Hosted by Creative Planning Director of Financial Education Jonathan Clements and President Peter Mallouk, this month’s podcast looks closely at locking in financial benefits amid economic uncertainty. They also discuss what’s rallying the Bear Market; the types of companies that are leading the way; and the role of tech stocks and their sustainability.
Time Stamps:
[0:00] – The Bear Market rally, and why it’s happening
[3:10] – The when – not if – of recovery
[7:00] – How large-cap stocks and tech companies are dominating
[10:30] – Alphabet soup recovery types
[14:23] – What you can do NOW!
[22:22] – Peter and Jonathan’s tips of the month
Transcript:
Jonathan Clements: Hi, this is Jonathan Clements, Director of Financial Education with Creative Planning in Overland Park, Kansas. With me is Peter Mallouk, President of the firm. And we are Down the Middle. Peter, it’s May 1st, and we are in the middle of a bear market rally. We saw the S&P 500 drop 34%, and since then we’ve clawed back more than half of that loss. What’s going on?
Peter Mallouk: Well, I think when this first started out, you had the combination of all this information about the coronavirus with no clarity whatsoever. How does it spread? Is it going to be a big deal? Is it not? Should we wear masks? Should we not wear masks? We still don’t have a great amount of clarity, but we have infinitely more than we had when this all started.
The second thing that we had was this concern around the collapse of this financial system itself, like we had in ’08, ’09. There was a lot of people go to the bank and requesting cash. People were dumping everything, even high-quality bonds. And we saw the Federal Reserve, Congress, the President, everybody go all in in a way that is unprecedented in the history of the United States to support all of these markets, saying they’d print all the cash that was needed to cover any withdrawal from a bank, thus preventing a bank run, saying they were going to back up the bond market, which instantly, within one day corrected a lot of losses from the bond market. And the market immediately repriced everything, going 21% in two and a half days following those announcements. It was very, very rapidly.
So we removed from the equation, the first part of the bear market rally was removing from the equation systemic failure. So now we’re just left with, well, what are the consequences of coronavirus? How much unemployment is there going to be? And more importantly, how much of it’s going to stay that way? It’s one thing if a restaurant terminates everything. It’s another thing if the restaurant doesn’t rehire them all and reopen in 45 days.
So I think where we are today, we’ve got more information going into our models around how this spreads, where it spreads. Does heat matter? Are these new medications going to work? The new announcement from Gilead yesterday, for example. We’re getting a little bit more clarity, but we’re still way off our highs. Especially when you get away from the obscured large-cap U.S. market, we’re still well off our highs because the market really doesn’t know how this is going to play out because anybody who knows anything about a model knows put garbage into it, you get garbage out of it. If you put things into a model that are uncertain, which is where we are now, you’re going to get a lot of uncertainty coming out on the other side. So I think the broader markets and the global markets still way off their highs is where it’s supposed to be in all things considered.
Jonathan: But I guess the difference now from say a month ago is that at this juncture people are really thinking about not whether we’re going to recover, but how long it’s going to take. So go back five or six weeks and people were thinking this is going to be economic apocalypse. We have no idea when this pandemic is going to be over. And now people are saying, “Okay, the economy’s going to recover and we are moving quickly to address the health aspect of this even if we don’t know how quickly we’re going to have a super effective treatment and how quickly we’re going to have a vaccine.” And so that’s a much better place to be.
Peter: Yeah, you’re exactly right. And if I look at historically at all of the major bear markets, we just go back to the last in ’08, ’09, when you shift away from is everything going to just fall apart to how long is this going to take, that’s a very different dialogue.
Now, there are some investors in certain markets that still have the existential question of is this all going to fall apart if you have a certain basket of stocks? But for the diversified investor, you’re right. I mean, the when is this going to turn is a lot better spot to be and accounts for a lot of things. And I think that’s because of the government’s actions to really remove the systemic risk and some of the early progress we’ve made with that commitment to finding a treatment.
