The CARES Act: Implications for Individuals

As I’ve written about on the blog and covered on the podcast recently, the CARES Act is a big piece of legislation. (Remember….the total package is $2.2 trillion!). We’ve covered several sections of the bill and how it might impact you on the blog recently, including a deep dive into the paycheck protection program.

There are also many provisions in the bill we haven’t covered. Specifically, sections relating to stimulus checks, expanded unemployment insurance, mandatory distribution holidays, penalty free retirement account withdrawals, and student loan relief. Coincidentally, all have been commanding a large number of questions from clients of Three Oaks recently.

Like all legislation there is a great deal of gray area in this piece of legislation, especially given the urgency with which it was passed. The IRS, SBA, Department of Labor, and other government entities are scrambling to provide relevant guidance as soon as possible. So while there may appear to be some planning opportunities with regard to the law, it’s entirely possible they’re just a temporary mirage. Nevertheless, here’s what we know now about the CARES Act and how it might impact you as a taxpayer.

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Where Do We Go From Here? Market Thoughts & The Risk of Financial De-Leveraging

Well that escalated quickly. We are now officially in the second fastest bear market on record. Bear markets become official when stocks fall 20% or more from their peaks. Ordinarily this takes months to play out. Bad news comes out, stocks sell off a bit. Everyone goes home, thinks about it, and comes back the next morning. More bad news comes out, stocks fall a bit further, and so on. Here’s some data from Marketwatch on how long it typically takes to enter a bear market:

With the Coronavirus driving the U.S. and much of the world to shelter in place, our economy has come to a screeching halt. Some forecasters are guessing that we’ll see a 5% drop in GDP this quarter, others are predicting as much as a 30% drop.

Whatever camp you reside in, the picture is not pretty. Markets did not take long to notice. Whereas it takes on average 136-137 trading days to enter a bear market based on the data above, it only took us 19 to get there this time – the second fastest on record:

So where do we go from here? A stimulus package is just about to be passed (finally). Markets rebounded as much as 12% yesterday and another 4.5% today. Even though the public health picture still looks bleak, we are starting to wrap our heads around how long the pandemic may continue.

Here are a few things I’m reading and my thoughts on what happens next.

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Coronavirus is Spreading…..Markets are Plunging…..Is it Time to Panic?

**Update: I wrote this draft on Saturday, and since then oil has dropped 30%, circuit breakers for the U.S. stock market fired this morning, and the 10-year U.S. bond yield has fallen below 0.5%. The charts and numbers you see here are as of Friday. My stance has not changed.

What do the following have in common?

U.S. marginal tax rates are too low
Central banks printing money will lead to asset bubbles
Washington partisanship
Political turmoil with Russia, the Middle East, or North Korea
Trade war with China

These are the risks that could derail the decade long bull market and business cycle we’ve enjoyed since 2009, according to market pundits. Viral contagion? Nowhere to be found.

At this point there are over 100,000 cases of Coronavirus across the world, with 400 being here in the U.S. While the media has certainly fanned the flames of panic, COVID-19 will have a substantial negative impact on the global economy. The best epidemiologists in the world are forecasting that 40%-70% of the world’s population will contract the virus. People are beginning to cancel flights & vacations. Small businesses are scrambling to put together “work from home” contingency plans. All of which will be a drag on the economy.

The markets have…taken notice. After a tumultuous few weeks, the S&P 500 is now down 8% on the year and investors around the world have flocked to safe havens like long term U.S. treasury bonds.

Here’s the return of TLT, a 20+ year U.S. government bond ETF over the last week and YTD.

TLT: 20+ Year US Bond ETF YTD Weekly Returns

The Coronavirus is Spreading....Is it Time to Panic?

Source: Kwanti

TLT: 20+ Year US Bond ETF YTD Returns

Source: Kwanti

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Market Update: Q4 2019

Picture what you were doing on January 1st of 2019. Maybe you were getting an early start on your fitness goals for the year. Maybe you were up early, ready to take in some New Year’s day football. Maybe you were in bed all day nursing a hangover.

If I were to ask you what you thought the stock market would do in 2019, what would you have said?

Would you have guessed that 2019 was the year that the 10-year bull market finally came to and end? Would you have said you had no idea?

What I’m guessing you wouldn’t have said was that the S&P 500 would be up 30% on the year, tossing market bears aside like leftover confetti from the night before. At least I wouldn’t have.

Yet here we are, about one year later, and that’s exactly what happened. And not only did the S&P climb 30% on the year, it did so in extremely steady fashion. This was true in the fourth quarter of 2019, just as it was in the first three.

Could this be the year that the bull market wanes? Read on for more details and background.

