Bob’s Journal for 3/19/20

Some Notable Events That Grabbed My Attention This Week

In the last week, we moved from concerns about economic growth to concerns about liquidity for businesses and individuals.

The first sign of the change was the Federal Reserve’s emergency move to reduce the interest rates it controls down to zero and institute other measures. The extent and timing of the moves indicate there probably were liquidity problems at one or more overseas banks.

The liquidity spilled over into the United States this week. Credit markets that had been fairly stable and calm as stocks declined suddenly became volatile. Interest rates on non-government debt rose while interest rates on short-term government debt were plummeting, increasing the spread between the rates.

In addition, businesses began to report being unable to issue short-term debt in the credit markets. Several analysts said the credit markets basically are frozen. As businesses were forced to close or curtail operations because of the pandemic, they and their employees need cash to pay continuing expenses. But they’re finding it hard to raise the cash.

An additional complication is that Saudi Arabia and Russia are increasing the supply of oil when demand is declining. The price of oil is plummeting, and that’s putting strains on a lot of energy businesses.

These developments triggered additional actions by the Fed and Treasury and similar actions by their counterparts around the globe. You can read some details here.

Lack of liquidity in markets, especially credit markets, is what made the financial crisis after the Lehman Brothers bankruptcy so bad. Despite the central bank and treasury actions, the problem still isn’t fully resolved. Credit spreads, indicating the difference between interest rates on treasury bonds and rates on corporate bonds, remain wide.

The liquidity crisis is why almost all investments now are declining. It’s why our preferred stock positions and closed-end funds declined sharply this week.

Other signs of the liquidity crisis are that the price of gold is declining, reversing its strong increases early in the coronavirus crisis, and long-term treasury bonds are giving up much of their recent gains. Distressed investors are selling assets. Investors are selling whatever they can to raise cash, and quality assets are the easiest to sell.

The closed-end funds now are selling at extreme discounts to net asset value. Their share prices declined much more than the prices of the underlying assets.

For example, Cohen & Steers Limited Duration Preferred & Income (LDP) now sells at a 24.09% discount to net asset value, compared to a six-month average discount of 0.95%. The distribution yield is up to 13.59%.

For those who bought before this week, this is not a good time to sell. You’re holding assets that are worth more than you can get for selling shares of the funds in the markets. Investors with spare cash should consider when is a good time to add to these positions.

This liquidity crisis should be temporary, but government action is required to restore liquidity and calm investors.

In addition to the moves by the Fed and Treasury, the markets will need to see strong, intelligent fiscal stimulus from Congress. With so much economic activity being suspended, lost revenue must be replaced by cash infusions from the government to avoid widespread bankruptcies. The plans discussed to date, such as giving each taxpayer $1,000, don’t deal with the real problems or give confidence to the markets.

Reality checks like these are why I’ve recommended for a long time that most retirees have enough guaranteed income from Social Security and annuities to cover their fixed, basic expenses. An alternative I’ve recommended is to have a conservatively invested safety fund that will cover two to five years of living expenses, so you won’t be forced to sell investments at distressed prices to raise cash.

The only safe haven in a liquidity crunch like this is cash. Even our diversification and margin of safety policies don’t provide full protection in this environment.

I don’t recommend selling investments at this point in response to the market declines. (Below I do recommend some strategic sales to consider for tax reasons.)

We certainly will have a decline in economic growth in the first quarter of 2020 and probably in the second quarter, at least. But a very serious recession already is priced into the markets. We own quality investments that will bounce back when the liquidity shortage is resolved.

Once Congress acts, I will re-assess the outlook.

Actions You Can Take Now

Most people are looking at the markets and their portfolios. As I’ve said before, too many resources are focused on the markets and other things we can’t control.

Now, there are actions you can take and control that will increase your financial security. Consider some of these moves while markets are down.

* Last week I suggested a review of the decision of whether or not to convert a traditional IRA to a Roth IRA. If you missed it, take a look at last week’s Bob’s Journal.

* In the April issue of Retirement Watch, I explained how it can be beneficial over the long term to make gifts of property that have declined in value, as long as you don’t have a loss on the property. Consider making gifts of property that have been hurt in this market, by making the gifts either directly or through trusts.

