready to allocate fresh capital to keep consumers and businesses relatively whole until the US economy restarts. In all this, it is important for investors to understand that big businesses stand to benefit as smaller firms struggle, a real tailwind for the fundamentals of large public companies.

As I mentioned, one of the big highlights of the past week was what occurred in the oil markets, so I’d like to focus on that topic for minute if you don’t mind. In our Laidlaw Five outlook one of our concerns was an exogenous shock that could take the price of oil to over $75/barrel. We truly did get an exogenous shock, but nothing like any of us have experienced. David, beyond the obvious answer of Demand specifically for refined products such as gasoline thru people driving and flying again, how do we see our way out of this mess?

The stock market’s belief that current policy measures are sufficient to support a share price recovery underscores the outlook that the U.S. economy will stage a recovery as we move later into 2020. Over the weekend, Treasury Secretary Mnuchin stated his view that 3Q20 would see strong growth. Summer generally sees a seasonal peak in energy consumption, so demand recovery will be the main driver to clear the current record oil inventories.

Looking out further, though, it is harder to see a rapid drawdown of oil inventories as economic growth is likely to be fairly modest and the path of economic recovery “W-shaped” with slowdowns and restarts around potential subsequent COVID outbreaks. Using the Fed Funds Futures (FFF) curve as a market-based forecast for economic growth, it currently discounts essentially 100% that the Fed maintains its current 0–25 bp interest rate policy through at least November 2021. While not as actively traded, the FFF’s 2022 prices show it is not before June 2022 that the odds of a Fed interest rate increase go above 50%.

Bottom line, with economic growth appearing to be this sluggish, the oil production capacity being shut-in now is likely to remain offline through the end of 2021.

David, I want to turn to a topic now that I know is near and dear to your heart and where you are considered an industry leader as one of the founding partners in BTblock – Blockchain.

There was a fantastic article this week that discussed how Blockchain could be an efficient way to source medical equipment or validate COVID-19 immunity. Now to most of our listeners as well as myself, blockchain is best known as the record-keeping system behind cryptocurrencies like Bitcoin and Ripple. In its simplest terms, blockchain is a decentralized way to keep records that are shared among participants and that cannot be changed.

However, I know it’s not simple so maybe you could offer some insights into the world of Blockchain along with explaining how it could be a potential weapon against the Coronavirus.

At its heart, it is that simple. We are talking about data integrity. Deploying blockchain across the current fragmented state of health data, that is the challenge.

Like all pandemics, COVID has served to highlight human frailty. However, unlike all previous pandemics, COVID is impacting a global economy which depends on the successful operation of highly complex and extended supply chains. Changes in business strategy have resulted in companies that are now more extended enterprises than vertically integrated firms. As such, they need to ensure reliability and consistency. At the same time, consumers have come to demand more information about the goods they purchase.

Distributed ledger technology (DLT), or blockchain, is means to deliver the high level of integrity increasingly demanded. This is especially so as the global economy increasingly deploys sensor networks that enable the “internet of things” (IoT). With an increasingly digitized global economy, cybersecurity needs are becoming of greater importance. In this regard, DLT offers a greater means of securing data, whether enterprise or personal.

In the context of COVID, DLT can offer a means to provide anonymized health data records. Over the weekend, my colleague, Dr. Alex Cahana, published a Medium post “COVID-19 Data Is Valuable Because We Are Valuable.” Dr. Cahana states that to address COVID successfully we need mass testing, crowd intelligence and decentralized tracing. Economically speaking, 35mm tests per day at an annual cost of $100bn, is a fraction of the $350bn in monthly losses due to the ongoing lockdowns and social distancing measures in the US. In terms of health data, clinical notes, lab and imaging results, genomic and wellness data added to insurance claims, purchasing and social media input has contributed to an already saturated 2.7 zettabyte (2.7tn gigabytes) digital universe.

COVID has shown, however, that this digital universe is fragmented, uncoordinated and quite fragile. Health data might be designed for daily operations, but it is not organized for multi-party crisis management, which requires real-time research and analytics. Moreover, the presence of many intermediaries like enterprise data warehouses, data aggregators, administrators of patient and government registries have created an attack-, collusion- and censor-vulnerable environment.

With COVID there is a continued reliance on this fractured data universe to provide information, but it does not leverage the real-time capabilities of federated learning, combined with privacy preserving technologies (like ZKP, TEE and Homomorphic encryption) and blockchain. One of the efforts to protect personal privacy led by MIT, is building an open, interoperable, privacy-preserving protocol called Private Automated Contact Tracing (PACT) which is designed to be a technical standard/specification that anyone can deploy on any smartphone without revealing private information to other individuals, the government, health care providers, or cellphone service providers.

There is an opportunity in putting in place the health data platform necessary to combat COVID to deploy a decentralized approach, where both contact and location data are collected exclusively in individual citizens’ “personal data stores”, to be shared voluntarily, only when the citizen has tested positive for COVID-19, and with a privacy preserving level of granularity. DLT is a technology protocol that can enable this approach.

Dr. Cahana concludes the article by making a critical observation, “We are our actions and our actions are who we are. These actions are captured by data and every time these data are used, abused or sold by a 3rd party, a part of our dignity is stripped away. These technologies are not merely privacy-preserving, but are dignity-preserving.”

While COVID may have served to highlight again our human frailty, this is now a time where technologies such DLT can be used to maintain human dignity.

David let’s bring it back to the markets and a topic that I have received more than a few questions about – the debut of Draft Kings this past Friday (DKNG) through the use of something called a Special Purpose Acquisition Company, or SPAC. For our listeners who aren’t familiar, a SPAC is a company with no commercial operations that is formed strictly to raise capital through an initial public offering for the purpose of acquiring an existing company. They are also known as “blank check companies,” and have actually been around for decades, it’s just that in recent years, they’ve gone mainstream, attracting big-name underwriters and acquiring companies such as Richard Branson’s spaceship company Virgin Galactic Holdings (SPCE), Twinkie-maker Hostess Brands (TWNK), restaurant chain TGI Fridays and of course the aforementioned Draft Kings. In fact, last year, SPACs raised a record $13.6 Billion in 59 IPO’s!!!

David, what else should our listener’s know about this growing segment of the public markets and is it something that should be part of an investment portfolio as we move forward in this new world?

