21 September 2020
Not so GREAT EXPECTATIONS
There has been a lot of excitement in the marketplace, especially among those investing in large technology firms, and for good reason. Big technology companies had an amazing run over the last few months. While Greedy Farmer portfolios made modest gains off the less-discussed long-duration treasuries (U.S. federal government bonds) and gold, it is the stock market which attracts the attention of most people.
Is my glum blog title appropriate in light of the stock market recovery since late March? Eh, yeah, I think it is appropriate… because of the economy… it still stinks!
It would be fair to say I should also be glum for missing out on the technology stock boom. Yes, it would have been nice to own more of that than I did, but, in general, I am happy with my Greedy Farmer portfolios as they have performed much better than markets at the low (late March), generally better in the mid-range and only trailed moderately at market peaks (think February and early September). This is where I want to be. Fundamentals remain poor and risks abound.
The stock market rebound has been more amazing than expected as a result of unprecedented action by the world’s major central banks and governments. In hindsight, there were clues that such unbelievable government measures would be taken, that a maximum level of liquidity and fiscal stimulus would be introduced. Even though it was unimaginable American citizens would, on average, experience an income increase of 12% so far this year, that is what really happened. Economist David Rosenberg explained this to Ian Brown on August 2nd, “Q&A with David Rosenberg: Pandemic economy calls for discipline and patience”, The Globe and Mail – Report on Business”. Rosenberg notes, the government transfers have been equally dramatic here, in the Great White North. As I mention, there were pre-pandemic clues that such dramatic action would be taken. Let’s explore those clues by looking at government action pre-Covid.
What happened pre-Covid? Big government spending (and deficits) and easy monetary policy were both implemented pre-Covid, that is what happened! Governments North and South of the 49th parallel were increasing deficits by spending more and by introducing poorly designed tax changes while easing monetary policy (creating lower interest rates) at the top of the business cycle, which is never good. Governments took these actions despite the knowledge that is available to all of us, that economic cycles rarely last longer than 5 – 10 years at a maximum, yet our governments were determined to buy more time for our economies. While they may have believed this would buy them election success, it is unfair to all of us, as we are being bribed with our own money and we pay the price of the economic hangover after.
If government does not pay down debts and tamp out bubbles during the top of the business cycle, when can they? Just as rich / doting parents may choose to save a kid from many hardships during their youth, may set them up in the family business and attempt to ensure success and shelter them from the bumps and bruises of earning their own way in early adult-hood. In a similar way, our governments attempted to forever protect us from recession it seems. Now our economy may remain soft for a long time, weighted down by massive debts and declining demand.
I won’t review the details of the government actions here and now. It is simplest to point out the situation on the ground, pre-Covid. Even before the scourge of the virus, interest rates of all term length were held down and government deficits had climbed dramatically. Maybe even more importantly, total net debt per citizen of Canada and America (adding government, corporate, and personal debt) was at all-time highs despite very low unemployment rates. The result, no one was prepared for an economic shock.
Many experts had been warning of the eventuality of a pandemic (we had just experienced SARS, H1N1 and MERS in some parts of the world) just as we have also been warned of a “catastrophic solar flare” that will knock our power-grid apart as per Ethan Siegel senior contributor to Forbes Magazine, “This Multi-Trillion Dollar Disaster Is Coming, And Solar Astronomy Is Our Prime Defense”. These are the kind of things that sound far-fetched, but governments are supposed to be ready for. They are supposed to have plans in place, money set aside in just the same way you have life insurance, that you never plan to use. It isn’t any different. They cannot say, “no one could have known this would happen” as some government and corporate leaders have said for over six months now. Governments are supposed to prepare for the unexpected, why else would you have a military?
One way to prepare for the so-called unexpected, have money or borrowing room remaining. Worded another way, knowing that economies cycle, pay down debt at the top of every cycle so you can spend during recessions and pandemics without breaking the bank, as we are now.
