Blog – Page 3

July 27, 2020 By Stephen Tally

How to Find the Right Financial Advisor: Hint, It’s Almost Like Finding the Right Spouse

I recently saw some social media thread comments where people voiced complaints about financial advisors. “Bunch of high-priced crooks” generally summed it up. I swiped passed without much thought.

Later that evening, my wife recounted a conversation she had while serving jury duty, and it made me pause. She went on to say that while on lunch break, she and two others had brown-bagged for the day and had the usual conversation in the breakroom – “What do you do?” “Are you married?” “What does your husband do?” That last one turned out to be the bingo question. My wife said that I was a wealth manager and had my own company. Juror number seven asked, “how do you know if an advisor is a good guy, and how do you decide if they’re trustworthy?” He went on to say that his father-in-law had not one, but two bad experiences with brokers/advisors, and it had cost him a great deal of money. I was sad to hear that what I discounted earlier in my social media stream may be more legitimate than I had thought. Clearly, naive thinking on my part.

I’ll confess, my wife thinks I’m a pretty good guy. (When she has doubts, I remind her she said yes!) The way she answered genuinely made me proud. She said that she had listened to me talk about my work and my work experiences so much over the years that she felt confident that her response was really the right one and the one that mattered most.

“He always asks a lot of questions. He doesn’t ever assume he knows you or what problems you need help solving. It’s really important that you like each other and that it’s hard to have a good relationship if you don’t. That’s where the trust part comes in. And, it’s important that you understand everything that’s going, and he won’t move on until you do. I wanted to say, ‘he’s like his dad, who was the most generous person ever, and he genuinely likes helping people,’ but I couldn’t explain that part.”

Great answers!

I understand the position I’m in and the importance my role plays in people’s lives. It’s serious business, and I treat it as such. I’ve learned many things in 22 years of wealth advice, but the top two things on my list that make people crazy are their kids and their money! Rightly so. Family is everything and family takes funding. Hence, the importance of hiring the right person. But, how do you know if an advisor is ethical and has your best interest at heart? If you can’t meet with my wife for a little due diligence, these tips may help.

BrokerCheck, is a repository of records for registered individuals that contains history of their troubles or lack thereof.
Google the potential advisor – you’d be surprised.
Continue to ask questions throughout the relationship
Never do anything you don’t understand. Ever.

Ask questions. Lots.

What licenses do you hold?
What custodians do you work with?
How do you charge clients?
What are your fees?
What is your investment philosophy?
Do you manage assets in-house, or is it outsourced?
What are your disclosed conflicts of interest?
What is the liquidity of recommended investments?
Can you provide cash flow modeling?
Do you provide written plans if requested?
How will we communicate?
How often will we meet face to face?
Are you an ensemble team or a solo practitioner?
How many clients do you have?

I’m not meant to be everyone’s advisor, and not everyone is meant to be my client. That is a fact. There are good reasons for that, and they’re not nefarious ones. Any good advisor should tell you the same. Being ethical and putting the client’s needs first are the minimum requirements you should expect and accept.

There were lots of good, qualified candidates out there, but I did my due diligence and married the right girl. Do your due diligence, and you’ll have a better experience too.

May 26, 2020 By Stephen Tally

YOUR 401(K) OPTIONS AFTER JOB LOSS OR EMPLOYMENT CHANGES

Sadly, the headline article in the Wall Street Journal reads “Decade of Job Gains Erased in April.” The article went on to say the April unemployment numbers hit a record 14.7% and payroll numbers dropped by 20.5 million workers. No one knows for sure, but unemployment estimates during the Great Depression are around 25%. I’ve not seen any commentary that would suggest we would match the tragedy of the 1930s, but there’s no certainty. We can all hope that the numbers are at a peak, and as the country begins to reopen, more Americans will return to work. It’s a difficult time for everyone and undoubtedly compounded for those that are furloughed or have lost their jobs.

With so many issues to address during this most unusual time, tending to your 401(k) may not be a priority. When I initially meet with clients more often than not, I discover they have a trail of 401(k) assets strewn across multiple employer plans. I don’t mean to imply that it’s inherently bad if this is the case. I do find some clients have been very diligent in keeping up with multiple accounts. But I also find that many times they’ve been neglected and are not positioned to best represent the risk budget of the client or the current economic environment. Whether you’re an employment victim of COVID-19 or maybe you’ve had a robust career and have changed employers multiple times, you should take the time to evaluate your options.