As you said, Rick, Special Purpose Acquisition Companies (SPACs) have been with us for some time. Note that the SPAC management team has a limited period of time, typically 24 months, in which to identify the acquisition target and structure a deal. Once the deal is set, the SPAC investors have to approve the transaction. If approved, the newly acquired entity becomes the operating business of the company.

While SPAC issuance was typically seen as indicative of a market top, investors should consider that in light of the stock market decline, particularly for smaller companies, the acquisition environment for SPACs has improved in 2020. As such, the deals SPAC teams strike may prove on balance to be more attractive than their historical record which has been more “hit or miss.”

As we come to the end of another great episode, David, I’d like focus our final question on a topic that has been written about a great deal over the years and that is the great value vs. growth debate. In fact, this week in our Quarterly Investment Committee meeting we spent a great deal of time discussing that very topic so I think our listeners would be interested in your thoughts and whether it’s time to rotate out of growth and into value or if you even agree that is a strategy to pursue?

The debate of Growth vs. Value is kind of a “chicken or the egg” argument. Before companies become large established firms they start as small unknown entities that contain within them the seeds of greatness.

I’ve spent enough time over the course of my time on Wall Street to been exposed to both sides of the debate, first in my time as a research analyst covering the global auto industry where value was most times the determining factor in making recommendations and later in following technology companies where the trade-off between a company’s growth prospects in terms of its addressable end market and its valuation drove recommendations.

What I can say is that the pace of disruptive technology innovation has accelerated over time and this inexorable march poses a growing challenge to all established companies, namely either disrupt yourself or risk being disrupted. With that insight I tend to view many companies that fall in the Value category to be those at risk for disruption. It is said that companies earn their valuation over time and with that it helps to recall the hallmark statement from the film “The Shawshank Redemption,” namely, “Get busy living or get busy dying.”

To bring this point back to the context of our discussion today, we noted earlier that the COVID downturn favors larger firms as having an advantage over smaller entities. I would say that this applies most categorically to the tech sector’s mega-cap companies, the “FANG” names who have ample financial strength to take advantage of the present downturn to move into a wider array of businesses.

The stock market recovery in part reflects this as these names represent +20% of the S&P 500, a level of concentration not seen since the 2000 market top. What is different now is that these companies are solidly profitable and as they take advantage of the COVID downturn are very likely to increasingly become so. Obviously, nothing grows to the sky, but for the present the “FANG” names may be relatively unchallenged.

That said, we are happy to be proven wrong as we continue to look for those emerging companies who contain with them the seeds of future greatness.

Hello and welcome to another episode of “A Brighter Future” Laidlaw & Co’s podcast series. I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

1. Putting together this week’s episode, I was reminded of the famous opening paragraph from Charles Dickens’ novel, “A Tale of Two Cities,” – “It was the best of times, it was the worst of times” and I think our listeners would agree. On the “best of times” front, we had the major averages all positive for the week with the NASDAQ leading the pack up over +6% (+16.6% over the past 2 weeks), followed by the S&P 500 with a gain of +3% (+15% over the past 2 weeks) and the Dow up +2.2% (+15.2% over the past 2 weeks) while on the “worst of times” front, we had another unemployment claims report in excess of 5mm, bringing the 3-week total to over 22mm, March 2020 retail sales plummeted to worst ever on record, industrial production dropped to the lowest level since 1946 and there were dismal earnings from firms like JP Morgan, Goldman Sachs, Schlumberger Rite Aid and Bank of America.

What’s your take on this market? Is this a “bear market” rally and if so, should investors consider some de-risking here?

With the S&P 500 up +28% since the March 23rd low and the rally in tech sector mega-cap names ensuring the Nasdaq 100 is no longer down for 2020, this is more a time for investors to look opportunistically at the dislocations that have taken place in the securities market. A well-known institutional investor, Oaktree Capital founder Howard Marks, made a very salient point in this regard in his 3/31/20 investor letter, “waiting for the bottom can keep investors from making good purchases, so the investor’s goal should be to make a large number of good buys, not just a few perfect ones.”

That said, please recognize we are in the midst of a corporate earnings reporting season where many companies will take the high degree of uncertainty as a chance to say that they aren’t able to give guidance, something that normally would be anathema to Wall Street. At this time, however, we believe investors should look more to two factors that together are constructively supporting the market upturn here: 1) the developments taking place around containing the spread of the COVID-19 Coronavirus (“COVID”), and 2) the extent and timing of the fiscal & monetary policy response to alleviating the economic impact of COVID.

2. On past episodes, you have shared the importance of paying attention to economic indicators to give you an idea of where the market and economy are headed. I’d like to make this a two-part question, First why were the three reports (i.e. retail sales, industrial production & the Empire State manufacturing survey) so are important? Second, I think many people hear the terms – leading indicators and lagging indicators. Can you share with our listeners the primary differences and what you focus on?

The importance right now of the economic data is that they demonstrate just how devastating the impact of COVID has been. The sudden nature of the economy’s deceleration is something to behold and its impact is being widely felt. While production data is important, we all know that supply follows demand. In this regard, retail sales plunging -8.7% in March 2020, the biggest decline since the U.S. government started the monthly data series in 1992 (after falling by a revised -0.4% in February 2020), gives a stark indication of the cliff the U.S. economy just fell over. With consumer spending providing 70% of the U.S. economy, the retail sales number clearly spells out the magnitude of the deceleration as demand evaporated in the face of COVID across a range of sectors.

Note nevertheless that while COVID is destroying demand in the retail sector it is also serving to accelerate shifts in the channel. For example, U.S. e-commerce spending is up more than +30% from the beginning of March 2020 through mid-April 2020 compared with the prior year period, according to market research firm Rakuten Intelligence. Along with the overall boom in e-commerce spending, sales data show consumers have shifted their focus to entertainment products (e.g. books, games) reflecting the new normal of life in quarantine.

As investors we are always trying to look ahead. The stock market tends to anticipate events roughly 6 months ahead. Relative to leading versus lagging economic indicators, it is interesting to note that retail sales along with the S&P 500 index are two of the ten data series used by The Conference Board in constructing its Leading Economic Index. Lagging indicators primarily confirm what has already happened and so may not offer as much informational value. In this regard, the March 2020 retail sales report was the deer that just came through the windshield.