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Cash is King: Competitive Pressures in the Brokerage Industry & How to Get a Decent Yield

If you’ve been paying attention to financial headlines or the brokerage industry at all, you may know that competitive pressures have been heating up recently. Last year Charles Schwab announced it was reducing commission rates for stock trades to $0, hoping to capture market share and thwart momentum from upstart firms like Robinhood. Oh, and once the pressure on competitors began to sink in, Schwab purchased TD Ameritrade.

Since then more chips have begun to fall. Vanguard and Fidelity both decided to follow suit and reduce their own commissions to $0. As the brokerage industry continues to mature, I’m certain we’ll see more changes that benefit investors. In the meantime, you may be asking how these brokerage firms are even able to offer trading for free. Isn’t that how they make money? How can brokerages be profitable when they don’t charge anyone for trading?

Over the last decade or so brokerage firms have transitioned steadily away from commission revenue and toward net interest margin. Just like a bank, the idle cash sitting in your investment accounts is reinvested by your broker.

You don’t see this, of course. All we see as investors is the paltry monthly interest that accumulates in our accounts. But just like a bank your brokerage firm is taking that cash, reinvesting it in various bonds, collecting somewhere between 3%-5% per year, and paying you a fraction of that.

Is this a nefarious activity? Absolutely not. But it does mean that brokerage firms have a major incentive to suppress the interest paid to everyday investors. And with equity market valuations stretching further and the business cycle growing more gray hairs, it’s becoming more important to command an adequate yield on our cash.

This post will cover how you can go about it.

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Is Index Investing Really a Bubble?

Back in September, Bloomberg published an article about index investing that made a few waves. If you read the book or watched the movie “The Big Short”, you might remember Michael Burry. He’s the former doctor turned hedge fund manager who lives in Silicon Valley (and rocks out to death metal in his office while pondering investment strategy).

The article made waves because Burry claims that index investing is a massive bubble. Comparing index funds to CDOs (collateralized debt obligations), Burry’s perspective stoked fear in the hearts of more than a few investors. Here’s the guy who correctly identified one of the biggest bubbles and upcoming crashes of all time. And he’s saying that index investing could be a bubble too? Maybe the simplicity we’ve enjoyed of investing in index funds was really a big mistake. What if he’s right?

Don’t run for the hills just yet. There’s been some great discussion of whether the argument is fair (here, here, and here, for example). Here’s my take on whether index investing really is a bubble.

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I Keep Hearing We’re Nearing a Recession. Are We Nearing a Recession?

There’s been more than a few news headlines recently claiming that we’re on the verge of an economic recession. For many business owners and investors the word recession is a lot like Voldemort. It’s so evil and scary that you’re not even supposed to say it. “Recession” evokes fears of falling stock prices, unemployment, and scarcity.

So what exactly is a recession? And should we treat them with the same respect that Harry Potter treats Lord Voldemort?

Recessions are technically two or more consecutive quarters where national gross domestic product contracts. Gross domestic product (GDP) is sum of all the goods and services a country produces. It’s the broadest and most common way to measure economic activity and the strength of the economy. Growing GDP is a good sign, falling GDP is a bad sign. This is what US GDP growth has looked like since 1930. Lots of major swings between 1930 and 1950, and relatively steady since about 1985. Note that by that time the US dollar was the world’s reserve currency, we were off the gold standard, and interest rates had started to stabilize after stagflation in the 1970s.

Now on to why you should care. The more goods and services a country produces, the better off its citizens are financially. There’s more wealth being created, more jobs available, and usually faster rising wages. For businesses this means that your customers have more stable employment and more discretionary income to buy your products.

In a recession GDP contracts. There’s less economic activity. From a business’s perspective your customers have fewer jobs, lower wages, and less discretionary income. Revenue dries up, and you may be forced to lay employees off yourself. Times are tough.

From an investor’s perspective, recessions are tough on asset prices. The value of your stock holdings, including index funds, depends on the market’s expectation of future cash flows & profitability. Recessions are tough on cash flow, tough on profitability, and tough on stock prices. Recessions often coincide with bear markets.

So where are we now? Are we actually nearing a recession, or is the rhetoric we’re hearing on the news just propaganda? I’m no economist, but I do have some background and stay informed as part of my day job. Here’s my take on whether we’re nearing a recession.

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Market Update: Q3 2019

I’ve written and published quarterly market updates religiously since launching Three Oaks Capital Management back in 2014. At first I had physical newsletters printed out on six thick pages of card stock, and mailed them out to clients and other contacts. Shortly afterward I began adding the commentary to www.3oakscapital.com, and started calling the distribution “Investment Insights”. A few years after that I abandoned the print version, and distributed the commentary solely through the blog.

