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Third Quarter 2020 Newsletter
July 22, 2020
INVESTMENT QUARTERLY
SEARCHING FOR REMEDIES
As we head into the second half of this strangest of years there are 5 major events that will likely influence the kind of environment we will live in this year and next. The five events are COVID-19, the Federal Reserve’s policy, the government’s fiscal policy, the election, and psychological impact of these events on the investment world.
COVID-19
Despite the optimism in some areas that we will have a vaccine late this year, the time it will take to vaccinate enough people to reign in the virus is significant. The late surge of infection in the first wave has caught most of us by surprise and leaves me wondering what the second surge Dr. Fauci and others are talking about will look like. If it leads to a second shutdown, all bets on a recovery will be off. The Great Depression may move down a peg to Second Greatest Depression in that event. At least one of the theories, that heat would knock out the virus, has been proven to be incorrect.
Until we can move freely in an open economy and travel without fear, shop without masks and eat inside restaurants, there is likely to be a significant headwind to economic recovery and a more upbeat psychological outlook.
FEDERAL RESERVE POLICY
The FED has stated that they will do whatever is necessary to keep the economy afloat. This implies that interest rates will be kept low for at least the next eighteen months unless there is a significant change in economic conditions. Low interest rates have led to a boomlet in new housing starts and a robust market where properties are selling for decent margins over asking price. The concern in many corners is that the FED’s policy will lead to significant inflation. To an extent this concern is being realized, but in the stock market and gold, not the economy as a whole. One major concern is that much of the FED’s stimulus is ending up in the stock market rather than in investment or in consumer spending. A recent paper by economists Van Hoisington and Lacey Hunt Phd., Indicated that 92.9% of national economies are now in recession. In 14 prior global recessions the average was 54.3%. With world trade likely declining 15% in 2020 one beneficial catalyst has hit the dust. The record debt of the US, aided and abetted by FED stimulus steps, has shown it will depress growth. In earlier US economic history, a dollar of new debt provided three dollars of new domestic growth. In the last four quarters each dollar of debt has generated only 13 cents of GDP growth. Our past GDP growth, since 2008, was the lowest recovery rate in over 50 years, but our debt grew at a phenomenal 28% annualized rate in the same period.
We need sustained economic growth to pull out of this mess and there is no evidence yet that it will result from the FED’s policies. The obstacles that we are trying to overcome are new and significantly large enough so there is no precedent, only trial and error or, hopefully, success.
FISCAL POLICY
Finally, the government woke up to the fact that economic recovery needed the support of fiscal as well as monetary policy. Unfortunately, it took COVID-19 to set the wake-up alarm. We are now in the midst of the largest giveaway program the country has ever seen. By default, we are now in a state of MMT (Modern Monetary Theory), a Leftist ’s theory that says it doesn’t matter how much we borrow as long as we are only borrowing from ourselves. If that doesn’t make sense to you, join the club. Debt is debt and eventually needs to be paid back. While original MMT thoughts were based on support for social programs and infrastructure, the current programs have dwarfed the original proposals. Working this out, if it can be, as we go forward will be a real test for our economy.
I presume this largesse cannot go on forever so what will happen when it stops is a worrisome unknown. It will slow down the recovery even if it does eliminate a real collapse of the economy.
THE ELECTION
The positional spread between both parties and candidates should lead to a very volatile market heading into the election. The implications for the economy and U. S. policy across the board are significant. Right now, the polls are favoring Biden and his tax and economic package that are likely to negatively affect the economy and the stock market. If Biden does win and increases the long-term capital gains tax to 40%, there is likely to be a lot of selling late in this year. Also, a return to an over regulated economy would tend to slow down any recovery from the current deep recession.
PSYCHOLOGY
Sentiment in the market is upbeat judged by market performance relative to economic performance. Forecasts for 2nd quarter GDP range from a negative 35% to a negative 15%. In the face of this the market has rebounded strongly and speculation is starting to break out. The recent example of a bankrupt Hertz stock with 0 value being driven up to over $4 by Robinhood speculators is only one example of a return to the 1999-2000 market psychology. Some bad news can easily turn market psychology negative and it is more likely that bad news will develop down the road.
The caution flag is still out. Stay healthy and financially protected.