Jonathan: So, I think one of the things that is really important for investors to keep in mind going forward from here is that the focus is going to be on the future and not on the current economic numbers that are coming out because those are going to be pretty ugly for at least a couple of quarters. We’re going to see high unemployment. We’re going to see slow economic growth. And also for anybody who pays attention to stock market valuations, one of the things that we’re going to see pretty soon is the market’s price-earnings ratio, which is probably the most widely watched valuation measure, is going to start to look awful because corporate earnings are going to start to look awful in the short term. And if earnings are lousy, then that means price-earnings ratios are going up. But it doesn’t mean that stocks aren’t a good buy.
At this juncture, one of the most interesting things about how this decline has played out is that even though the numbers are going down rather than up, this looks very much like 2019 stock market. What do I mean by that? Well, we’ve seen U.S. shares outperform foreign shares, we’ve seen growth stocks outperform value stocks, and we’ve seen large company stocks outperform small company stocks. What do you think explains this pattern that we’re seeing, Peter?
Peter: I think that there’s so many different things going on within this. And I think a book can be written just about this topic whenever the U.S. large-cap run is over. I mean, if we look at historically the number of times large U.S. stocks beat international and emerging markets and small cap and mid-cap and so on over a 10-year period, it’s a small majority of the time. But if we look at the last 10 years, large U.S. has been where it’s at. It’s really outperformed small stocks, foreign stocks, emerging. The reason people invest in these other asset classes is they expect to do better, just like you invest in stocks instead of bonds because you expect to do better, otherwise why bother?
And when we look at a year like this year where bonds have done much, much better than stocks, no one throws up their hands and says, “Well, I’m never going to own stocks again. I’m going to own all bonds.” They understand that one in four years bonds do better than stocks, but on occasion bonds do better than stocks for even five years or 10 years. But even in those markets, people usually think eventually that will turn.
The dialogue between large U.S. stocks and everything else is a little different. I think some people think this is here to stay and large U.S. is just going to do better all the time. And that, of course, doesn’t make sense to anybody that understands how the risk premium works. No one would ever invest in a small company again.
And I think we have a couple anomalies all taking place at the same time. So first, from 2000 to 2010, international stocks, emerging market stocks, small stocks, they trounced large U.S. stocks. Large U.S. stocks earned zero over 10 years and everything else crushed it. And the narrative then was, “Oh, the U.S. has already grown. It’s late in the cycle. If you want to outperform, you should be overseas. How obvious could this be?” Right? And so that was one component of it is just basic reversion to the mean, something John Bogle talked a lot about had to account for some of it.
But the second story, and I think the bigger story is the rise of big tech. So very big technology is infinitely scalable and it’s ubiquitous, it’s everywhere. And if you look at the five biggest stocks in the S&P 500, they make up more market cap than the bottom 350 stocks. That’s how big companies like Apple and Microsoft and Google and Facebook are. I mean, these are huge companies. Until a few years ago, we didn’t have a single trillion-dollar company. Now we have a whole bunch of these big tech companies that are around the trillion-dollar mark. Now the question is how long can that go on is one of the questions.
But the third anomaly is in this down market, when we have a down market, people worry more about small stocks than large, obviously, because it’s less likely that your local restaurant chain, even if it’s publicly traded, is going to survive, but it’s very likely McDonald’s and Chipotle are going to survive.
And the fourth anomaly is you have what are people doing when they’re inside? They’re on Facebook. They’re using Google. They’re using the technology. They’re going to Amazon instead of going to a retail store. And so these huge tech companies that have outperformed everything else are suddenly outperforming again because everyone’s needing to use technology while they’re inside.
So you have all these factors in the large U.S. tech company space. And when will it turn? I think when you get out of the crisis, you lose, obviously, the component of people moving towards this. But there will still be the tail effect of people migrating towards using big tech. I mean, there are people, that somebody somewhere on the corner of the Earth wasn’t using Amazon as much as they are now, people who weren’t using Zoom until now, and so on. I think some of this is going to linger.
But I think, make no mistake, over the long run can these trillion-dollar companies, are they going to become $4 trillion companies before the rest of the market grows a lot? How much more can they grow relative to these other companies? Eventually, there will be a rotation to another asset class. And it usually happens when everyone’s thrown up their hands and said, “This is the new normal,” which the last time that happened was when people said, “We shouldn’t be invested in large U.S. stocks because it’s been a decade. Clearly, this isn’t the path for the future.”