401(k) Options After Job Loss or Changes

When employment terminates, employees are no longer eligible to contribute to the retirement plan. While you aren’t required to close your account, you do have options.

Cash it out
Leave it in the old plan
Transfer it into the new plan (if you’re in a new plan and they allow transfers into the plan)
Roll it into an IRA Rollover account.

I do have strong words of caution for the first option. Cashing out your plan may result in substantial taxes due. Keep in mind your contributions have been made pre-tax, and distributions will be taxed as ordinary income. You may also be subject to early withdrawal penalties.

Determining what to do may not be as simple as you think. Or it may be as simple as, “I want all of my assets under one roof.” There are many variables to consider; the biggest being everyone is a unique individual, and there isn’t a general answer that fits everyone. I encourage you to champion your cause (assets) and take control. That may mean meeting with someone like me to see how this best fits your overall financial plan. Maybe you don’t feel comfortable deciding on your own; perhaps you don’t have the time to dedicate appropriately; or reasonably so, you don’t want to do it yourself—all good reasons to schedule a visit.

That said, let’s look at the pros and cons of the remaining three options.

Leave 401(k) Assets in Your Former Employer’s Plan

Advantages

Investment plan choices may include low-cost, institutional-class products
Investments remain tax-deferred until withdrawal
May be able to take loans against your account
May not have to take any action or complete additional paperwork
May be able to take penalty-free withdrawals if you left your old employer between age 55 and 59
Retirement plan balances may be protected from creditors and legal judgments under federal law
May be able to roll over to a future employer’s plan later
Access to investor education, guidance and planning provided to plan participants
Total costs may be lower than other alternatives
A plan fiduciary selected investment choices on your plan menu

Disadvantages

Investment choices would be limited to those in the plan
Former employer may pass certain plan administration or recordkeeping fees through to you
Even though you still participate in the plan, you would not be able to contribute any new funds
Managing investments among multiple accounts can be a lot of work

Roll over 401(k) Assets into a New Employer’s Plan

Advantages

Total costs may be lower than other alternatives
Investments remain tax-deferred until withdrawal
May be able to take penalty-free withdrawals if you leave your new employer between age 55 and 59
Retirement plan balances may be protected from creditors and legal judgments under federal law
Plan investment choices may include low-cost, institutional-class products
May have access to investor education, guidance, and planning that your new employer provides to plan participants
A plan fiduciary selected investment choices on your plan menu
If you roll over to a new employer’s plan, you may not have to take required minimum distributions (RMDs) if you decide to keep working

Disadvantages

Investment choices would be limited to those in the plan
New employer may pass certain plan administration or record keeping fees through to you
May be required to complete paperwork to have your assets moved over
If you hold appreciated employer stock in your former employer’s plan account, there may be tax consequences. You should consult with a tax advisor

Roll over Your Old 401(k) Into an IRA Rollover

Advantages

Assets are managed by a financial professional
Investments remain tax-deferred until withdrawal
Access to a wide range of investments, such as mutual funds, ETFs, stocks, bonds, and options
Access to a wide range of tools, resources, and services
May have the flexibility to convert to a Roth IRA
May still have the option to move assets to a future employer’s plan later
May be able to take penalty-free withdrawals before age 59½ in special circumstances (such as higher education expenses, health insurance premiums or first-time home purchase)

Disadvantages

Not able to take a loan against your account
Any outstanding plan loan balances need to be repaid before rolling over or you may incur income taxes and potentially a 10% tax penalty
Investment activity may incur trading-related expenses, including commissions
May not have access to the same investments in an IRA that you had in your plan
The level of protection from creditors for assets in an IRA is lower than in a plan
If you hold appreciated employer stock in your former employer’s plan account, there may be tax consequences. You should consult with a tax advisor

Mutual Funds and Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

May 8, 2020 By BFT Financial

Financial Updates | May 2020

What a difference a month makes. Global equity markets (MSCI All Country World Index) have rallied by 27% from their March lows. Last month we recommended investors stay invested in equities and not to sell at the bottom.