In terms of the economic indicators I rank as most important right now, the one data series available with the greatest frequency is the weekly U.S. unemployment claims report released at 8:30amET every Thursday. The fact you mentioned earlier that 22mm workers have filed for unemployment in the last 3 weeks is staggering. Bear in mind that the U.S. workforce was at a high of 164.6mm in February 2020, so 13.4% of that total is now unemployed. COVID is taking a severe toll.

3. If you don’t mind, let’s stay on the topic of the economy – I have heard more than a few people raise the prospect that all of these Fed dollars and spending programs will, eventually, be inflationary. Is that something you’re concerned about and if so, how should our listeners be positioned to best take advantage of that scenario playing out?

With WTI oil prices trading at $14/barrel, I do not expect that investors will have to be concerned about an energy input price lead inflation spike anytime soon. However, seeing as more than $8tn of fiscal and monetary stimulus (9% of 2019 global GDP) has been added to the global economy with the onset of COVID, it is appropriate to consider whether this may have long-run inflationary consequences.

There is a market-based means of tracking this, namely, Treasury Inflation-Protected Securities, or TIPS, which are securities whose principal is tied to the Consumer Price Index (CPI). The principal increases with inflation and decreases with deflation. So far in 2020, TIPS have appreciated +3.4% and were at their March 6th high up +5.7%. Note that TIPS have traded up to 5-year highs in 2020 and are back near the highs last seen in December 2012, so the market is attuned to possible inflation acceleration. Still, with substantial portions of the global economy under COVID lock-down, we do not see inflation in today’s real economy with the distinct exception of toilet paper. Near term, however, the additional liquidity provided by fiscal and monetary stimulus appears to have found its way into financial asset pricing, namely the +28% gain by the S&P500 off its March 2020 low.

Investors may wish to have some hedge against inflation. Historically, that role has been fulfilled by owning gold-linked securities. So far in 2020, gold as tracked by the SPDR Gold Trust (ticker: GLD) is up +11%, in the process outperforming TIPS. Either way, in this market, a positive return is something to be appreciated.

4. As we have discussed on previous episodes and in the “Laidlaw Five,” Healthcare remains a place where investment dollars continue to flow and this week we saw some exciting news on the COVID-19 front as Gilead Sciences reported positive results, albeit in a very small population, from their drug Remdesivir. In addition, as we touched on last week, there are 254 clinical trials testing treatments or vaccines for the virus, many spearheaded by universities and government research agencies, with hundreds more trials planned. But I think our listeners would be interested in your thoughts on the topic discussed recently by Barron’s that Healthcare will be going Digital with things like Teledoc. To me, in addition to the disruption of how we work every day, do you think how interact with our healthcare providers will alter radically as well?

During COVID, the shortcomings of the healthcare system in terms of items such as personal protective equipment (“PPE”) have highlighted the need to be able to deliver healthcare services remotely, a development clearly serving to bring forward the transition to digital in healthcare.

In NYC, for example, at Mount Sinai Health System, the hospital started treating patients from outside their negative-pressure rooms to minimize times workers had to enter: nurses monitor ventilators remotely, and doctors call patients on tablets via Zoom to conserve PPE. Separately, Mount Sinai data scientists built artificial intelligence tools to speed discharges. A program scans a patient’s medical records, combing through blood work, vital signs and temperature readings to determine who can be sent home in the next 72 hours. Through raw ingenuity, it was developments like these that allowed America’s beleaguered health system to remain afloat throughout the COVID crisis.

With a new-found appreciation for how technology can be better integrated into how healthcare is delivered and public health monitored, investors can expect to find innovations coming forward during the COVID crisis. One important long-term consideration is how the trade-off between public health and personal privacy is managed as substantial amounts of personally identifiable information will be gathered in the process of COVID testing, tracing and tracking. Data anonymization techniques will be required in order to uphold such newly introduced standards such as GDPR and CCPA. Stayed tuned for developments in this area.

5. On Thursday night last week, the White House outlined broad new federal guidelines for opening up the country that will put the onus on governors to decide how to restart the economies in their states amid mounting fallout from the coronavirus outbreak.

The guidelines outline a three-phase process for opening up the country based on the scope of the outbreak in individual states and also don’t suggest specific reopening dates. Instead, they encourage states to base their decisions on data. It seems like this is a good “first step” at getting people back to their lives, careers and schools. Setting aside personal political opinions, could you address the plan and give us your thoughts on how this could be good for the macro-economy and the markets?

First off, it is critical to recognize that no restart plan can stand a reasonable chance of success without having sufficient testing resources in place, something that arguably will require federal government support to state and local governments that have been fiscally hard-hit by COVID.

Looking at New York State, for example, Governor Cuomo said over the weekend that with a $16bn budget deficit that spending levels in public hospitals may need to be cut by -50%. A federal plan to reopen the U.S. economy that delegates responsibility to the state governments without providing the necessary aid and support is doomed to failure from the get-go.

Second, this is a critical time to distinguish between necessary social services and discretionary personal services. The need to educate our children, to allow college and graduate students to complete their degree programs is a necessary part of the human capital formation that will drive the U.S. economy over years. The unavailability in the re-start program of safe, secure and reliable childcare programs in an economy where one in three jobs held by women has been designated as essential work puts a substantial portion of the population at risk and likely serves to deter labor participation by placing unacceptable barriers in the way.

Federal government support for testing, safe day care centers and educational institutions is critical. Arguably, other more discretionary services such as restaurants and movie theaters are going to have to wait. In this effort, the federal government is going to have to lead from the front, not to set up the states for failure, especially those states that have suffered the brunt of the COVID crisis and paid the price in full.

6. As we close out this podcast, I would be interested in your thoughts on the return of some of the major sporting events. The NFL Draft will be occurring this week on-line, but the PGA, NBA and MLB all appear to readying a return, sans fans, in the next few weeks. Do you think it could be a great morale boost for people to watch a baseball game, basketball game or golf tournament instead of re-reruns of the ’85 National Championship (which, by the way, Villanova still wins)?

