Weekly (distribution list)

What Next?

Even though stocks should rise over time, we think the pace of the market rally is set to slow because extraordinary government supports for the economy are set to fade, and valuations have run ahead of fundamentals. Changing Tack It is hard to bet against stocks for the long-term. Since the 1920s, stocks have produced a positive return every 20 years based on S&P 500 annual returns. Stocks tend to beat bonds and cash over time, supporting the idea that markets tend to reward risk. But this fact obscures the reality that stock investing also involves periodic drops. Not everyone…

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Time for Tactical?

Years ago, it was easy to make money. Those who were around during the 1970s may even remember earning near 20%. A three-month CD in December 1980 earned over 18%, according to data from the Federal Reserve. Such rates are near 0.18% today — far below the core inflation rate (+1.3% year-over-year). At that rate, a $100 investment would grow to only $101.80 over ten years. Evaporating Interest Rates And don’t think buying longer-term bonds is the answer, either. Ten-year U.S. Treasury bonds now yield 0.7% compared to over 3% just two years ago. A $100 investment in a zero-coupon…

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Steady-As-She-Goes

We continue to see improvement in several indicators from a very weak second quarter. It is likely that, after a 30% annualized drop in GDP in Q2, Q3 could see a 25% annualized rebound. Progress is also seen in weekly data such as the Federal Reserve Bank of New York’s Weekly Economic Index (WEI). This index tracks ten daily and weekly indicators of real economic activity scaled to align with the four-quarter GDP growth rate (Chart A, below). The WEI spotlights consumer behavior, the labor market, and production weekly. As beauty is in the eye of the beholder, so too…

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It is hard to conclude almost anything with certainty amid this pandemic. Are schools open? Or closed? Or half-open and half-closed? There seems to be less unanimity in Congress on policy issues. The size of continued supplemental unemployment benefits was at issue before this weekend’s executive order. Republicans favored a $200 additional benefit, and Democrats wanted $600. President Trump’s $400 figure falls neatly in the middle of the $200-$600 range, but questions over the order and funding for the order remain. The “muddled middle” will have to suffice for now, but, by comparison, today’s situation is far better than where…

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The best-performing stocks since the beginning of the pandemic have had one thing in common — a high degree of financial flexibility. The worst-performing stocks were the least flexible. Before we start, it is important to define “flexibility.” For us, it has always meant low debt and high profitability. These characteristics tend to build buffers that help ensure survival during difficult times. Where to Find Flexibility Technology stocks, for example, have been a good place to find flexibility lately. The average technology company is very profitable, with very little debt. The sector’s return on assets (10.6%) is higher than any…

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Another Round, Please

Negotiations over a second stimulus round are underway, ahead of Congress’ early-August recess. News reports suggest President Trump’s team may be looking for a $1 trillion package focused on payroll deductions and support for unemployed workers that does not create “disincentives” for returning to work. By contrast, the House of Representatives advanced the $3 trillion HEROES bill in May. That bill seeks more significant direct cash payments to individuals, aid for states, and other measures. The GOP is expected to release details of its plan over the next few days. Whatever the final number, this will likely be the last…

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While Treasury and Corporate yields fell in June, Municipal yields were generally flat and actually unchanged for the last two weeks of the month, as the summer slowdown kicked in. This underperformance has brought Munis back to an attractive level vs. comparable Corporates, though not as compelling as back in March. After unprecedented outflows during the market dislocation, Muni Mutual Funds have reported seven consecutive weeks of inflows totaling over $15 billion. These inflows combined with seasonally elevated coupon and maturity payments should lead to strong demand through the summer.

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Executive Summary: The second quarter brought a surge in stock values predicated on three critical assumptions. First, fiscal and monetary measures would be sufficient to support an economy suffering a tremendous hit. Next, the economy could begin a process of “reopening” and avoid a second wave pandemic shutdown. Finally, progress will be forthcoming toward a treatment or vaccine for COVID-19. While the future could always play out differently than expectations, equity markets seemed willing to focus on positives, rather than lingering unknowns, throughout most of the second quarter.

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What a Quarter

The second quarter saw stocks roar back from March losses. Global shares rose 38%, and high yield corporate bonds rose 20%. Long-term Treasury bonds were flat, and gold was up 15% (chart, below). The rally began after global stocks fell by one third from February 19 through March 23 as COVID-19 spread outside China, and shutdowns began. Since March 23, markets focused on measures taken to deal with the pandemic and its effects on the economy. A $2.2 trillion stimulus package and extraordinary central bank actions triumphed over fear and uncertainty. Volatility reigned throughout the first half of this year….

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This week closes out a most volatile quarter. Stocks are on track to rise by the most during the quarter (+19% as of this writing) since 2009 despite a sharp contraction in the economy. The powerful rally leaves many wondering about valuations amid a pandemic and recession. Even though price is important, we should avoid relying too heavily on standard valuation metrics such as price-to-earnings multiples because this economy is far too volatile to assess business prospects accurately and because stock values are determined mostly by long-run, rather than short-run, earnings power. Price is Important Overpaying for stocks can take…

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The Case for Quality

A significant shift in financial markets occurred roughly twenty years ago. It was June 2000, and Federal Reserve Chairman Alan Greenspan had just raised the short-term interest rate to 6.5%. Within months, a falling stock market would lead the economy into a short and shallow recession.  Unbeknownst to anyone at that time, the central bank would soon begin cutting rates further than they ever had before. In so doing, they would usher in a new era of easy credit. In this commentary, we make a case for investing in quality, especially during this ultra-easy credit era. Why do we call…

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Last Monday, the National Bureau of Economic Research declared the longest economic expansion in U.S. history over. After beginning in June 2009, the expansion lasted for 128 months through February. Born in the depths of a severe financial crisis that started at home, many worried the U.S. would suffer a long decline. In the ten and one-half years that followed, the U.S. economy and markets outpaced most others, leaving domestic stocks with premium valuations. Even though U.S. stocks appear relatively expensive, we should remain tactically overweight domestic assets for now because dollar-denominated assets can convey significant benefits during times of…

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Half Full

Reopening the economy has stirred some optimism amid a wash of depressing forecasts. The Federal Reserve Banks of Atlanta and St. Louis have a model that estimates the U.S. economy may contract at a 42-48% annualized rate in Q2. For a more optimistic read, the Federal Reserve Bank of New York “Nowcast” estimates a 31% pace of decline in Q2. Thirty-six million lost jobs and record drops in both industrial output (-11% April) and retail sales (-16% April) are driving the slump. The second quarter is going to be a bad one, but recently markets seem to be looking beyond…

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MuniWatch

After experiencing unprecedented stress in March due to the effects of the coronavirus, the municipal bond market has returned to more of a sense of normalcy as the new issue market begins to open and trade activity stabilizes. This report looks at forces shaping recent changes in the municipal bond market.

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Dividend Cuts

Some companies are cutting dividends as the economy weakens. A recent Barron’s article lists about sixty firms that eliminated, suspended, or cut dividends since February. We decided to look at the fundamental characteristics of the companies cutting dividends. To do this, we created an equally-weighted portfolio comprised of the stocks in the Barron’s article and asked several questions. What was the dividend yield at the end of last year, before coronavirus hit? What was the financial profile of the dividend cutting firms based on profitability, leverage, and dividend policy? Finally, what happened to the stock prices of those firms which…

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