Investor Insights

May 2020 Investor Report

Published: June 1, 2020Updated: June 18, 2020

By: Stash Graham

Equity prices continued to move higher in May, albeit at a slower rate than April. Of note, the separation between the stock market and the economy has never been more disconnected. We have written about this growing dynamic in the past, but the disconnection is worse than ever before. Over the last three weeks, we have seen some of the stalwarts of the investment community Warren Buffet and Charlie Munger of Berkshire Hathaway, Stanley Druckenmiller of Duquesne Capital, and David Tepper of Appaloosa Management have all commented that the risk/reward dynamics of the current stock market is poor. Stanley Druckenmiller says it is the worst environment he has ever seen. David Tepper says it is the second-worst environment he has ever seen (second to the 2001 Dotcom Bubble). As the US economy reopens, it is important to review what the early reports have shown.

To review the early “returns” of the state’s reopening their economies, we look to the recently released Federal Reserve Beige Book. We have pointed out the Beige Book before as the survey is a good indicator of what the regional business community is telling their regional Federal Reserve bank officials. Georgia was one of the first states to reopen large parts of its economy, starting April 24. However, economic activity per the Federal Reserve Bank of Atlanta continued to highlight a decline from April to early May. On April 30th, Texas stay-at-home orders lapsed. The state, the nation’s second-largest economy, had one of the shortest lockdowns in the country. While economic activity contracted further, the district reported the pace of decline did moderate from April to early May in manufacturing and services. The concluding economic outlook remained highly uncertain, providing little evidence of a strong recovery. This does make sense however as damage to the labor market and the loss of wage income have been so severe for some households involving the now 40 million Americans who have filed for unemployment benefits since March. While some households have taken on material pressure, the regional Federal Reserve banks have pointed out their survey’s that some businesses have struggled to get employees back because these former employees are getting paid more while unemployed. The Federal Reserve Bank of Philadelphia’s survey said that 29% of firms said the expanded unemployment benefits have made it tough to get employees back. The Federal Government’s $600 per week pandemic supplement ends at the end of July. Keep an eye on the 4th round of stimulus to see if an extension of this program is made. As of right now, households are ok, largely due to this supplement payment, but we forecast when this $600 per week is terminated that we will see downside pressure on income and spending.

Separately, the Federal Reserve Bank of New York’s Empire Manufacturing Survey showed activity continued to deteriorate in May. Capital spending expectations held in negative territory, indicating that even if the virus shock proves largely transitory, uncertainty about future outbreaks, spare capacity, and reduced profits will restrain outlays for a lengthy period. Capex plans remained in negative territory for a second month. Capacity utilization in the United States has been on a downward trajectory over the last 50-60 years. After the 2001 dotcom bubble and the 2008 Great Financial Crisis capacity utilization never recovered to the previous cycle’s level. This is an important point as businesses will not need to spend money on goods as they have existing machines that are not being used. The unused manufacturing capacity hurts industrial firms who create or assemble parts for later finished products like machines. This dynamic feeds on itself and hurts job and wealth creation especially in an industry that has been under a lot of pressure for over a year now.

The minutes of the April 28th-29th FOMC (Federal Open Market Committee) meeting, released in the middle of May, showed great concern among monetary policymakers as they reviewed the economic downturn that has already occurred, the type of recovery we should expect, and ways for the Federal Reserve to assist the economy. Consistent with recent comments from Federal Reserve Chair Jerome Powell, FOMC officials appear to be shifting toward expectations of a less robust recovery. The released minutes also covered concerns about increasing bankruptcies due to the increasing amount of debt occurring during this recession, which could suppress growth and speed of recovery as more income is needed to be paid to cover interest expense. Changed consumer behavior is also a reported concern that has yet to develop yet but Fed officials are monitoring closely. As we reach the end of an economic recession, consumers become net savers. This change is natural as households draw down on their emergency funds if a person in the household was laid off. Another reason for saving would be if you thought your job could be next. As an economy that is dependent on consumer buying goods, saving becomes a problem for policymakers.

On an interesting final note, google trends indicate the amount of “permanently closing” web searches have trended higher since the end of March. At the same time, Google searches for “temporary layoffs” have trended lower since its peak at the end of March. While we are at it, google searches for “unemployment benefits” have stopped falling at the same steep rate compared to April. Interesting to note that this Google search of “unemployment benefits” has led initial jobless claims of late. If this trend continues the rate that initial jobless claims fall should be slower as the search trend for “unemployment benefits” has flattened out. However, with the PPP (Payroll Protection Program) forgiveness deadline approaching June 30th and the “big business” forgiveness deadline, which included companies like airlines, coming at end of September, a second wave of layoffs should be expected.

Accordingly, we continue to monitor all developments associated with the state reopenings. We would expect to see some economic headlines indicating improvement, however, the stock market is pricing in more of a recovery than we are currently seeing especially considering that the S&P 500 is off by only -13% from all-time highs. We need to maintain discipline and monitor all possible investment opportunities. The sectors or assets that we have written about before as areas of interest are still favored positions for investment. Single-family home REITS, Multifamily home REITs, Regulated Utilities, Telecom companies with good balance sheets, and special situation opportunities continue to be listed towards the top of our “buy” wish list. Lastly, we have started sending weekly recaps covering important topics of the week that we believe you should be aware of. If you have not received either one (they are emailed on Friday evenings), please reach out to the office and provide your email address and we will get you added onto the distribution list. Thank you for your continued trust during these uncertain times. If you have any questions, you are encouraged to reach out to us!

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

Graham Capital Wealth Management, LLC (“Graham”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Graham and its representatives are properly licensed or exempt from licensure.