We welcome the return of sports for the inspiration they offer us all of human achievement, of individuals on their own or by coming together as a team overcome challenges and triumph over adversity. Together we will get through this, no doubt, and, with the return of sports, it is going to take some balls to do it. That said, let’s play ball!

Hello and welcome to another episode of “A Brighter Future” Laidlaw & Co’s podcast series. I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

1. We had a holiday shortened week that produced a +12% move up in the S&P 500, +13% for the Dow and +11% for the NASDAQ. So, is that an “All Clear” for investors or is this one those “Rip Your Face Off” rallies in a bear market that we hear the pundits on Bloomberg, CNBC, and Fox News discuss?

Yes, we managed to squeeze roughly 2 years-worth of expected stock market returns into 4 days with the S&P500’s +12.1% gain, but to be honest it is fair to say the market got by with a little help from the Fed. The $2.3 trillion program announced Thursday 4/9 came on the heels of another record-breaking weekly unemployment claims report of 6.6 million workers.

Note that including the Fed’s efforts, the major Western economies have to now put out relief programs totaling $8 trillion (9% of 2019 global GDP of $87 trillion). Clearly, a tide of liquidity is being unleashed globally in response to the COVID-19 Coronavirus (“COVID19”) pandemic.

In all this, it is becoming clear that perhaps a bottom has been seen for the stock market, barring an unforeseen failure of COVID19 containment measures.

2. On Thursday 4/9/20, The Federal Reserve unveiled emergency programs that could dole out more than $2 trillion in loans to businesses of all sizes, as well as to struggling city and state governments, in a bid to keep the economy afloat as it is ravaged by the COVID19 pandemic. Is this much Fed intervention good and is it needed or is there some “moral hazard” here as they now are buying low-grade debt?

When over 10% of the U.S. workforce has filed for unemployment benefits over the past 3 weeks, the time for contemplating niceties such as “moral hazard” is limited as the overriding goal for the Fed is to salvage as much of the U.S. economy as it can under the employment portion of its mandate. As such, the Fed is engaging in a “no holds barred” effort to address the COVID19 economic downturn, one that is likely to be protracted. The thinking within the Fed Open Market Committee (“FOMC”) was indicated over the weekend by Minneapolis Fed Governor Neel Kashkari commenting that without an effective therapy or a vaccine for COVID19, the U.S. economy could face 18 months of rolling shutdowns as the outbreak recedes and flares up again.

Moral hazard notwithstanding, markets are clearly encouraged by the Fed’s readiness to offer support that will extend into purchasing low-grade private sector and municipal debt. Some speculate that before all this is through the Fed may follow the path of the Bank of Japan to purchase equities directly. Strange times call for bold measures.

These developments have prompted investment firms, such as Laidlaw, to call that the bottom for the stock market has already been reached. Goldman Sachs has withdrawn its previous near-term S&P500 2,000 price target and put up a year-end 2020 S&P500 price objective of 3,000. Our Laidlaw target of 3,420 is more ambitious and will be subject to fine-tuning as more data becomes available over the upcoming 1Q20 corporate earnings season.

3. Relative to the 2020 election, this week with Senator Sanders officially suspending his campaign it appears that Former Vice President Biden is the presumptive Democratic nominee to run against President Trump in November. What might this portend relative to the economy, foreign affairs and the global standing of the U.S.?

While the current U.S. Administration was significantly involved in Russia and Saudi Arabia and other OPEC+ member countries reaching agreement over the weekend to reduce daily oil production by 9.7mm barrels (12% cut from 2019 daily global oil production of 80.6mm barrels), the fact remains that the current U.S. President is clearly a nationalist committed to moving our country away from the global leadership position it has held since 1945.

Although the U.S. Federal Reserve last week took significant action to bolster the U.S. economy and help stabilize global financial markets in the process, this week there are equally critical meetings of the IMF and The World Bank that aim to help stabilize the developing countries where the vast majority of the world population lives. The U.S. interest in having these meetings succeed lies not just in preserving markets for U.S. investment and export, but also in ensuring these regions do not become reservoirs of COVID19 infection and sources of even greater mass migration.

No one nation alone can protect itself in the face of a global pandemic such as COVID19. Going it alone is not an option. Working successfully with existing multilateral institutions and global partners requires a different mentality than the “zero-sum” approach that President Trump personifies.

That said, these times require a different leader. Former Vice President Biden has a demonstrated record of working effectively on a global scale. Known to many leaders across the world, Biden is the person who can provide the leadership expected from the United States. Biden will get the job done and get America on the road to rebuilding its economy. In contrast, Trump would preside only over a continuation of the COVID19 pandemic that his undoing of preceding administration’s prevention efforts brought upon the country.

4. As a follow-on to politics, let’s talk about investments that can be dramatically impacted by political events – commodities and more specifically, Oil and Gold. First, Oil. Last Thursday might have been one of the most important days for the energy markets in years, if not decades, with the OPEC+ meeting. It’s hard to believe that a few months ago we were worried the price of oil might exceed $75 per barrel and today we’re questioning if it could drop below $20. What’s your take on the OPEC situation and what could be expect?

As mentioned earlier, global oil production is on track for a -12% reduction from prior year levels. Whether this will be sufficient to return the price of oil to the U.S. shale-oil producer breakeven level of $45/barrel depends on the extent of the U.S. economy’s decline.

Recently, plans have been put forward to re-start the U.S. economy from its current state where 95% of the population is under “stay at home” orders. On balance, the plans indicate the economy will return to roughly 80% of its pre-COVID19 levels. Now, although that may sound encouraging, it still represents an economic collapse in line with The Great Depression.

Presume the U.S. experience would be matched by the rest of the world economy and quick math would tell you a -12% oil supply cut will be swamped by a -20% economic contraction. The markets are reflecting oil prices staying the $20-30/barrel range for now with WTI trading at $23, down from the $29 price spike on Friday 4/3 when OPEC+ discussions were getting underway.

5. Next as far as Gold, our Investment team at Laidlaw Asset Management has had a Gold allocation for some time and as a member of our Investment Policy Team you know we increased that recently. However, for every article written about the portfolio benefits of having an allocation to Gold there are two saying things like “gold is a barbaric relic that no longer holds the monetary qualities of the past. In a modern economic environment, paper currency is the money of choice” or “gold’s only benefit is the fact that it is a material that is used in jewelry.” With Gold being up 15% YTD thru last Thursday, does an allocation still make sense and if so why?