April’s dramatic turnaround has not altered our positive view of equities on a 12- to 24-month basis, especially relative to government bonds. However, the odds of near-term profit-taking is significant, which could lead to a renewed market correction.

Risk assets have rallied thanks to a healthy dose of economic stimulus and mounting evidence that the number of new COVID-19 cases has peaked. Unfortunately, the odds of a second wave of infections remain high. In the absence of a vaccine or effective treatment, only mass testing can keep the virus at bay.

Such testing will become available, but probably not for a few more months. Meanwhile, the global economy remains depressed. As earnings estimates are revised lower, stocks could give up some of their recent gains.

The Economy Is In Freefall

The global economy is on track to suffer its worst contraction since the 1930s. However, the combination of aggressive monetary and fiscal stimulus will prevent a rising wave of defaults from swelling to a crippling tsunami that permanently curtails household income. Given that banks and households have stronger balance sheets than in 2008, when governments ease lockdowns, the economy will recover quicker than it did following the Global Financial Crisis (GFC).

The economic lockdowns and the collapse in consumer confidence continue to take their toll on the U.S. and global economies. The eventual end of the stay-at-home orders and the progressive re-opening of the economy will halt this trend. The rapid monetary and fiscal easing worldwide will allow growth to recover smartly in the second half of the year, but only after authorities loosen extreme social distancing measures.

First-quarter U.S. growth is already as weak as it was at the depth of the recession that followed the GFC. The second quarter will be even worse.

U.S. industrial production is falling at a 21% quarterly annualized rate and the weakness in the Purchaser Manager’s Index (PMI) manufacturing survey warns that the worst is yet to come. In March, retail sales contracted by 8.7% compared with February, which was the poorest reading on record, and year-on-year comparisons will only deteriorate further. Annual Gross Domestic Product (GDP) growth could fall below -11% next quarter with both the industrial and consumer sectors in shock, according to the New York Fed Weekly Economic Index.

The International Monetary Fund (IMF) expects the recession to eclipse the recession that followed the GFC. Under the IMF’s base case, the resulting output loss will total $9 trillion in the coming 3 years.

The IMF’s forecast indicates that growth will suffer substantial downside relative to its baseline scenario if the second wave is strong and forces renewed lockdowns. In this scenario, the current package of stimulus must be increased even further to avoid a depression-like outcome.

If a second wave of infections forces renewed lockdowns in the fall, then 2020 growth could be even lower, and this would be very negative for equity markets.

The Good News

The good news is the economy will recover quicker than it did following the GFC. The deep recession engulfing the world should not evolve into a prolonged depression because banks and household balance sheets are in a better shape than in 2008.

While the recovery will be chaotic, the economy will not remain as depressed for as long as it stayed after 2008, which will allow nominal GDP to recover faster than after the GFC.

Consumers are also in better shape than in 2008. Last December, U.S. household debt stood at 99.7% of disposable income compared with a peak of 136% in 2008. More importantly, financial obligations represented only 15.1% of disposable income, a near-record low.

As long as governments help households weather the current period of temporary unemployment, consumer bankruptcies should remain manageable. The collapse in the consumption of durable goods (for example cars) has created pent-up demand, but not a permanent downshift in the demand curve.

Investment Implications

Despite short-term risks, we continue to favor equities on a 12- to 24-month investment horizon, especially in an environment where a second wave of lockdown can be avoided.

Stock valuations have deteriorated, but they remain broadly attractive. While multiples are not particularly cheap, the equity risk premium remains very high. In other words, stocks are attractive because bond yields are low.

Low inflation for the next 18 months will allow monetary conditions to stay extremely accommodative. Growth will recover in the second half of 2020, so the window to own risk assets remains fully open if we can avoid a second wave of complete lockdowns. Ample market liquidity also continues to underpin equity prices.

The Structural Outlook For Inflation… And Bond Yields

Looking further out, the outlook for inflation will depend on whether the structural forces that have suppressed the rise in consumer prices over the past few decades intensify or weaken.

On the one hand, it is possible that the pandemic will cast a shadow over consumer and business sentiment for years to come. If households and firms restrain spending, this would exacerbate deflationary pressures. Likewise, if governments tighten fiscal policy in order to pay off the debts incurred during the pandemic, this could weigh on growth.