Back to my original criticism… of my own expectations… I should have expected government to save the day, bomb us with money, resurrect a good part of the stock market. When the government trend of the day is to spend in good times, I should know they will spend like mad men in bad.
Yet, government does not always control everything, so even though a bailout of the economy could have been expected, all may not be saved. Government cannot prevent bankruptcies where there is no profit, for example. Some skepticism was warranted and still is. This economic drama may not have played itself out quite yet.
As an aside, it is important to note, Capitalism needs recessions. As harsh as that sounds, we don’t yet have a process that keeps productivity improving, that leans out our processes, culls the weak companies, the surplus labour, the inefficient methods, other than a recessionary reset. A mild, manageable recession is what strengthens our economy putting us in a better position to battle unexpected shocks such as Covid-19. Government needs to allow healthy, gentle recessions to occur.
All of this to say, again, it should not have been a shock when huge fiscal transfers and monetary easing was implemented as the Covid 19 shock began to play out. That is enough history for now, let’s look forward.
Has the spending and the liquidity (crazy-low interest rates / government purchases of bonds to expand the money supply) healed the economy and saved us from hardship? I think it is more reasonable to think government action has delayed and spread the hardship into the future while taking the sting out of the initial shock.
What does this mean for investing? It appears, deflation will remain a concern, at least in the near term. It seems, rather than the “V” shaped recovery the stock market indexes appear to predict, a long drawn out climb out of the ditch is more likely as bankruptcies, additional layoffs, and debts pile higher… the easy gains have been made and a market backslide may be underway, even among those technology giants that have boomed of late.
A market slide may also be driven by public sentiment and consumer behaviour because of the emotional impact of the pandemic / shut-down shock. Scroll to the bottom of this blog where this idea is explored, in the Additional Thought.
At this point, I want to reflect briefly on the Greedy Farmer Investing Plan from late March and include A Revised Plan for Today.
The End-of-March Investing Plan With Revisions For Today:
Plan: A very gradual trimming of the long duration U.S. treasury holdings
Actual: I purchased a couple percent more, but the total value fell as treasuries lost some ground and are now worth just over 30% of the Greedy Grower
Plan: A gradual increase in gold holdings
Actual: I did buy more gold & they gained value – now about 26% of the Greedy Grower
Plan: Grow cash holdings from the bond trimmings (treasuries)
Actual: Cash did grow but from various stock sales, not from treasury sales – cash is now around 30% of Greedy Grower
Like I had indicated, a plan was needed even if it was soon altered. The plan was a reference point to adjust from. As it became apparent that deflation would be a greater force than inflation the bond trimming was delayed, and gold purchases were accelerated some.
To repeat the title of the last Deep Thought, this is THE PLAN NOW as we head into October and then the U.S. election and maybe a Canadian one as well?
Hold steady, the long duration treasuries (ZTL) and either trim holdings as they grow or purchase Real Return Bonds to hedge against inflation. I do not expect to buy the Real Return Bonds but that is a possibility if inflation did appear. Inflation makes a lot of headlines, from time to time, however the people I read think it is still some time away. I expect to trim ZTL and VGLT back to 30% once they become 35% of holdings.
Hold steady, the gold holdings. I expect to hold up to 30% gold related holdings and trim back to 26%, on occasion.
Stock purchases will be selective and cautious in the coming months. At present they make up around 10% of holdings. This assumes we are heading into a stock-market pullback. At the same time, we never really know that and will never accurately pick the bottom. We will never know for sure what governments will do, so that is possibly the most difficult variable.
In the end, the Greedy Farmer Investing portfolios have proven to reduce the depth of the lows, still have increased in value through most of the year, are well positioned to profit in an uncertain future.
Exact and real time portfolio positioning is provided to those with Greedy Farmer Investing memberships. A detailed portfolio update will be completed by mid-October and will show end of third quarter holdings for the Greedy Grower, Retired Grower, and the smaller / more simple Greedy Builder portfolios. Greedy Farmer Investing complete transparency means I will continue to update my performance on the website weekly.