Like all investments, the price of gold reflects a carrying cost which is namely the interest rate charged to finance a position.

With interest rates declining dramatically worldwide, the cost of owning gold has fallen accordingly. Given the expected monetary relief over the next 18 months, interest rates are likely to remain low. So, this is one good reason for gold to appreciate in value. Second, there will be record levels of fiscal stimulus which over time may result in a return of inflation. Gold has historically been considered an inflation hedge.

That said, gold is up +14.7% so far in 2020 and likely to hold these levels, if not trend higher.

6. To bridge back to another of our “Laidlaw Five” themes, Healthcare. I read last week that according to Informa Pharma Intelligence, there are more than 140 experimental drug treatments and vaccines for the coronavirus in development world-wide, most in early stages, including 11 already in clinical trials. They went on to say that counting drugs approved for other diseases, there are 254 clinical trials testing treatments or vaccines for the virus, many spearheaded by universities and government research agencies, with hundreds more trials planned. In fact, researchers have squeezed timelines that usually total months into weeks or even days. I am assuming this massive response to COVID19 not only supports our investment thesis for healthcare but maybe offers some new segments for our listeners to consider?

The healthcare sector has been a greater area of focus for investors than even the Laidlaw Investment Committee had considered in December 2019. Dealing with the COVID19 pandemic requires testing, healthcare system capacity building (e.g. staffing, equipment, supplies), palliative measures and, eventually, curative vaccines.

As is well known, developing a vaccine is a process that will take time. Experimental therapies can be developed and put to test in 6-12 months, but to get to a proven, commercially available vaccine may take 18-24 months. That said, it is important to see what palliative measures are already commercially available that can serve to stabilize patients and thus reduce the burden on existing equipment (e.g. ventilators).

In this category, we are interested to see that Pfizer’s Viagra may prove effective in treating COVID19. A pilot study in China is testing the drug in COVID19 patients with breathing troubles who do not yet need mechanical breathing assistance. Like nitric oxide, Viagra, known generically as sildenafil, dilates blood vessels. As such, Viagra may help open the tiny vessels that draw oxygen from the lungs, allowing patients to overcome the respiratory distress that occurs in some cases of COVID19.

7. As we near the end of this week’s episode, let’s come back to overall markets and economy. Recently there has been a “parade of pundits” suggesting their thoughts or vision on the shape of the recovery. I have heard everything from a W, V, U, L, a Check Mark and this weekend Barron’s even referenced blips of an electrocardiogram or “EKG.” Can you offer some guidance on this “alphabet soup” and what your best guess is for the shape of the recovery.

In estimating the path of the U.S. economy’s recovery, the process of containing and eradicating COVID19 will bring a “start, stop” character to the economy as expected periodic outbreaks will lead to re-imposition of social distancing measures. Consequently, it is likely that “W” will end up the winner in this forecasting alphabet contest.

Meanwhile, in anticipation of COVID19, available capacity is likely to be cut significantly for businesses such as airlines and restaurants, moves for which there may not be a pricing benefit as demand is still suppressed. For example, Lufthansa has mothballed a substantial portion of its aircraft and stated that air traffic volumes may not recover to pre-COVID19 levels for 40 years.

Longer term, research on the economic impact of pandemics has shown that real rates of return are depressed for up to 40 years as demand is suppressed and input costs (e.g. wages) are moderately higher.

As part of developing a longer-term view, it is important for investors to consider that firms surviving the COVID19 crisis will have to master a business environment which sees the acceleration of three trends: 1) an energized adoption of new technologies, 2) a reconfiguration of global supply chains, and 3) the likely ascendance of well-connected oligopolies.

We will discuss these trends further in the weeks ahead.

Hello and welcome to another episode of “A Brighter Future” Laidlaw & Co’s podcast series. I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

1. QUESTION: After last week’s developments (e.g. March 2020 Employment Report, Oil Price Spike, COVID-19 Coronavirus (“COVID19”) spread), what are the near-term factors driving the markets?

ANSWER: Right now, there are estimates that the U.S. economy is operating at 75% of its rate prior to the onset of the COVID-19 Coronavirus (“COVID19”). One item from the March 2020 employment report released Friday 4/3 is that the broadest U-6 measure of unemployment rose +1.7 percentage points to 8.7% of the U.S. workforce from 7.0% in February 2020, the largest month-to-month change in the history of the data series (starts in 1994) and a clear indication of the magnitude of COVID19’s shock to the economy.

If sooner is better for the stock market in terms of economic recovery, then “V-shaped” (quick down, quick up) is better than “U-shaped” (quick down, slow up) recovery. The fact that Fed Funds Futures are not pricing in a “V-shaped” recovery means it is likely the stock market doesn’t have a “V-shaped” recovery priced in either, so the likelihood of further rapid stock market collapse may be diminished.

That said, there are bulls out there who may be premature in their recovery timing. Apart from how quickly the healthcare policies to contain COVID19 are relaxed (note this is expected to be gradual, not rapid, hence the “U-shaped” recovery expectation), the other critical variable markets will have to deal with is the global price deflation caused by the protracted demand destruction COVID19 wrecks upon leveraged corporates. More broadly, deflation taking hold will serve to raise investor concerns as to the earnings power of companies and depends on whether their business models can function profitably in this new economic environment. The market will likely have difficulty handling the wholesale rethink of corporate earnings power deflation brings.

In investing as in the land of the blind, the company with positive pricing power (an analogy to sight) is king. How well we navigate the tides of deflation depends on both finding companies with positive pricing power and, if aggressively inclined, shorting companies that do not.

For now, COVID19 remains the gating factor on the economy and the stock market. Near-term, the flattening of the infection curve will offer support to bulls. The full measure of recovery will likely be the realization of either a commercially available vaccine or reaching a level of herd immunity, something that may require 60% of the global population to be infected which would be approximately 4.7 billion people out of the estimated 7.8 billion world total.

2.QUESTION: What developments are taking place in the energy sector and are there any positives for the broader economy?