Jonathan: So, we’ve had this pretty brisk stock market recovery over the last five weeks or so, and we’re thinking about, well, what is it going to take to have further stock market gains from here? As you mentioned, Peter, certain sectors of the market are still way below their highs, even if the large-cap growth stocks aren’t. And one of the things that there’s been a lot of discussion about, and I know you’ve written about, Peter, is what’s going to be the shape of this economic recovery? Is it going to be V-shape? Is it going to be U-shape? Is it going to be L-shape? You just recently introduced me to a new version of this, the square root shape. And the W. The W was new to me as well. Should people concern themselves with this or is this really just a matter of managing your own expectations?
Peter: Yeah. I think that this is the way people make predictions. And I think that all of these are coming out of, again, the things that are going into the math, right? To know what kind of recovery you’re going to have, you have to know when people are going to feel safe going about business as normal and how long it takes to get there. It takes a long time, it takes longer for people to get employed. The short time, people can get employed more quickly.
So does anyone know the answer to that? I think a lot of people think they know the answer. There seems to be a big group that thinks we’re all going to go back to work and everything’s going to be fine and it’ll disappear in a month. There also seems to be a big group that thinks we’re going to go out there and there’s more coronavirus everywhere than there was when this started. And so it will spread even faster and we’ll all wind up back in quarantine.
And if you have conviction around those things, then you have your shape of the recovery. If you think everything’s going to be back to normal and we all go back to work and we’re going to get a treatment or something very, very quickly, or it just burns out or whatever it is, that that particular group thinks, well, here comes your V-shape recovery. If you think we’re all going to go back out there, it’s going to spread quicker than ever, and we’re all going to be back home, well, then the market’s going to tank again on main street and for Wall Street, and then we’ll have to recover later, which means we’ll have our W-shape recovery.
So I don’t put a lot of stock in these things. We could literally have any shape. And the most likely one is we go back to work and there are fits and starts. It’s not going to be a V, it’s not going to be a W, it’s going to be a graph that somebody will have to make up a new letter for or a new symbol for when it’s all said and done. But at the end of the day, no one knows because everything’s derivative of this big event we’re having.
And then also, let’s just say for a second that somebody has total certainty around that. Let’s just take the most optimistic scenario, everyone goes back to work, there’s a total cure in a week. Even there, we don’t have total certainty because an investor never has total certainty with the stock market. Even before coronavirus, we didn’t know how the stock market would do a week, a month, or a year from now. So we certainly aren’t going to know just because of what happens with the coronavirus. I mean, there could be a war, there could be a terrorist event, someone in North Korea could die and who knows what their successor will be like. We could get into a trade war with China. I mean, just all the normal variables we used to talk about before coronavirus are still going to be there.
I’m curious your thoughts about all of this, Jonathan. You’ve written a lot about the markets through all of this. How do you see this playing out and how investors are perceiving it?
Jonathan: Peter, if my livelihood was dependent on forecasting the stock market, I would be a very poor man. There’s no percentage in trying to guess which way the economy’s going, which way the stock market’s going. And frankly, to be a successful investor, you don’t have to be. None of us control the economy. None of us control which direction the markets go in. And so what we should do is just accept that and then focus on the things that we can control.
And so what I’d do, Peter, is just move on to the next thing we want to talk about, which is what should folks be doing right now? What are the things that are within our control? For instance, something that you and I have talked about extensively in the past is this is a great time to be rebalancing your portfolio. If you came into this market decline with a say 60% stock, 40% bond mix, at this juncture you might be down to let’s say 50% stocks and 50% bonds.
If you have a consistent bone in your body, this is the point at which you say it’s time to rebalance, it’s time to get back to my target percentages, and that means I should be moving money out of bonds and into stocks to get my portfolio back to the risk level that I settled on in calmer times. And when you do that, ideally you do it in a retirement account so you don’t end up triggering big tax bills. So I would say rebalancing, that’s one thing that you can do. You can control your portfolio’s risk level. And if you haven’t done it to date, now’s a great time to be doing it.