Good Investing, Stay Greedy!
Another economic factor to be accounted for and which has been written about in The Economist magazine, is the impact of the Covid 19 pandemic on public sentiment, “Psychological scars of downturns could depress growth for decades: Research presented at Jackson Hole conference models the effect”.
People dramatically and emotionally affected by Covid-19 may view the world differently going forward. People may alter their view of the world believing they need to hold a higher amount of savings, a larger cash cushion, if you will. Since people, and it may be a lot of us, based on historical studies, will be saving more, we as a result, will spend less. The spending or actually the saving level is tracked by the U.S. Bureau of Economic Analysis. That institution tracks the personal saving rate – which is that part of income people save. Below, is a chart of the most recent such data, shown twice. The first chart makes it easy to see how high the saving rate spiked, upon the initial impact of the pandemic and lock-down and what saving rate it has settled down to, so far. We can note, the saving rate has generally been less than 7.5% for the last 25 odd years and, so far, since the Covid 19 virus experience has impacted the U.S. economy, has settled down to 17.8% after spiking much higher. If it stays as elevated as even 15%, that is 7.5% higher than recent history (15% – 7.5% = 7.5%). Using very simple mathematics and knowing about 70% of the U.S. economy is supported by consumer spending, we can calculate as follows: 7.5% personal savings rate increase X 70% of the economy which is consumer spending = 5.25% reduction in U.S. economic activity. To understand what this means note that the U.S. economy was growing about 2.5% per year, using the 2019 growth rate. A 5.25% economic slow-down is big.
The second chart, below, provides the U.S. saving rate since 1959 to provide some context. You can easily see how rare a saving rate at the current rate of 17.8% is.
Conclusions should not be made yet, however. The incredible government cash transfers did provide a lot of people with excess savings, as did staying at home / not spending. Many people have saved these surplus funds, which came from an unexpected source (the U.S. treasury) and this has never happened before. The personal savings rate will need to be tracked for a while to see where the trend goes from here. Economics never provides a final answer!
U.S. Bureau of Economic Analysis, Personal Saving Rate [PSAVERT], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/PSAVERT, September 6, 2020.
A similar effect of the pandemic will be individuals’ comfort with risk. Individual investor “risk appetite” is lessened when there is less confidence in the future and this is also discussed in the “Psychological scars…”, Economist article. This lower risk appetite may elevate investors’ desire to hold lower-return, lower-risk companies. This could result in lower economic growth as newer, innovative, potentially more productive technology is often considered riskier and thus no longer thought of as investible.
There… gloomy yet? That is not the intention. We just need to be realistic, as investors. There are still ways to make money, we just need to focus on sectors that do well during such problem times, such as gold; and we need to invest in innovative companies that have found a way to profitably grow. We need to take on risk, but the right kind of risk, and then diversify the risk.
A further caveat to the down-in-the-dumps review… the world does move faster than it did in the past. Technological developments and world trade (assuming we still allow world trade!) force good things through our often stubborn, short-sighted decision processes. Our job, as investors, is to reward ourselves by rewarding the best priced, best run companies. Sort of a greedy but virtuous circle!
Good Investing, STAY GREEDY!
Ian Brown, “Q & A with David Rosenberg: Pandemic economy calls for discipline and patience”. The Globe and Mail – Report on Business, August 2nd, 2020.
Ethan Siegel, Senior Contributor, “This Multi-Trillion Dollar Disaster Is Coming, And Solar Astronomy Is Our Prime Defense”, Forbes, January 31, 2020. Also, Starts With A Bang – contributor group.
“Psychological scars of downturns could depress growth for decades: Research presented at Jackson Hole conference models the effect”. The Economist, Finance & Economics, Free Exchange, August 27th, 2020 edition.