Hosted by Creative Planning Director of Financial Education Jonathan Clements and President Peter Mallouk, this month’s podcast looks closely at where markets stand through several distinct Covid-19 phases. They also discuss how a few companies have swayed market indexes including the S&P 500; mid-year moves to better your family’s financial picture; and why rebalancing at predetermined times – like the end of a calendar quarter or year – can miss the point of rebalancing altogether.
Time Stamps:
[0:00] – 4 phases of Covid-19 (so far!), and the associated market impacts
[4:05] – Why the markets are surprisingly strong, all things considered
[7:35] – What’s giving hope to foreign stocks’ performance – finally
[9:55] – Fine-tuning your financial picture amid the havoc
[15:05] – Opportunities as unique as the year 2020
[17:05] – Peter and Jonathan’s tips of the month
Have questions or topic suggestions?
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Transcript:
Jonathan Clements: Hi. This is Jonathan Clements, director of financial education for Creative Planning. With me is Peter Mallouk, president of the firm. And we are Down The Middle. Peter, it’s July 1st and we are four or five months into the pandemic. We’ve seen the stock market go down sharply. We’ve seen it rebound sharply. And yet not only is the coronavirus still with us, but it’s spreading faster than ever. So can this continue? Can we continue to see the stock market do well if we haven’t got the coronavirus under control here in the US?
Peter Mallouk: Well, I think this is so interesting because this is a case study in markets. And I think there’s a lot of things happening at once. And I think people, some folks, if you watch CNBC, Fox Business, they’re conflating a bunch of different issues. And I think first, the first go round we knew nothing. We were debating the mortality rate. I mean, you would see 5%+ people that get it are dying and we have headlines of kids dying and things like that. A lot of fear. A lot of misinformation and a lot of things we just didn’t know yet. On top of that, the market’s looking at everyone locked inside and it’s free falling. People start to panic and you have this rush on bonds and stocks and everything else. So that was event number one.
Event number two is the federal government comes in the United States and says, “We’re not allowing everything to fall apart. We’re going to buy bonds. We’re going to flood the banks with cash. We’re going to flood the system with cash.” And in three days, we saw a 21% jump. That was phase two. The market’s saying, “Okay. This is not ’08, ’09. We’re not going to have systemic collapse.” Phase three is we start to learn more about the virus. Mortality rate’s lower than we thought. You’re more at risk if you have pre-existing conditions and you’re older. We start to see some success. Some parts of the world actually show they can beat this back a bit. Even countries where it was very extreme, like Italy, we start to see that. So the market starts to gain confidence that there’s a path out of this.
Now we have phase four, which we could categorize as mis-execution and incompetence. So something that the whole world proved can be beaten, in the United States, we’ve somehow proved that we’re going to make a political thing out of this. We’re all going to fight about it and we’re not going to do the things that the rest of the world has done that show we can contain this. And now the market’s at this point where it’s saying, “Hey. What’s going to happen here? If we’re really going to see this spread…” As of today we’ve got the vast majority of states is seeing a substantial spike and some are bordering on really out of control, “What’s going to happen here?” We’re also seeing the number of people dying going down. So what’s interesting is it seems like people have abandoned listening to healthcare officials and the government and are just kind of taking matters into their own hands.
And if you look at the data, it appears that people that are older and at risk are being safer because less people are dying, but more and more people are getting it. And the reality is these other people that are getting it, that may eventually show up in the death numbers as they go hang out with other people. The market’s confused. So we’re seeing big spikes up and big drops down as the market tries to figure out what does this mean for businesses, because all the market cares about, the only thing the market cares about, is future earnings. Are company’s going to make money in the future? And if a bunch of people die over this, a lot more, if 100s of 1000s more die, no, companies are not going to make money, because everyone’s going to cocoon.
If we can get this under control, whether it’s because the government or people get together and figure it out or we get a treatment or whatever, the market will recover. And we’re at this inflection point. We’re at the new inflection point, phase four here in this coronavirus deal, where we just don’t know… We don’t have clarity of what’s going to happen yet.