So what else would you be telling people to do right now, Peter?
Peter: Yeah, what I love about that rebalancing is it’s forced selling high and buying low. It’s forcing you in this environment to sell bonds and buy stocks. And if someone’s got the discipline to do that ongoing, they’re going to come out ahead. They’re going to break even ahead of the market.
I think the other thing that an investor can do is look for tax losses and realize them. A lot of people wait till December to do this. Your S&P 500 fund is down, and if you wait till December, maybe it’s positive then. But today it’s down. So sell it and go buy a fund that’s similar but not the same, that’s correlated but not the same. And you’re able to put the loss on your tax return, but you’re not market timing, you’re staying in the market. So it’s an easy way to improve your after-tax returns without taking a risk, one of the few freebies in the tax code. You just have to take advantage of it as well.
Jonathan: So, I think another thing that people should be doing right now even as they take tax losses, even as they look to rebalance their portfolios is they should step up their savings rate. So one of the things that I have is I have a solo 401(k) plan for my self-employment income, and I maxed that out five or six weeks ago. I normally put money in gradually over the year, but this was my opportunity. So I put in the full $26,000 to max out that plan for 2020. And I would encourage other people to do that. If you’ve got a 401(k) plan at work, a 403(b) plan and you can afford it, think about stepping up the amount that you contribute each paycheck right now while security prices are still well off their highs.
That piece of advice, though, comes with one caveat. If you get a matching contribution in your 401(k) plan or in your 403(b) plan, check with your human resources department to find out how they apply the match. So in certain companies, they match it pay period by pay period, and that means that if you do all your contributions early in the year, it could be that you’ll miss out on some of those matching contributions. But if they don’t operate that way, if the company just matches you either at the end of the year or as you put it in, then go ahead, max it out now because this is the time when you want to be buying.
Any other advice to investors right now, Peter?
Peter: Yeah, I think with interest rates very low, looking at your loans and seeing what you can do to improve your situation, there is a good thing. So whether it’s looking at refinancing your home mortgage and locking in a long-term low interest rate. There is a little bit of a disconnect between mortgage rates and interest rates right now that will eventually resolve, so keep an eye on that. Or even looking at your car loans and other loans, credit cards, anything that you can take from a higher interest rate to a lower interest rate and lock it in where when we’re in a period where rates are historically low is a great way to take advantage of a temporary situation to have a permanent long-term fix for the debt side of your portfolio.
I think another thing people should look at is always make sure you have access to what you need. With our clients, we talk about cash-wise. With our clients, we talk about in a portfolio having five years in conservative investments. Some people outside of that need to have emergency reserve, make sure they’ve got access to liquid cash. If you’ve got a job and that job has, like most jobs, some uncertainty with it, it’s always good to have enough money in cash to make sure you can get through things.
I think for people that are fortunate enough to have a home and large taxable accounts, you don’t really necessarily need cash. You need access to cash. So for example, if you think you need to have $100,000 sitting in the bank to feel comfortable but your life expectancy is 30 years, that’s going to be a very expensive $100,000 cushion. If you invest that and earn even a couple percent more a year, it makes a very, very big difference in the amount of money you have over your life. And you can always borrow against that account in the event of an emergency so you’ve got the access to cash. Or if you have a home and it’s paid for, you could have a line of credit for $100,000 which you can go borrow against the house if you need to. And that way your money’s working for you when you don’t need it, but it’s accessible to you when you do.
Jonathan: Yeah. And I think that raises an important point, Peter, which is for a lot of people right now, there’s a lot of economic pain out there. A lot of people have lost their jobs and there are many people who are worrying that they could lose their job. So if you’re in that position, if you feel like your job isn’t secure, this might be the moment to start stockpiling some cash. This might be the moment to get those credit cards paid off so that you don’t have that burden if you end up unemployed. And if you don’t have a home equity line of credit, you’re much more likely to get approved for that while you still have a paycheck coming in. So go ahead and apply for that home equity line of credit.