On the other hand, high government debt levels may increase the political pressure on central banks to keep rates low, even once the labour market recovers. This could eventually lead to economic overheating in two-to-three years.

A partial roll back in globalization could also cause consumer prices to rise. Global trade was already stagnant even before the trade war flared up. The pandemic may further inflame nationalist sentiment.

On balance, we suspect that inflation will rise more than expected over the long haul. This is not a particularly high bar to clear. Investors currently expect US inflation to average only 1.2% over the next decade based on Treasury Inflated Protected Securities (TIPS) break even yields. Market-based inflation expectations are even more subdued in most other western economies.

If inflation does surprise to the upside, long-term bond yields are likely to increase by more than expected. Therefore, government bonds offer an increasingly poor cyclical risk-reward ratio. However, investment grade credit, emerging market debt and private credit might offer interesting opportunities in the next few years.

Bottom Line

We think the coming months will remain volatile and a negative development in the pandemic trajectory could set off another equity market correction.

However, for long-term investors there are opportunities to add to their risk assets in both equities and fixed income.

DISCLAIMER: The views expressed in this economic update are those of the author and do not necessarily reflect those of BFT. This update contains “forward-looking statements” that relate to future events, including future economic performance and plans. These forward-looking statements can be identified by the use of such words as “believe,” “think,” “intend,” “may,” “will,” “should,” ”expect,” ”anticipate,” “estimate,” or “could,” or variations of these terms or the use of other comparable terms. There are certain risks and uncertainties that could cause actual results to differ from those predicted in the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this update.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value. The Nasdaq Composite Index is an unmanaged group of securities representative of the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange.

The MSCI World is a market cap weighted stock market index of 1,644 stocks from companies throughout the world. The components can be found here. It is maintained by MSCI, formerly Morgan Stanley Capital International, and is used as a common benchmark for ‘world’ or ‘global’ stock funds intended to represent a broad cross-section of global markets.

April 16, 2020 By BFT Financial

Covid-19 Common Questions About the Market & Investments vLog

On April 2nd we held a webinar to address some of the questions posed by BFT Financial customers, as well as give an overview of the current market landscape. Below is a condensed version of the discussion with Stephen Tally, BFT CEO and Chief Compliance Officer. Please note, the information given reflects what was known at the time. If you would like to get the latest news and updates, please subscribe to our newsletter here.

Please feel free to also listen and watch the video version (run time of 36 minutes).

Skip to a specific question and answer section
WHAT’S THE CURRENT LANDSCAPE?
IS BFT OKAY?
WHAT’S THE IMPACT ON MY PORTFOLIO?
SHOULD I SELL AND MOVE TO CASH?
SHOULD WE BE DOING ANYTHING RIGHT NOW?
SHOULD WE BE BUYING STOCKS WHILE THEY’RE DOWN?
IS THIS GOING TO BE THE SAME AS 2008 OR IS THIS DIFFERENT?
HOW LONG IS THIS GOING TO LAST?
THE FEDERAL RESERVE IS TAKING ACTION. WHAT DOES THAT MEAN?

WHAT’S THE CURRENT LANDSCAPE?

The Virus

We know now that the virus is highly transmissible. Fortunately, we know that the mortality rate is lower than SARS, MERS and H1N1 and that the most affected are the elderly and the compromised. We’ve seen COVID 19 move from China to all parts of the world in a matter or weeks. This past week the US became the highest reported country and it’s escalated to crisis levels in New York from a care availability standpoint. New Orleans sadly may follow. But there is good news. China has seen cases drop over the last several weeks and that, for now, appears to be the result of quarantining. The numbers in Singapore, Hong Kong and South Korea support that. So, while we’re behind in the lifecycle of the situation, we have good news and evidence to draw from.

The Stock Market

This has been the most rapid market decline ever. It took 6 trading sessions to drop 10% and only 16 more to drop to 30%. We’ve recovered from the lows but have a lot of ground to regain. The thing to keep in mind is, if you go back to January 31 and take a market assessment, you’d say the economy is strong and prices are a bit elevated but within a range that’s not alarming. What has changed is clarity. The virus appeared and that caused a transitory shock to the stock market. It seems that the market reacts better to bad news than the unknown, which makes sense. You can model bad news and price in risk and future earnings. It’s difficult to model the unknown.