Jonathan: I think one of the things that’s fascinating, Peter, about what has been happening in recent weeks is we’ve seen this resurgence of the coronavirus, or really not so much a resurgence. It’s a rapid spread in other parts of the country other than the northeast. And yet while the stock markets become sort of squidgy through this period, we still have relatively rich valuations. We still are way off the bottom. It seems to me that the stock market or investors collectively are saying, “Okay. Yeah. We realize there’s a problem here. We’re not that uncomfortable with where the market is right now.” I mean, to me it’s astonishing that given the spread of the virus, the market is not lower.
Peter: I think it’s interesting because I think the market is really… The indexes I should say, are masking a lot of what’s really happening in the markets. So if you look at Apple, I think that that’s an interesting company. I just read that just their stock buybacks alone cumulatively are more capitalization than the bottom 450 stocks in the S&P 500 put together. The index is really skewed by the fact that you’ve got five to 10 companies that represent a very large percentage of the index. Those five to 10 companies… And by the way, historically this is pretty normal. It used to be energy companies and consumer cyclical companies. And today it’s big tech.
Now the issue with big tech is they benefit from quarantine. You’re watching more Netflix. You’re using Zoom more. You’re on Facebook more. You’re using Google more. You have to use Amazon because you can’t go to Lululemon or whatever. Everything you’ve got to get on Amazon. And so these companies are benefiting from this crisis. And they’re up. So those few stocks, those five to 10 stocks, are really masking a lot of weakness. There are certain sectors that are down far more than 50% associated with travel. And the average small company stocks are still in a bear market. I mean, most of the economy’s suffering. But even with all that, to your point, it’s still stronger than you would expect.
People are somewhat optimistic that we are going to find our way through this thing one way or another. And the market was so strong, not just the market but the economy. Unemployment was so low. We were starting to see moves in lower wages going up, which is a sign of strength. You can’t go hire anybody new. You got to pay people more. We were starting to see those things that the market still feels like if we can get this behind us in a few months, that there will be a new resurgence. And that’s I think an underlying pinning to your point that we see in the markets.
Jonathan: And of course, the one other thing that has gone on this year is that the main alternative to stocks, bonds, has become considerably less attractive. I mean, yields are at half the level they were at the beginning of the year. And I think a lot of people are looking at their portfolios and saying, “Yeah. The economic outlook is a little bit shaky, because we haven’t got the coronavirus under control. But the fact is, if I buy high quality bonds today, I am locking in after inflation, after tax returns that are negative.” And stocks remain at this point the only game in town if you’re hoping for a decent real return over the long-term. So people are sort… Maybe it’s just by default.
Peter: Yeah. I agree. I think sometimes some of it’s about what’s a stock worth, but really it’s about what is it worth relative to bonds, what’s it worth relative to the bond market. And you really have to look at stock valuations in comparison to bonds. Same with real estate. They’re all comparative. And so where bond yields are, so goes the rest of valuations.
Jonathan: So even as the coronavirus seems to have spun out of control here in the United States, a lot of foreign countries seem to have done a remarkably good job of bringing it under control. And the question I have in my mind is this going to turn out to be an inflection point where after a decade during which foreign markets have lagged behind the US, will we see a change? And will foreign markets start to lead because they’re going to be the beneficiaries of their greater self-discipline and that’ll mean stronger economic growth and hence better stock returns? Any thoughts on that, Peter?
Peter: I think it’s really interesting because there’s always been rotations throughout histories. And whenever you think it can’t possibly change, it does. So 2000 and 2010, the United States, they called that the lost decade because the S&P 500 earned zero. And everyone said, “Oh, of course.” With hindsight bias, “It’s obvious the US can’t grow at the pace that overseas companies can. Emerging markets are growing faster. International economies are growing faster. Of course that makes sense.” And then from 2010 to 2020, the US did better than the rest of the world, very substantially. But again, skewed by five or 10 companies that happen to be American companies, these big tech companies. If you take those five companies and you go put them in the international index, it looks a lot better.