ANSWER: The effort on the part of the U.S. to stabilize the price of oil is aimed at keeping prices over the break-even $45/barrel level for U.S. shale oil producers so employment can be sustained and corporate defaults forestalled in the energy sector. Whether Saudi Arabia and Russia can reach an agreement to reduce production levels remains to be seen, but it would appear to be in their long-run self-interest to undermine U.S. energy independence.

For now, with WTI oil futures trading at $27.70/barrel, the market is apparently not putting much credence in the likelihood of the U.S. succeeding in its price stabilization plan. Separately, lower oil prices translate to lower gas prices at the pump which does provide some benefit to the U.S. economy, so it is good to be mindful of the available positives at the juncture.

3. QUESTION: Relatively low-risk investments such as bond funds have seen price declines this year. Of the 19 bond fund categories tracked by Morningstar, only 4 have seen price increases this year. What is taking place here?

ANSWER: We discussed earlier investors having to come to grips with deflation, a pricing environment that the global economy has not had to deal with for some time.

Right now, the world’s biggest source of deflation is China where producer prices registered a -0.4% decline in February 2020 compared with a year ago after rising +0.1% in January 2020. This is a drag on the price of goods being shipped overseas from the world’s biggest trading nation.

The problem with deflation for fixed income investors is that it raises default risk as loss of pricing power causes issuers to fail. Arguably, the decline in bond funds last week is a confirmation that higher levels of default risk are being priced into the market. Similarly, the widening out of credit spreads for lower-grade borrowers.

4. QUESTION: The Fed has stepped up on the monetary policy front in terms of providing support to financial markets, but clearly the economy requires substantial fiscal relief as well. With CARES I bringing $2tn in relief, to what extent will that carry the U.S. economy?

ANSWER: The Friday 4/3/20 failure to launch for the relief payments offered to small businesses under CARES I was unfortunate and indicative of the haphazard character of the current Administration’s efforts to address the COVID19 crisis. That said, the expectation is relief payments will be forthcoming over the course of April 2020 which may serve to blunt to some extent further sharp increases in unemployment.

The bigger question now is how discussions are shaping up around CARES II. With Congress not scheduled to be back in session until Monday 4/20/20, there is a slackening in the pace of relief efforts that are urgently needed to support the U.S. economy during the COVID19 crisis. Indications are that current COVID19 containment measures may be extended and so remain in place until late in 2Q20.

As it now stands, the CARES I relief program is thought sufficient to support the U.S. economy until early May at best. With GOP leaders such as Senate Majority Leader McConnell indicating a reluctance to move forward on CARES II until having the opportunity to examine the full benefit of CARES I, the risk is that Congress will fall behind the curve in trying to get out ahead of the COVID19 impact on the U.S. economy.

5. QUESTION: In all the focus on the COVID-19 Coronavirus response attention has been diverted from the 2020 elections. Any developments there to note?

ANSWER: Due to COVID19, Democratic presidential primaries have been postponed in 15 states and the Democratic Convention has been moved back to August 2020. The main effort to keep the 2020 elections on track will be to make sure that voting by mail is a viable option.

CARES I contained roughly $400mm in funding to develop the option further, but Congressional leadership has stated publicly that the full amount required is closer to $2bn. To that end, prospects for the 2020 elections going off as planned may depend significantly on the passage of CARES II.

6. QUESTION: COVID19 clearly meets the definition of a “black swan” event, an “unknown unknown” for investors. While COVID19 was in the news at a low level in early February, there was no one who was sounding the alarm. Is this just what happens with a very speculative stock market, at the peak where there is a new normal that things are wonderful?

ANSWER: Going into 2020, the stock market was riding high on hopes that the Trump trade wars were dying down as the Phase I agreement had been reached with China and the downward pressure the tariffs had imposed on the global economy was beginning to be lifted.

The possibility of a global pandemic such as COVID19 was clearly a long-tail event, an “unknown unknown” that no one expected, much less factored into their near-term forecasts. It is likely to result prospectively in investors opting to have some type of hedge protection in place. The days of being an unhedged long investor are over.

7. QUESTION: We have discussed macro ideas, but how should investors implement these insights with some portfolio ideas. For example, the playbook says when fundamentals begin to deteriorate, you head towards defensive sectors such as consumer staples, health care, utilities and real estate investment trusts. Do you ascribe to a similar playbook? As well, I understand you have been building a new COVID19 Portfolio with Laidlaw Head of Asset Management Ken Mathieson, maybe you can offer a “sneak peek” here.

ANSWER: The traditional defensive investment playbook is undergoing revision as deflation is beginning to be factored in. Pricing power is a far more scarce commodity these days. Meanwhile, structural shifts to a more distributed workforce and increased levels of automation as organizations right-size their operational footprint to achieve sustainable profitability have implications that are negative for overall employment and consumer spending levels and highlight the likelihood of excess capacity in the commercial real-estate sector that may take a protracted time to clear.

That said, we have put together some thoughts on which companies are likely to prosper in the current environment as well as become more central to the global economy henceforth. Please find the list here:

Technology
Microsoft (MSFT, $160.68, market cap $1.2tn),
Amazon (AMZN, $1,956.15, market cap $974bn),
Nvidia (NVDA, $260.58, market cap $160bn),
Zoom (ZM, $119.05, market cap $33bn),
Atlassian (TEAM, $134.41, market cap $33bn),
Slack (WORK, $24.82, market cap $14bn)

Healthcare
Abbott (ABT, $80.69, market cap $142bn),
Regeneron (REGN, $508.05, market cap $56bn),
Teledoc (TDOC, $150.11, market cap $11bn),
Moderna (MRNA, $34.49, market cap $11bn)

Leisure
Netflix (NFLX, $369.17, market cap $162bn),
Activision (ATVI, $61.88, market cap $48bn),
Take-Two (TTWO, $121.09, $14bn)

Food
Walmart (WMT, $122.52, market cap $347bn),
Costco (COST, $297.12, market cap $131bn),
Uber (UBER, $24.64, market cap $43bn),
Campbell (CPB, $49.05, market cap $15bn),
Dominos (DPZ, $334.36, $13bn)

Technology

Microsoft (MSFT, $160.68, market cap $1.2tn),

Amazon (AMZN, $1,956.15, market cap $974bn),

Nvidia (NVDA, $260.58, market cap $160bn),

Zoom (ZM, $119.05, market cap $33bn),

Atlassian (TEAM, $134.41, market cap $33bn),

Slack (WORK, $24.82, market cap $14bn)