Earnings and Employment

What we do know now is that earnings will drop dramatically for Q2 and Q3 before they gather upward momentum and unemployment will increase as dramatically.

Gauging how far earnings will fall is tough. One economic model that I’ve seen estimate as much as a 15% decline in the S&P500’s earnings before beginning to normalize at the end of the year. That will have a negative effect on GDP. Keep in mind, not all earnings recessions are accompanied by an economic recession. That’s the good news. And, once the clouds break the market should start to price in a virus free run rate for earnings. That puts us back on an upward trajectory again.

Employment in the short term will be rough. Business closures are translating into lost jobs. Unemployment may hit 6% or worse by mid-year. No question this is a concern that’s been priced into the market. I have two positive comments here. First, we’ll be coming off a very low unemployment rate. In February it was 3.5%. As reference, the lowest in the last 70 years was 2.9% in January of 1953. Second, as the virus subsides or we develop a treatment, demand will pick up and business will need to rehire.

IS BFT OKAY?

Yes, we’ve well capitalized and most importantly we’re all safe.

Our structure builds in a safety net for you. We work with three big, great custodians, Schwab, Fidelity and TD Ameritrade. Our client’s assets are held at the custodian meaning we don’t have your cash or holdings on our register. That’s an added layer of security. If something terrible were to happen to us our custodians would be right there to help you.

WHAT’S THE IMPACT ON MY PORTFOLIO?

If your portfolio doesn’t look like the stock market it shouldn’t behave like the stock market. Meaning, if you have an allocation of equities and bonds your risk exposure is reduced. That said, there hasn’t been any place to hide.

SHOULD I SELL AND MOVE TO CASH?

If you participate in the downside don’t de-risk at the bottom. Be in a position to participate in the recovery. There are endless charts that illustrate the impact of poor investment decisions, namely selling low and repurchasing higher and the impact of missing the three best market days of the year. What you’re really saying is “I know that the market is going lower and I also know where that bottom will be.” The first part of the trade is the easy one to make, sell. The second, buy, is terribly hard.

SHOULD WE BE DOING ANYTHING RIGHT NOW?

From a portfolio perspective, the answer is most likely no and be patient. We’ve already put in the research and effort to build a solid investment portfolio and we model for good markets and bad markets.

What you can and should be doing is:

Reduce your trading. When volatility is up it’s easy to get whipsawed in a trade. If you must trade, make sure there is enough liquidity in your trade.
Review your debt load and interest rates on your debt. It may be a great time to refinance your home.
Review your cash flow-If you’re in retirement can you lower any withdrawals? Try to not sell securities to generate cash.

SHOULD WE BE BUYING STOCKS WHILE THEY’RE DOWN?

I like the thought process but be careful. If you do have cash to invest this will most likely be a good opportunity. But I’d advise to do your homework and not be in a rush. We may be at a bottom or we may be near a bottom. My preference in a situation like this is it’s better to be a little late than a little early.

Ask yourself:

“Would I have bought this 12 months ago?”
“Am I only buying this because it’s depressed?”

That’s speculation and it may or may not work out. Stocks can be priced low for a reason and there needs to be a catalyst for them to reflate.

There are plenty of good deals out there and making bets on a single stock or sector probably aren’t necessary for future gains.

Also, be aware that things will most likely change once this has passed. So, there are a lot of questions to ask. How will business be transacted once we’ve become accustomed to virtual interactions? What solutions did we adopt and are they likely to stay in place? Business will resume once we get the all clear but it may not look completely the same.

IS THIS GOING TO BE THE SAME AS 2008 OR IS THIS DIFFERENT?

I don’t think so. We don’t have the baggage like we did in 2008. Bad debt, housing market in shambles, banks with loads of bad assets on the books, failed investment banks; all that is absent.

We also have better tools and regulations in place. I’m sure you’ve all heard “limit down and limit up.” In 2008 it was curbs and market halts. Limits are used to ensure proper trading and liquidity in trading. We’ve seen record volume and the processing has been very good.