But broadly speaking, the US has done much better than overseas. Everyone keeps waiting for that catalyst that flips things overseas. I think it will come. I don’t know if… Well, it will come. It always does. I don’t know if this is going to be the event that does it. I think we’ve become such a global economy that so much, it’s very hard to see some companies doing well without US demand and vice versa. We’re very, very interconnected. We really are all in this together in a way we haven’t been before. We’re going to see the rotation. Is this the catalyst that makes it happen? I’m not so sure.
Jonathan: And of course, the other thing to think about, going back to what you were saying earlier, was the many of the companies that have been leading the US market this year of helping to support the market averages, Alphabet, Facebook and so on, they’re global companies. So even if it turns out that European economies and Japan perform well economically, those US companies may be the beneficiaries.
Peter: That’s exactly right. Yes.
Jonathan: Anyway. Every conversation I have with my family or with friends, 90% of it is about COVID-19. And that also seems to be the way it is with these podcasts these days. So, let’s have change of pace, Peter. Let’s talk about something else. The middle of the year and it’s a good point at which people should start to reassess their finances, because there’s more to your finances than just what’s going on with COVID-19. One of the things that I’ve been discovering from friends and family is that a lot of my friends and family are big procrastinators because they push back the tax filing deadline to July 15th. And guess what they’re doing in this right now? They’re doing their taxes. So if you haven’t got your taxes going, it’s time to get on them, because the deadline is glooming. And similarly, by July 15th, you have to have paid your estimated taxes, not only for the second quarter but for the first quarter as well.
So you better get that checkbook out and make sure there’s enough money to write those big checks to the IRS. And when you do that, one of the things that you’re going to want do is try to figure out what sort of taxable income you’re going to have for 2020. And that’s not just in terms of paying your estimated taxes, but also what else you might do within your portfolio. One of the things that we’ve talked about before on these podcasts and people might want to think about for 2020 is whether this is the moment to do Roth conversion. And if you can do a Roth conversion and do it at a tax rate that’s going to be lower than your likely tax rate in retirement, this may be a good year to do it, because you can convert a larger percentage of your IRA from a traditional IRA to a Roth IRA and the tax bill will be less than it would’ve been earlier in the year when the stop rates was substantially higher.
Peter: I guess it’s great advice. I would always encourage people, I’ve just seen this messed up enough, at least talk to an accountant and run a projection with the accountant. Just make sure you get it right and that you understand incremental tax brackets and things like that before you pull the trigger on it.
Jonathan: Yeah. That’s for sure, because it’s not just about your average tax rate. It’s about whether you’re going to bump yourself into a higher tax bracket with this additional taxable income. And of course the other thing is when you do Roth conversion, ideally you’re not dipping into your traditional IRA to pay the resulting tax bill, because that’ll create even further taxes. What you want to do is have the cash sitting in a regular taxable account to cover the tax bill. So coming back to the markets, Peter, I mean one of the things that people should be doing on a regular basis is rebalancing their portfolio. Hopefully back in March, they were rebalancing into the stock market. Do you think as part of people’s mid-year financial planning reviews, they should thinking about rebalancing the other way now that they’ve had this big bounce back in the stock side of their portfolio?
Peter: I think it’s an interesting time too. So, we did rebalance our client portfolios in March near the bottom of the market. And I think it’s a big mistake when people wait until the end of the year to do it. The way frankly most 401(k), 401(k)s include target date funds that rebalance at the end of the quarter or the end of the year or halfway through the year, miss these opportunities, I think, which is unfortunate. But I think rebalancing back, instead of rebalancing back, it might be time to revisit your allocation given how low bond yields are. And see, do you really want to go back to your old allocation or given where expected returns are now, should you be rethinking what the allocation is? If it’s where it’s supposed to be, then yes, rebalance back.
Jonathan: Yeah. I mean, it’s an interesting question. So in my own personal portfolio, I have not rebalanced back from stocks to bonds as the stock side of my portfolio has recovered. And instead I’ve been thinking about just what you said, Peter, about whether given the expected returns in the stock market versus expected returns to the bond market, whether I actually want to carry a higher percentage in stocks going forward, and to the extent that I want to keep the risk level in my portfolio under control, whether in terms of my bonds, I want to have a somewhat higher quality and have somewhat shorter duration. So the bonds are safer, but the stocks side of my portfolio is obviously somewhat riskier because there’s a higher allocation. And I think it’s going to be a really interesting conversation that’s not just going to happen this year, but in the years ahead as people start to figure out what the implications are of the low, low bond yields that we have. It really changes so much of financial planning and portfolio management, generating retirement income and so on.