* Today’s extremely low interest rates provide an opportunity to make no-interest loans to family members with little or no tax cost. The interest rate charged on these loans can be extremely low if the loan is made today. More details about family loans are in the Tax Watch article in the August 2019 issue of Retirement Watch.

* A related opportunity with interest rates so low is to sell assets to your children in an installment sale. Someone with a large estate that might be subject to the estate tax either now or after 2025 when the current exemption levels are cut in half can remove assets from the estate economically by selling some of them to children using an installment sale.

* Selling depressed assets to harvest the tax losses can be a good strategy. Sell assets that have paper losses. The losses offset capital gains on your tax return so that the gains are tax-free to the extent of your losses. Up to $3,000 of losses that exceed your gains can be deducted against other income. If that doesn’t use up all your losses, the excess can be carried over to future years and be used in the same way.

* If you have a mortgage or other debt, look into refinancing at today’s low interest rates. The lenders are deluged right now, but rates are likely to be low for a while. Begin the process as soon as you can.

* Be sure your estate plan is updated to reflect the current situation. You want a medical care power of attorney that names an agent who can act for you in an emergency.

I recommend that you appoint more than one agent. In addition, the document should provide that an agent can act alone if the other agents aren’t able to do so. In this environment, it’s possible that more than one of the trusted people you would want to help make decisions will be affected by the coronavirus. The agents might not be able to serve or be unable to get to the hospital to help make decisions.

* You also should be sure key loved ones know the important features of your estate plan. Your executor, trustees and power of attorney agents need to be able to access the key documents when needed and take actions.

The Data

The data we’re seeing now all measure activity before the economy began to shut down in response to the coronavirus pandemic. So, don’t read much into it.

New unemployment claims are the first to reflect the pandemic. They surged by 70,000 to a total of 281,000. That’s the highest level since September 2, 2017, and the largest one-week percentage increase in claims ever other than those related to natural disasters.

Manufacturing tumbled in the New York region, according to the Empire State Manufacturing Survey. The index from the survey declined to a negative 21.5 reading in March, compared to 12.9 in February. That’s the lowest level since 2009. Optimism about the next six months declined sharply. Businesses are less optimistic than they’ve been since 2009.

The Philadelphia Fed Business Outlook Survey was similar. It was reported at negative 12.7 for March, compared to 36.7 in February.

Industrial Production in February was positive. The headline number was a 0.6% increase, compared to a revised 0.5% decline in January. The manufacturing component increased only 0.1%, compared to a revised 0.2% decline in January.

Consumer Sentiment as measured by the University of Michigan was still high in March but lower than in February. The Consumer Sentiment Index was reported at 95.9, compared to 101.0 in February. But the March number exceeded analysts’ expectations.

Retail sales tumbled in February. The Census Bureau reported a 0.5% decline compared to a 0.6% increase in January. Excluding autos and gasoline, sales declined 0.2% in February, compared to a 0.7% increase in January.

Housing starts technically declined in February, but that’s because January’s number was revised substantially higher from the initial report. Starts declined 1.5% in February but are up 39.2% over 12 months. The revised January starts is the highest level since December 2006.

Home builders are a little bit less optimistic in March. The National Association of Home Builders (NAHB) Housing Market Index declined to 72 from 74 in February. The index has been in the low-to-mid-70s for six months. That’s a positive level. About half the responses to the survey were received before stocks started declining.

There was an unexpected surge in job openings in January, according to the JOLTS (Job Openings and Labor Turnover Survey) report. Openings increased 4.4% for the month. Hires and separations didn’t change much. Job openings now have exceeded hires for 61 consecutive months.

The Leading Economic Indicators index from The Conference Board for February stayed positive at 0.1%. But that’s well down from January’s 0.7%.

The Markets

The S&P 500 fell 12.52% for the week ended with Wednesday’s close. The Dow Jones Industrial Average lost 15.41%. The Russell 2000 dropped 20.58%. The All-Country World Index (excluding U.S. stocks) declined 17.08%. Emerging market equities sank 17.54%.

Long-term treasuries fell 7.78% for the week. Investment-grade bonds lost 10.77%. Treasury Inflation-Protected Securities (TIPS) dropped 4.50%. High-yield bonds declined 9.71%.

On the currency front, the U.S. dollar increased 4.89%.

Energy-based commodities lost 18.00%. Broader-based commodities fell 14.55%. Gold declined 8.71%.

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