Banks are much more capitalized.

You and I have less debt and more in savings than ever before.

And to my earlier point, the market didn’t have a fundamental problem two months ago. I can’t say we’ll pick up right where we left off but once we get past quarantining a great deal of demand will pick up and employment should follow suit.

HOW LONG IS THIS GOING TO LAST?

I wish I had an answer, but I don’t. If we follow the quarantine that will be helpful. But this one is up to the scientists. Fortunately for us, the world’s best is working in concert.

I KEEP HEARING THE FEDERAL RESERVE IS TAKING ACTION. WHAT DOES THAT MEAN?

This is an “at all cost” initiative for every country.

Monetary Policy

The Fed has been all in from day one. They were ridiculed at first for attempting to fight a virus with a rate cut while in reality they were signaling their commitment.

Cut the overnight rate to zero
Bond buy backs of treasuries $700 billion, mortgage backed $200 billion and first time ever some corporate bonds
This puts more money in circulation and adds much needed liquidity
Back stopping prime money market funds

Read the most recent updates on the Federal Reserve responses to COVID-19.

Disclosures:

The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of BFT Financial Group. Neither BFT Financial Group nor the author makes any warranty or representation as to the accuracy, completeness or reliability of this information. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall BFT Financial Group be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither BFT or the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.

April 13, 2020 By BFT Financial

Quarterly Review Q1 2020

In the first quarter of 2020 the Dow Jones Industrial Index2 declined 23%, which makes it the worst quarter in its 135-year history1. However, the Dow declined 38.4% from February 19th till March 23rd before a rebound in the last week of March. Markets have never dropped this far this fast before.

A month ago, there was still hope that the Coronavirus outbreak could be brought under control before it would paralyze the global economy. Since then, the number of new, recorded COVID-19 cases has mounted every day and outright fear prevails.

At the moment, a painful global recession is underway. Consumers are not spending; firms are facing a cash crunch and potential bankruptcy. And globally employment will be slashed. The next few quarters could result in some of the worst Gross Domestic Product (GDP) growth numbers since the Great Depression.

Risk assets have very quickly discounted this dire scenario. The global stock-to-bond ratio has collapsed by 47% since its peak in January. 10-year US bond yields temporarily fell below 0.4%¹.

The dollar has rallied against every currency and even gold traded below $1500 an ounce. Brent crude trades below $30/bbl¹.

In this context, investors must assess if risk asset prices have declined enough to compensate for the economic hazards created by the COVID-19 pandemic. If the massive amount of monetary and fiscal stimulus announced can turn around the economy in the second half of the year, then stocks and risk assets are attractive. Otherwise, they are still not cheap enough.

It is important to remember, this is a medical crisis and the situation is not comparable to the Global Financial Crisis (GFC) of 2008 or even the 1930s depression. While the shock is of unknown depth and duration, what we do know is that the containment measures and social distancing almost automatically bring economic activity to a halt. The impact on economic activity will likely be sharp and deep. We see the shock as akin to a large-scale natural disaster that severely disrupts activity for one or two quarters, but eventually results in a sharp economic recovery.

The OECD released its estimate of the economic impact of COVID-19 lockdown policies around the world. The sobering conclusion of the OECD’s work is that the initial direct impact of the shutdowns could be a decline in the level of output between one-fifth to one-quarter in many economies. Put differently, the OECD’s estimates imply a decline in annual GDP growth of up to 2 percentage points for each month that strict containment measures continue. If the shutdown continued for three months, with no offsetting factors, the OECD’s research suggests that annual GDP growth in OECD economies could be between 4-6 percentage points lower than it otherwise might have been.

Fortunately, monetary and fiscal authorities are responding forcefully to the crisis, but the length of the lockdowns remains a major source of downside risk to the economy. We see encouraging signs from major central banks and governments that monetary and fiscal response is starting to take shape. The pledged policy response has been swift, and we expect total fiscal stimulus to be similar in size to that of the global financial crisis but compressed into a shorter timeframe. At this moment, global governments have pledged an amount of economic stimulus equal to 5% of global GDP. In the US, the Coronavirus Aid, Relief, and Economic Security (CARES) Act provides for fiscal spending on the order of 10% of GDP, the majority of which is likely to be spent this year.

