Quarterly Reflections - July 2021

Operations for profit should be based not on optimism but on arithmetic.

~ Benjamin Graham (American economist and investor, 1894 - 1976)

Nothing is impossible: The word itself says “I’m possible!”

~ Audrey Hepburn (British humanitarian and actress, 1929 – 1993)

On the economy

This good time has been brought to you by the Federal Reserve’s basement bargain interest rates and the exemplary credit of the U.S. Government. The government has been heartily spending since our last brutal crisis and recession in 2008 when the world’s housing and financial backbones collapsed. Borrowing at extremely low rates, and spending, to smooth over the jarring effects of the pandemic crisis may have been easier to do since the Great Financial Crisis was barely in the rearview mirror. Then, and now, large stimulus bills have been seen as a successful salve.

The debt that we now owe to others and to ourselves has crossed over $28 trillion. This exceeds our nation’s gross domestic product (GDP), the net value of all goods and services produced. The Biden Administration’s spending proposals could push the debt-to-GDP ratio to 113% in 10 years. Even with growing tax receipts, up 16% in 2021 thus far, the U.S. is on course to continue the borrowing spree.

Yet the impact on our economy has not been felt all that much. Stock markets have shrugged off concerns. Inflation, an expected side effect of idle money sloshing around, has risen but not outrageously. The value of the U.S. dollar did fall in 2020 as the Federal Reserve pushed interest rates to the zero range and investors took their money elsewhere. But even that has reversed in 2021 as the U.S. gets healthier, opens up, and is again seen as a safe haven to park assets.

Another way to gauge how harmful the debt may be is by comparing our economic growth based on GDP, to our long-term interest rates, based on the 10-year and 30-year U.S. Treasury rates. If GDP is higher than rates, this suggests strength and that our government may be able to get away with continued budget deficits and debt in the near-term.

The International Monetary Fund recently raised its 2021 U.S. growth projection to 7.0% and believes during 2022-2024 cumulative GDP will grow 5.3%. By comparison, at the end of June, the U.S. 10-year Treasury traded at 1.47% and the 30-year at 2.10%, lower than near-term GDP growth expectations, making the cost of servicing the debt acceptable, for now.

To that point, while our debt has increased by nearly $7 trillion since 2019, interest payments have declined from $375 billion to roughly $300 billion this year. The Congressional Budget Office predicts that interest payments will fall further to $284 billion by 2023 before resuming an upward trend if the Fed does indeed increase rates when expected. This timing will coincide with growing unfunded Social Security and Medicare liabilities and as GDP gains will be coming back to earth.

As our economy mends and begins to look more like its healthy 2019 self, we have much to be grateful for, like domestic demand for goods and services, strengthening labor markets, and productivity and innovation gains, to name a few. As the larger picture permits us to get beyond the profound effects of 2020’s economic lockdown we should heed the advice of never wasting an opportunity offered by a crisis. Perhaps while in the glow of better days ahead, we can address our budget and debt, lest another crisis loom.

On the markets

The stock and bond markets weathered some readjustments during the second quarter before ending higher with much less volatility than has been seen in years. All stock sectors, other than utilities, made gains. Bond prices also headed up in recovery from a rough first quarter.

The dominant trend towards buying up value-styled stocks that began in late 2020 began to fade somewhat and investors regained interest in growth stocks. This shift came once investors believed the Federal Reserve would keep interest rates low for the current time even given rising inflation and an economy that is rapidly improving.

Conservative investors still seem worried and have returned to the bond market, pushing prices up and corresponding yields down. The 10-year note fell to 1.45% from a high of 1.74% in the first quarter. For any investor in a treasury bond these days, the real return on their interest payments, which is simply the return an investor receives after considering the rate of inflation, is negative. If a bond purchased today yields 1.45% and annual inflation averages 3%, then the real return is negative 1.55%. This is a challenge for investors but one that many feel comfortable with because the fear of losing more elsewhere weighs heavier.

Investors are not just settling for basic U.S. Treasury bonds either. Junk bonds have been popular all year, trading at more stable prices with investors clearly comfortable with the additional risk that comes from lending to financially less- stable companies.

Across the pond, things may be looking up for the Eurozone after being well behind the U.S. in terms of economic growth. The region long struggled to recover from the financial crisis a decade ago and the one caused by Brexit just recently. It has similarly had more trouble getting out of the COVID-19 calamity. Throw in political and social unrest along with Europe’s willingness to experiment with negative interest rates and the region has been unappealing to even the long-term investor.