Healthcare

Abbott (ABT, $80.69, market cap $142bn),

Regeneron (REGN, $508.05, market cap $56bn),

Teledoc (TDOC, $150.11, market cap $11bn),

Moderna (MRNA, $34.49, market cap $11bn)

 Leisure

Netflix (NFLX, $369.17, market cap $162bn),

Activision (ATVI, $61.88, market cap $48bn),

Take-Two (TTWO, $121.09, $14bn)

Food

Walmart (WMT, $122.52, market cap $347bn),

Costco (COST, $297.12, market cap $131bn),

Uber (UBER, $24.64, market cap $43bn),

Campbell (CPB, $49.05, market cap $15bn),

Dominos (DPZ, $334.36, $13bn)

Hello and welcome to another episode of “A Brighter Future” Laidlaw & Co’s podcast series. I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

1) David it seemed like last week lasted a year instead of 5 business days, but this time last Monday when we spoke I don’t think either of us could have predicted what would unfold. That day, S&P broke thru the 2200 level and the markets had their worst day since 1987, only to be followed by an almost 20% moved back up b/w Tuesday thru Thursday!! I have heard that Bear Market rallies can be violent, some even call them “rip your face off” rallies. Is that what happened and maybe more importantly is that what we can expect going forward?

In broader terms, the MSCI All Country World Index plummeted roughly -34% from its February record high to its recent low on Monday 3/23/20. So far, it has recovered more than 25% of that loss. To our view, it reflects the “buy the rumor” effect of the U.S. Government providing large scale fiscal and monetary stimulus in the hopes of tiding over the economy during the worst of the COVID-19 Coronavirus (“COVID19”) outbreak. The $2 Trillion fiscal relief package was a record. Record relief served to generate a record relief rally.

However, now investors will have to contend with following “sell the news” phase as there still remain significant “known unknowns” and “unknown unknowns” that will likely serve to keep financial markets volatile. Nevertheless, there is encouraging news in that Congress is already at work on a Round 2 fiscal relief package and The Federal Reserve (the “Fed”) is fully committed to providing further monetary relief, both of which may be necessary should COVID19 containment measures effectively shut down the U.S. economy going into May 2020.

2) In addition to the market movements, we have some very good news out the Fed last week. They unleashed an unlimited QE for pretty much anything and the stimulus bill doubled in size ($1 trillion to $2 trillion) So, does all that justify potentially the best week for stocks since the 1930s?

Thankfully for us all, The Fed following the 2008 Financial Crisis put in place an annual Stress Test to ensure that should a similar financial meltdown occur that the U.S. banking system would be adequately capitalized. Now, instead of a regulatory exercise, the Fed finds itself essentially living in its own simulation.

Relative to a range of metrics, the current downturn is tracking close to levels the Fed had anticipated. For 2Q20, GDP growth is likely to be -10%. The unemployment rate is forecast to hit 6.1%. The yield for 10-year Treasuries bottoming at 0.7%. For corporate BBB bonds, the spread widening out to 550bp by 3Q20. The DJIA bottoms at 16,581 in 4Q20. At the worst close of 2020 on Monday 3/23/20, the DJIA was just 11% away. Not a bad call, in other words.

The Fed has its eye on the ball and investors should be encouraged by that.

3) Thursday’s historic (not in a good way) jobless claims was something for the record books. 3 million claims was essentially 5X the peak of jobless claims during the financial crisis. Was it simply an anomaly related to the virus (mostly restaurant, hotel and other service jobs that will come back) or does this set up for something worse?

Depending on how long it takes to contain COVID19, there are going to be long-term shifts that affect how different sectors perform once the broader economic recovery takes root.

For example, with a constant effort to sustain profitability, corporations will take this time to consider what is the right size of their current employment footprint. The sudden shift to “work from home” leads to a distributed workforce that now no longer needs office space previously used. Considering that long-term leases comprise a substantial fixed-cost, managements may decide shifting to a more distributed workforce is a viable option in light of how well the arrangement performs in the current economic downturn.

At the same time, technology companies who provide the platforms used by this new distributed workforce will see a structural shift in their favor. So, some of what we are experiencing in the unemployment rate is clearly a reaction of shutting down the travel, leisure & recreation service sectors, but there will be a longer-term trend that reflects corporate “right-sizing.”

4) I touched on the Stimulus package at the beginning of the show and while it’s big I am concerned about its true effectiveness. I read a report where an economist tried to gauge how much time the $2 trillion stimulus would buy the economy by using the 2019 total dollar U.S. GDP, which was $21.43 trillion. The $2 trillion figure is about 9.3% of last year’s GDP so he took 9.3% of a calendar year 34 days or just over a month. From a very high level, it looks like the stimulus will “buy” the economy a little over a month of partial shut-down. So if we go back and say essentially the economy began to shut-down on around mid-March (say March 15 for illustration) then that means the stimulus can help offset the loss of growth essentially to late April. That is scary when you realize that the new cases of the virus might not have even peaked in the US by that time. Should we expect another package or was his math wrong?

As mentioned earlier, Congress is said to be at work on a Round 2 fiscal stimulus package. This is most likely to be confirmed shortly as over the weekend federal social distancing guidelines have been extended to Thursday 4/30/20, something that will clearly serve to suppress the U.S. economy into May 2020.

While the Round 1 package had significant relief for businesses, it will be interesting to see if the Round 2 package offers more consumer-oriented measures such as student debt relief. Remember there are elections coming up in November 2020, if not sooner.

Stay tuned.

5) As we bring another episode to a close David, is there any guidance you could offer to our audience as they are trying to navigate these markets? For example, I have been asked a lot recently when is the bottom and when should I start buying and my response has been the only people who really “nail the bottom” are liars and lottery winners.

Nothing moves in a straight line, except perhaps a line drive in the now non-existent baseball season.

We expect markets to be volatile as investors are buffeted by negative COVID19 news reflecting what is truly a global tragedy. Nevertheless, investors should understand that substantial fiscal and monetary relief will continue and not just from the U.S. but from other countries as well. This flood of liquidity should serve to provide a floor under the markets.