Macroeconomic Outlook

The global economy is now in recession and this has occurred because policymakers saw it as the lesser of two evils. They judged, with good reason, that a temporary shutdown of most non-essential economic activities was a price worth paying to contain the virus.

Outside of China, the level of real GDP is likely to be down 1%-to-3% in Q1 of 2020 relative to Q4 of 2019, and down another 5%-to-10% in Q2 relative to Q1. On an annualized basis, this implies that GDP growth could register a negative print of 40% in some countries in the second quarter, a stunning number that has few parallels in history. Growth in China should stage a modest rebound in the second quarter, reflecting the success the country has had in containing the virus.

Nevertheless, the level of Chinese economic activity will remain well below its pre-crisis trend, with exports increasingly weighed down by the collapse in overseas spending.

A One-Two Punch

The “sudden stop” nature of the downturn stems from the fact that the global economy was simultaneously hit by both a massive demand and supply shock. When households are confined to their homes, they cannot spend as much as they normally would. This is particularly the case in an environment of heightened risk aversion, which usually leads to increased precautionary savings. At times like these, businesses also slash spending in a desperate effort to preserve cash.

All this reduces aggregate demand.

On the supply side, production has been impaired because of workers’ inability to get to their jobs. According to the Bureau of Labor Statistics, less than 30% of US employees can work from home. Since modern economies rely on an intricate division of labor, disturbances in one part of the economy quickly ripple through to other parts. The global supply chain ceases to function normally.

The fact that both shocks have been concentrated in the service sector, which represents at least two-thirds of GDP in most economies, has made the situation even worse. During most recessions, the service sector is the ballast that helps stabilize the economy in the face of sharp declines in the more cyclical sectors such as manufacturing and housing. This time is different.

The Night Is Always Darkest Just Before Dawn

“The night is darkest just before dawn. But keep your eyes open; if you avert your eyes from the dark, you’ll be blind to the rays of a new day…So keep your eyes open, no matter how dark the night ahead may be.” – Hideaki Sorachi

Right now, we are fighting an invisible enemy that is ravaging the world. However, victory might be in sight. The number of new infections has peaked in China and South Korea. We should watch Italy closely. If the number of new infections peaks there, that would send an encouraging signal to financial markets that other western democracies will be able to get the virus under control. While it is too early to be certain, this may be happening: Both the number of new cases and deaths in Italy have stabilized over the past week. Of course, there is still the risk that the number of new infections will rise again if containment measures are relaxed prematurely. Nevertheless, it is likely that global growth will begin to rebound in the third quarter of this year.

President Trump signed into law the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The bill provides fiscal stimulus of $2.2 trillion (or 10% of GDP), with at least 46% of the spending taking the form of direct funds for households and small businesses including $290 billion in direct cash handouts to middle-class households.

For investors, the passage of the law shifts the question about stimulus from “how big?” to “how effective?”. It is difficult to answer that question with high confidence because it depends in large part on the duration of the physical distancing measures in place. But at least two factors argue in favor of its effectiveness: the total size of the plan is large relative to other countries and relative to the fiscal stimulus that occurred in 2008/2009, and the plan will disproportionately benefit lower-income Americans who will likely need assistance the most. And U.S. politicians have already hinted that a second stimulus package might be a possibility if necessary.

The Fed has also dusted off the whole alphabet of programs created during the financial crisis to improve proper market functioning, and has even added a few more to the list, including a program to support investment-grade corporate bonds and another to support small businesses.

The good news is that there is no limit to how many dollars the Federal Reserve can create. The Fed has already expanded the supply of bank reserves by initiating the purchase of $500 billion in treasuries and another $200 billion in agency mortgage-backed securities (MBS) since relaunching its QE program on March 15th. Further MBS purchases will be especially useful given that mortgage rates have not come down as quickly as Treasury yields.

The Shape of The Recovery: L, U, or V?

Provided that the number of new infections around the world stabilizes during the next two months, growth should begin to recover in the third quarter.

What will the recovery look like? From the perspective of sequential quarterly growth rates, a V-shaped recovery is inevitable simply because a string of quarters of negative 20%-to-40% growth
would quickly leave the world with no GDP at all. However, thinking in terms of growth rates is not the best approach. It is better to think of the level of real GDP.