But Europe is quickly catching up with their vaccinations and they are ready to be back on the world stage. Their “old world” economy is suited to societies eager to get back to life, travel, and work. The largest European businesses are luxury and cosmetic brands, car manufacturers, pharmaceuticals, and energy companies. A weakening dollar would also make these markets more attractive. Europe’s STOXX 600 index has returned 13% year-to-date through June 30th, a run rate not much behind Dow Jones Industrial’s return of 14% and far better than it has performed in years.

As we embark on earnings season, a light will shine on whether investors believe that companies have justified their prices at these levels. And investors will be doing the arithmetic, not just taking the temperature on the optimism, to paraphrase Benjamin Graham’s advice. Many believe this is when earnings will really be most impressive before moderating towards the latter half of the year. The research firm CFRA is predicting a 60% overall rise year-over-year in S&P 500 earnings per share.

As always, even more important than where we just were, is where we are going. The corporate guidance will be exceptionally important as the world is at a crossroads in its reemergence from the COVID-19 pandemic. What individual firms say about their businesses will be driving not just their stock valuations but will speak to the entire market. Investors will be hanging on every word.

On personal finance

A common way to break down, or add up, a life is to consider that every major period is 8,000 days or roughly 22 years. 8,000 days in four periods to grow up, to mature, to nurture your own family and life and then to savor your prime. They are all complex in their unique ways but none more so than the bookends of the “growing” and the “savoring” phases which have sprouted entire industries and careers devoted to helping others navigate these eras.

On the final stretch of life, one development created to support individuals struggling with their physical or cognitive health is long-term care insurance. No one, or not anyone we know, is excited about the thought of needing long-term care insurance even though today over 12 million people are getting assistance in their day-to-day lives with activities like eating and bathing. Assistance is often provided by neighbors, friends, and family until more skilled, paid help is required.

Care may begin while one is still in their home as long as they are moderately independent and needs are not debilitating. As the level of services increases, so does the cost, particularly as one enters a facility that provides an ever-increasing level of care. According to the Department of Health and Human Services, the average person who uses long-term care assistance does so for three years. However, lets define “average”.

Only 33% of men ever spend a day in a nursing facility while 66% of women do. Most stays are brief, six months or less, and only 10% stay for longer than three years. Women, who are far more likely to go to a nursing home at some point, are also the long haulers.

Thus, it is women that have more to consider on this topic than others. Also given that they live longer (sorry guys but you already knew that!) and are more likely to have earned less over their lifetimes, they need to plan for the unexpected with more specificity than men typically do.

That said, everyone must consider how our health may play out as we get older. Do we have family and a network to help us if and when we are incapacitated with some illness? What savings are available to pay for the care? Can we afford the up-front cost of premiums on long-term care insurance? Knowing what is, and what is not, available may help with the decisions.

For starters, you may be “self-insured”. Personal savings gives one greater flexibility and control over your care, if there is enough money to go around. It can be done with careful saving, planning and budgeting. Knowing the costs upfront can help. Considering options like a continuing care retirement community may also be appealing when debating between a buying a policy and gambling that nothing will ever happen.

Government programs are available for veterans through the Veterans Health Administration and the low-income population through Medicaid. Most everyone else is ineligible for government aid. A common misunderstanding is that Medicare covers these costs. Even for those over age 65, Medicare provides very little and only for short terms.

Then there is insurance. Insurance sales people loudly touted long-term care policies for many years until bad news about their expense, onerous and confusing terms, and difficulty in actually getting insurance companies to pay claims forced the issuers to improve their product. Embarrassing public perception and government oversight has helped ensure that these policies are not as troubled as they once were. However, they are still expensive and have those tedious terms. A rule of thumb when shopping policies is to ensure that the starting premium is 5% or less of your monthly income. Premiums generally go up with inflation so keep that in mind too.

There are some hybrid insurance options that merit consideration. One hybrid mixes long-term care insurance with a life insurance policy. For those who worry that care expenses will decimate any inheritance for the heirs may find this appealing. Another policy blends in an annuity option so that the policy owner receives payments while being insured. The catch is that using your long-term care benefits can eat into the life insurance and annuity payments so you cannot have both in totality.

Thoughtful conversations, while challenging, are the key to having as much control over your life as possible. Best done in the “nurturing” phase of your life, so the 8,000 days in retirement is just how, or pretty close to how, you always imagined it.

For further reading, access this letter and direct links to relevant news articles from our blog at www.planserene.com. It is our true delight to help with your investments and finances and we thank you!

Disclosure

Statements and opinions on financial markets and economics are based on current market conditions and subject to change without notice. Due to the rapidly changing nature of financial markets, all information, views, opinions and estimates may quickly become outdated and are subject to change or correction. We provide information from reliable sources but should not be assumed accurate or complete.

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