That said, there are “unknown unknowns” that have not by their very nature been priced into the market. Should there be a sudden shock from an “unknown unknown” that creates a -15%+ decline (2100 on the S&P, in round numbers), that would fit with the 2008 playbook we have discussed previously. Buying that new low would feel awful, but it would also be a signal to policymakers that they will need to take further steps.

Know that in periods of crisis, capital markets drive policy response.

Hello and welcome to another episode of “A Brighter Future” Laidlaw & Co’s podcast series. I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.

1) Let’s start with the most relevant market question at this point, with the market down below 20,000 has it discounted enough of the Corona impact and at what level do you think it might stabilize?

Given the speed with which the COVID-19 Coronavirus (“COVID19”) has spread across the planet and the increasing severity of the response to address it, expectations for economic performance in 2020 are being substantially reduced. For example, St. Louis Fed chief James Bullard said 2Q20 GDP may shrink -50%, with unemployment hitting 30%. Morgan Stanley and Goldman also predict an unprecedented plunge. Morgan Stanley sees a -30% contraction, driving unemployment to 12.8%. Goldman already projected a -24% drop and expects global GDP to fall about -1% this year. Note that we had previously mentioned worst-case scenarios could see a hit to global GDP of as -$2.7 trillion, which would represent a -3.1% decline from the 2019 level of $86.6 trillion.

The main questions investors need to consider at this point are: A.) when will the global spread of COVID19 peak?, B.) how quickly can drugs be found to address COVID19?, and C.) can the infection curve be flattened such that available hospital capacity not be overwhelmed? On the first question, the expectation is the global spread of COVID19 should at some point during 2Q20, but possibly extending to 3Q20. On the second question, nearly 70 drugs and experimental compounds may be effective in treating the coronavirus, a team of researchers reported on Sunday night. The list of drug candidates appeared in a study published on the web site bioRxiv. On the third question, the issue here in the U.S. is whether the “stay-at-home” orders issued in a growing range of states will prove sufficient to slow the spread of COVID19. It appears that a 3- to 4-week hiatus may be the period of time necessary to depress the curve.

The bottom line is the economy bottoms in 3Q20 and begins to recover gradually in 4Q20. Given that the stock market tends to move 6 months ahead of the real economy, this scenario indicates a bottom in 2Q20. A look at the last 2 recessions (2000 – 2002, 2017) shows the S&P 500 bottoms at an average of 13x prior peak earnings and 20x current trough. Assuming markets decide 2020 S&P 500 earnings will decline a not unreasonable -30% this year, that puts the floor on the S&P 500 at 2100, a level that represents a further -9% decline from the Friday 3/20/20 close of 2305.

2) In some comments you made earlier in the week you compared the current situation with the 2008 melt down and said we need to keep to our 2008 playbook, can you discuss what you mean by that?

The situation in 2008 was one where the economic downturn required a fiscal policy response (e.g. TARP, Housing and Economic Recovery Act) in order for a floor to be put under the U.S. economy as it dealt with the dislocations in its financial structure from the sub-prime debt market collapse. While the financial system is now thought to be in relatively better condition, there is a fiscal policy response being developed to address the COVID19 recession.

This is a time-consuming process, something creating uncertainty for investors. While COVID19 is a different sort of shock than that seen in October 2008, markets are waiting on the federal government’s fiscal policy response just as in the 2008 Financial Crisis. It is reminiscent, but not in a good way, of the political maxim of “never let a crisis go to waste” that made the rounds at that time.

The 2008 playbook referred to here for the current stock market is to look at the volatility and valuation levels experienced in the S&P500 during the 2008 Financial Crisis and see how they are unfolding in the present environment. If the S&P500 continues to follow its 2008 trajectory, then US equities may try to hold here for a week or two. The holding pattern in 2008 lasted for 10 trading sessions, from 10/9/2008 (close 910) to 10/23/2008 (close 908). Important to note, however, this period was not the bottom for US stocks in 2008, which only came 20 trading days later (11/20/2008 close 752) and -17% below the 10/23/2008 close.

Above all, it is critical that investors do not believe that any equity market stabilization is a sign of an investable bottom in US stocks since history strongly suggests otherwise and we are mindful that 2020 is running the 2008 Playbook at double/triple time. The next flush down could, in other words, be days rather than weeks away.

3) In that interview you also said traders know the adage “never short a dull market” , there have been several articles regarding the “uptick rule” which was removed in 2007. How much effect do you think that has had on this massive volatility on the downside?

The factors that have created the volatility are the underlying fear and uncertainty associated with the impact of COVID19 on the economy which have led to a number of sessions where there is a dash for cash driving an environment where any asset with a bid is being sold. While the market rules around the uptick are important where are left with the view that it is all just rearranging deck chairs on the Titanic.

4) Do these “Algorithms” that more institutions use to trade exacerbate the downside and should the uptick rule be reinstated, or would it even be effective on these days when the market is halted on limit down?

There would be benefit from putting in place measures that serve to dampen market volatility and given more time for human market participants to sort out the current environment. That said, the last thing I think we should see is some form of an extended market holiday in which the stock market would be closed for a number of days. This is an environment where investors need to know that they have the ability to raise funds. Denying the opportunity to have liquidity would only exacerbate panic selling such as we have seen of late.

5) David we have been hearing a lot about actions the Government might take to help individuals and small business owners, which many of our clients are, could you comment on some of those measures and how impactful you think that might be?

The fiscal policy response being crafted may be overly focused on large corporations (e.g. airlines, cruise lines, hotel chains) and not enough on supporting the front-line responders who are addressing COVID19 (e.g. hospitals, specific states). For individual households the prospect of payments totaling $2,000-3,000 will be helpful and should serve to support demand as given the low level of household savings the monies received will very likely be spent.

6) We are obviously in unknown territory here with the Global epidemic, but what do you see as the “positives” that will give investors confidence, help create more stability and opportunities to buy?

Answering the questions spelled out above in Question 1 should serve as guideposts supporting investor confidence and the eventual stock market bottoming process that will unfold. Bear in mind, however, that given the likely long-term shifts in consumer and business behavior from the COVID19 pandemic, there are likely certain sectors that will remain depressed for a long time (e.g. cruise lines, commercial real estate). We will be there to help our clients find the opportunities that result.

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