Peter: Yeah. I mean, the new normal is very, very different than where we were a little while ago because interestingly, rates are low because of an underlying economic weakness and concern that forces national banks to lower interest rates. And yet that’s forcing people to buy riskier assets. And so where this all goes, how it all unfolds, I don’t think anybody knows, but it’s the only rational decision an investor, I think, can make.
Jonathan: And related to that, if you haven’t done it already, this is a great time to think about refinancing your mortgage. Just as bond yields have come down, that means it’s also cheaper when you borrow. So if you have a mortgage that’s 4% or higher, you could probably substantially lower your rate and maybe in the process shorten your mortgage and put yourself on track to be mortgage free by the time you quit the workforce. So this is a great time to look into refinancing. Other things that you might want to think about at this point in the year is making sure that you’re on track to fully fund your 401(k) or 403(b) in 2020. This year, if you’re under 50, it’s $19,500. That’s the magic number for fully funding a 401(k). And if you’re 50 and up, as some of us are, the number’s 26,000. So those catch-up contributions and certainly if you’ve got an IRA, Roth or traditional, it’s $6,000 if you’re under 50 and for those 50 and up, it’s $7,000.
So again, just see what you’re contributing on a regular basis and make sure you’re on track to fully fund those accounts by the end of the year. And that goes doubly so if you have some sort of matching contribution in those 401(k) or 403(b) plans. Something else that people may want to think about doing at this juncture in the year is thinking about whether they should be making any tweaks to their insurance coverage or to their estate plan. I mean, things happen in your family all the time. If you’ve moved state, it may be time to get a new will, because you want to have a will from the state you just moved in. If you just had a kid, it might be time to get more life insurance. If the kid’s just left home, maybe it’s time to dial down that life insurance. If you’re heading to retirement, you’ve got plenty of money to pay for retirement, maybe you don’t need that disability insurance anymore. There are all kinds of changes that we should be making to our estate plan and to our insurance as we have these family changes and life changes.
So Peter, we are heading towards our tip of the month. So have you got a tip of the month for us for July?
Peter: All right. I happen to have one, Jonathan. And for our listeners that are 70 and a half, normally you have to take the required minimum distributions, but as part of all the laws that came out to kind of keep things going through the COVID-19 crisis, you’re allowed to not take your required minimum distribution until you’re 72 now. So I would recommend that the listeners not to take their required minimum distribution this year.
Jonathan: Yeah. So not only has the age for taking required minimum distribution’s gone up to 72, but in 2020, Congress has said you don’t actually have to pull that money out of either your regular retirement accounts or even out of an inherited IRA. So that’s money you can leave in there and continue to compound. And if the market continues to rise from here, you’ll be happy you didn’t have to take those RMDs. So along those same lines, my tip of the month is to revisit your cash needs for the next five years.
In many ways, the markets have given us an extraordinary gift, a second chance. If you didn’t have enough money in the conservative side of your portfolio to cover upcoming expenses, expenses for the next five years, it’s the tuition payments for your kids’ college education, it’s the next five years of spending money, maybe it’s the size of your emergency fund, if you were on the small side when it came to that sort of stuff and then you went into the market decline, like, “Yikes. I’m not sure how I’m going to pay for this stuff over the next five years as the market stays down,” well, guess what? The market came back up and you’re getting the second chance. So think about your cash needs for the next five years and if you don’t have enough set aside, maybe this is the moment to make sure you do, so you’re in good shape if we do get a rougher stop market from here.
Peter: Good advice.
Jonathan: All right, Peter. So I guess that brings us to the end of today’s podcast. So, it’s Jonathan Clements, director of financial education with Creative Planning. You’ve been listening to me and to Peter Mallouk, president of the firm. And we are Down the Middle.
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.