And as you’ve written about extensively, Peter, people should also pay attention to what’s in the CARES Act and some of these stimulus payments that are available. I mean, presumably there’s a number of opportunities there that people should look at.
Peter: Yeah. I mean, the CARES Act has so many different things that could potentially benefit you. If you’re a small business owner in particular, you’re running out of time to take advantage of those things. And if you’re an individual, we have a reference guide that walks through literally the dozens of things that you need to be aware of. And so, I think it’s really important that everyone take a look at what’s available to them and how to navigate through all this. I mean, so many rules have changed from when you can take money out of a 401(k) and can you borrow from a 401(k) and so on, that I think everyone really needs to take some time and either look through our reference guide and presentation on the Cares Act or Google and get some information to make sure that they’re taking advantage of all the opportunities available to them.
Jonathan: And I think one thing we’ll just mention here before we wrap up, Peter, is required minimum distributions, whether you’re 72 or older or you have an inherited IRA, required minimum distributions are not required in 2020. And so for a lot of people who are trying to preserve the value of their retirement accounts, don’t want to increase their taxable income in 2020, that’s an opportunity. So if you’re not paying attention to the news, you should because those required minimum distributions are not required this year.
Peter: That’s right. If you’ve taken money out, you’ve got an opportunity to put it back in under several scenarios too. So that’s something else for our listeners to keep in mind.
Jonathan: All right, Peter, so it’s that time of the month, time for our Tip of the Month. So what are you suggesting that listeners do this month, Peter?
Peter: Well, one of the nice benefits of the new rules is if you’re single, you’re allowed to give up to $300 to charity, married $600, and it’s above the line deduction. So if you’re a standard deduction filer, you’re now going to get the full ability to write that off. And so if you’re in a position where you’re fortunate enough to be able to help others at a time like this, you’re going to get a break you wouldn’t normally get. And those are the limits to think about when you’re considering taking advantage of that. How about you, Jonathan?
Jonathan: Yeah. So this is actually a great time to be helping others. I mean, there are a lot of people in distress. And $300 is great to give, but if you can give more, for goodness sake, please do. This is a time when your neighbors need help.
So my tip of the month, Peter. We’ve all been sitting at home for six, seven weeks, and in many cases spending far less than usual and missing the rest of our lives. So what I would say to people is as you think about what it’s going to be like when the stay- at-home orders are over and you can go out and you can start to spend money more freely, think about what you’ve missed the most in recent weeks. What is it that you really have missed and would like to spend money on? And at the same time, think about the things that you haven’t been able to spend money on and maybe aren’t so important to you. So do you really miss eating out or maybe you don’t and maybe…
Peter: Yes. My answer to that is yes.
Jonathan: Whatever it is that you’ve missed the most, that’s really going to give you a clue to how you can get greater happiness out of your dollars going forward.
Peter: And Jonathan, you’ve written a lot about experiences over things, which you and I agree with a lot, right? That money does make a difference for people. You need a certain amount of money to not worry about a lot of things that cause stress in people’s lives. Once you have that income or those assets, we know that people, and research shows that people enjoy experiences over things. And you’ve done so many great articles in your book about that.
But one of the things isn’t the experience itself or even the memories of the experience, but thinking about the experience in advance and planning it in advance. So I’d take your tip maybe a step further and follow some advice you’ve talked about, which is enjoy the planning and thinking about it. So maybe now is the time to be planning your next summer vacation with some optimism that we’ll be able to do that and have the time to think about it and look forward to it.
Jonathan: Yeah, no, you’re absolutely right, Peter. One of the biggest parts of happiness from spending money is the anticipation. And I tell you, Peter, the thing I’m really anticipating is finally getting a haircut.
Peter: Me too. Oh, me too. And then going out to eat right after that.
Jonathan: So anyway, that’s it for this month. This is Jonathan Clements, Director of Financial Education with Creative Planning. You’ve been listening to me and Peter Mallouk, President of the firm. We are Down the Middle, and we look forward to speaking to you next month. Stay safe and be well and thanks for listening.
Disclosure: This commentary is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable, but is not guaranteed.