The following chart shows three scenarios:

A rapid V-shaped recovery where output quickly moves back to its pre-crisis trend.
A sluggish U-shaped recovery where output slowly rebounds starting in the second half of the year.
An L-shaped profile for real GDP where the level of output falls and then remains permanently depressed relative to its long-term trend.

In the end it will depend on how long it takes before the world will be able to go back to work. But when it does, the amount of fiscal stimulus will likely help the global economy to rebound in a way that is in between a V and U shape. In other words, we are more positive on the economic rebound then the majority of the current media reports.

Government Bonds: Deflation Today, Inflation Tomorrow?

As noted at the outset of this report, the current economic downturn involves both an adverse supply and demand shock. Outside of a few categories of consumer staples and medical products, we expect demand to fall more than supply, resulting in downward pressure on prices. This deflationary shock will be enlarged by rising unemployment in the short-term.

Looking beyond the next 12-to-18 months, the outlook for inflation is less clear. On the one hand, it is possible that the psychological trauma from the pandemic will produce a permanent, or at least semi-permanent, increase in precautionary savings. If budget deficits are reined in too quickly, many countries could find themselves facing a shortage of aggregate demand. This would be
deflationary.

On the other hand, one can easily envision a scenario where monetary policy remains highly accommodative and many of the fiscal measures put in place to support households are maintained long after the virus is eradicated. In such an environment, unemployment could fall back to its lows, eventually leading to an overheated economy, which would lead to higher than expected inflation.

We think that the more inflationary scenario over the next 2-to-3 years is more likely. Interestingly, that is not the market’s opinion. For example, the 5-year US TIPS breakeven inflation rate is currently only 0.69% and the 10-year rate is 1.07%. This means that a buy-and-hold investor will make money owning TIPS versus fixed coupon Treasuries if inflation averages more than 0.69% per year for the next five years, or 1.07% per year for the next decade. That is a bet we would be willing to take.

Equity Markets

In order for equity markets to find a bottom and start a more sustainable recovery, markets need to have more visibility on the potential economic outcome. Right now, the market does not see the light at the end of the tunnel but that could change quickly if we see the growth rate of the number of new infections starts to decline, especially in the U.S.

If and when that happens investors can start to estimate the length of the showdown and equity markets will quickly start to discount any recovery.

As mentioned before, we think the outlook is not as dire as the market now thinks. The extraordinary amount of fiscal and monetary stimulus will limit a lot of the current damage. And the market is discounting a lot of damage at this moment. We don’t know if of the market already has reached its bottom or that there will be further downside in the coming months, but we do think that
equity markets will start to offer value and are likely to be higher on a 12-month basis. Some of the sectors that had the largest selloffs like energy and financials could become outperformers in such a rebound.

Investment Strategy

The recent market volatility has been extreme, and it was made worse by the fact that liquidity in the market was severely disrupted, which led for example to a large selloff in investment grade fixed income ETFs and funds3. Only when the Fed stepped in and announced effectively unlimited liquidity operations, markets started to normalize.

As long-term investors, event driven market corrections generally do not move us to make changes in our asset allocations. Given the large movements in the stock versus bond ratio resulting from the market sell-off, a rebalancing of portfolios back to their strategic allocation will likely be appropriate once the market volatility calms down.

¹Performance data by Bloomberg.

²The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded “blue chip” stocks, primarily industrials, but includes financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks.

³ Mutual Funds and Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

Disclosures

Securities and investment advisory services offered through BFT Financial Group LLC, a registered investment advisor. Member FINRA, SIPC, MSRB.

This material represents an assessment of the market and economic environment at a specific point in time an is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.

This document may contain forward-looking statements based on BFT Financial Group’s expectations and projections about the methods by which it expects to invest. Those statements are sometimes indicated by words as “expects”, “believes”, “will” and similar expressions. In addition, any statements that refer to expectations, projections or characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Such statements are not a guarantee of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore actual returns could differ materially and adversely from those expressed or implied in any forward-looking statements as a result of various factors.

Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market. They are methods used to help manage investment risk.

Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.

Investments in emerging markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.

The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

You cannot invest directly into an index.