Writing a market update at all is starting to become less common in the financial planning community. Many of my peers, colleagues, and friends prefer NOT to publish or distribute market updates at all, as they believe it diverts their clients’ attention away from long term & consistent strategies.

The market updates I’ve written have evolved quite a bit over the years, but they’ve received a good amount of positive feedback all along. Clients like to know my take on the markets, and feel comfortable knowing that I have my eye on them. Other readers and contacts seem to enjoy the content too.

This quarter I am making a minor change to the format of Investment Insights. While I plan to continue producing them, starting this quarter all new editions will live on Above the Canopy as opposed to Three Oaks Capital’s blog. We have other changes to the blog, format, and site forthcoming, and this change makes the most long term sense. (Hint: there is a podcast on the way). But from here on out, you’ll find market updates on this site as opposed to Three Oaks Capital’s.

Speaking of this quarter’s edition, we have a number of items to touch on. First, the Federal Reserve reduced short term interest rates in both of their third quarter meetings. There continues to be a lot of trade uncertainty globally, inflation remains low, and there continues to be some weakness in global economic growth. This is the first time the fed’s reduced rates in ten years – the last time being December of 2008, when it cut rates from a range of 75 – 100 basis points to 0 – 25.

Elsewhere, US equities had another strong quarter, value shares outpaced growth in the small cap space, and the yield curve in US rates inverted for three days in August. Read on for more details.

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Value vs. Growth: Will Value Ever Come Back?

Returns from growth investing have substantially greater than those from value investing over the last decade. Looking back over the last 100 years or so, this isn’t the norm. Will value ever come back, or is growth here to stay? This post will examine the history, along with both sides of the argument.

So What Is a Value or Growth Stock, Exactly?

The investing world likes to categorize stocks in a number of different ways. Geography and size are two of the most popular methods. Another way is value vs. growth. Value stocks tend to be older, more established companies with “cash cow” type businesses. They don’t typically create exciting new technologies that might set the world on fire, but they have stable revenue and profit streams, and often distribute a portion of their earnings back to shareholders through a dividend. Think of companies like GE, Exxon Mobile, or Home Depot.

Growth companies operate a little differently. They typically reinvest 100% of their earnings back into the company to fuel future growth, rather than pay dividends to shareholders. They often have new products, services, or technologies that are spreading around the world like wildfire. Your FANG stocks are great examples of typical growth companies: Facebook, Amazon, Netflix, and Google. All have new technologies, services, or models that are taking the world by storm.

From an investment point of view, the reason you might buy a value stock is completely different than why you might buy a growth stock. In a value investment, you’re purchasing company shares because you think they’re worth more than the current market price. “Undervalued” is a common term you’ll hear in a value investment strategy. Metrics you might track to make this determination are price to earnings ratio, price to book ratio, or dividend yield.

Current share prices don’t matter as much in growth investments. In a growth investment you’re not buying a stock because you think it’s cheap; you’re buying it because you think the company will continue growing at an above average rate. Look at companies like Amazon. They’re terribly expensive on a valuation basis, but that doesn’t deter investors in the least. The company is growing so rapidly that the expensive valuation simply doesn’t matter to those buying shares. Metrics you might track here are earnings growth rate, EBITDA (earnings before interest, taxes, depreciation & amortization), or momentum.

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A Review of the CalSavers Retirement Savings Program

If you’ve been following the California legislative process at all, or if you own a business that employs people in California, you may have heard of the CalSavers Retirement Savings Program. In 2016, Governor Jerry Brown signed Bill 1234, requiring development of a workplace retirement savings program for private sector workers without access to one. The resulting program is known as CalSavers.

Basically, the program forces employers with more than 5 employees to defer a portion of their employees’ paychecks into a state run Roth IRA. These contributions are invested in default target date retirement funds, unless the employee directs their investments otherwise. Employees may also opt out entirely, if they choose.

The benefit of such a program is easy access to a retirement savings account. Employees could contribute to one on their own, of course, but that would require opening an account at a brokerage firm & making investment decisions. CalSavers greases the wheels by providing a “done for you” program that employees are defaulted into.

The positive spin here is that the program will certainly result in more retirement savings for many thousands of employees. The negative side of the story comes from the business community. Businesses without retirement plans will be forced to take the time to open a plan, enroll their employees, and deposit their contributions.

CalSavers isn’t at all unprecedented. At this point 21 states have enacted similar legislation. The law is taking a good amount of “heat” though. Several industry groups are suing the state treasurer in an attempt to derail the rule. Some plaintiffs don’t care for the state government telling them what to do, while others in the financial industry probably see the program as a competitive threat.

Whatever your take on the matter, businesses will be required to comply beginning in June of 2020 as the law stands today. This post will provide a quick overview of the program, including its benefits and shortcomings.

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