Robert B. Needham, CFA
As we enter the final 100 days of 2024, there's still plenty of time to make this year count. At Needham Advisory, we've compiled a list of eight essential steps to help you finish strong and set yourself up for success in the new year. These actions can provide a financial cushion, streamline your investments, and give you a head start on your 2025 financial goals. 1. Save $1,000 with Daily Contributions By setting aside just $10 every day for the rest of the year, you can save $1,000. This simple strategy creates a financial cushion or helps you reach a specific savings goal with minimal daily effort. 2. Max Out Your Retirement Accounts Make the most of your retirement accounts by contributing the maximum allowable amounts. In 2024, the contribution limit for a 401(k) is $23,000 (or $30,500 if you're 50 or older). For Roth IRAs, the limit is $7,000 (or $8,000 if you're 50 or older). Maximizing these contributions not only boosts your retirement savings but also takes advantage of potential tax benefits. 3. Roll Over Old 401(k)s If you have any old 401(k) accounts from previous employers, now is the perfect time to track them down and consider rolling them over into a current retirement account. This can streamline your investments and potentially reduce fees. However, keep in mind that rolling a 401(k) into a post-tax account like a Roth IRA means you will have to pay taxes on the 401(k) balance. 4. Research High-Yield Savings Accounts Consider moving some cash from your checking or savings account into a high-yield savings account (HYSA). HYSAs typically offer higher interest rates, which can help your savings grow faster, maximizing the returns on your emergency fund or other cash reserves. 5. Take Advantage of Gift Exclusions This year, you can give up to $18,000 per person without incurring any gift tax. Consider giving financial gifts to family members as a way to help them financially while also reducing your taxable estate. 6. Review Your Budget Take a fresh look at your budget to identify areas where you can cut back or reallocate funds. Even small adjustments can lead to significant improvements in your financial health. If you anticipate receiving end-of-the-year bonuses, plan now for how you will use those funds wisely. 7. Start Preparing for the Holiday Season Early Set aside a little money each week for holiday expenses. Consider affordable gift options, such as homemade gifts or experiences, and start organizing any travel plans to secure better deals and ensure a smoother season. 8. Check in with a Financial Advisor Schedule a quick call or meeting with a financial advisor to enter 2025 with a clear, up-to-date plan and some financial planning momentum. Whether it’s refining your budget or optimizing your investment strategy, getting expert advice now can set the tone for a successful new year. These steps can significantly impact your financial stability and preparedness as we approach the end of the year. If you need help with any of these strategies, we at Needham Advisory are here to assist you. Let’s make the most of the remaining days of 2024 together!
In the realm of labor laws, ensuring fair compensation for employees is a cornerstone of workers' rights. The Massachusetts Wage Act, consisting of Massachusetts General Laws Chapter 149, sections 148, 149, and 150, stands as a crucial piece of legislation that safeguards the rights of workers in the Commonwealth. Enacted to address wage-related issues and promote fair employment practices, the Massachusetts Wage Act plays a pivotal role in creating a just and equitable work environment for employees across various industries. The Basics of the Massachusetts Wage Act The Massachusetts Wage Act encompasses three key sections: 148, 149, and 150. Each section addresses specific aspects of wages, penalties, and legal recourse for employees facing wage-related violations. Section 148: This section focuses on timely payment of wages. It mandates that employers must pay their employees all earned wages within a certain timeframe, often weekly or bi-weekly. In the case of involuntary separation, employers are required to pay all wages due to the employee on the day of termination. If an employer fails to meet these requirements, they may be held liable for treble damages, which could amount to three times the unpaid wages. Section 149: Section 149 pertains to minimum wage regulations. It establishes the minimum hourly wage that employers must pay to their employees. This provision ensures that workers receive a fair wage that aligns with the cost of living and prevailing economic conditions. Employers are obliged to adhere to the minimum wage requirement, and failure to do so can result in penalties. Section 150: Section 150 deals with legal actions and remedies available to employees in cases of wage violations. If an employer unlawfully withholds wages, an employee has the right to file a complaint or bring a civil action to recover the unpaid wages. Moreover, employees who prevail in their legal claims under this section can recover not only the unpaid wages but also reasonable attorneys' fees and costs. Significance and Impact The Massachusetts Wage Act serves as a powerful deterrent against wage-related abuses and unfair labor practices. By establishing strict guidelines for payment of wages, minimum wage standards, and legal remedies, the Act empowers workers to seek recourse when their rights are violated. This legislation not only supports individual employees but also contributes to a more equitable labor market and promotes a healthier employer-employee relationship. Challenges and Controversies While the Massachusetts Wage Act is a commendable effort to protect workers' rights, challenges and controversies have emerged. One area of contention is the determination of what constitutes "wages." Some employers might argue that certain forms of compensation, such as bonuses or certain benefits, are not covered by the Act, leading to disputes over what is legally owed to employees. Additionally, enforcement and compliance can pose challenges, especially for small businesses with limited resources for administrative tasks. The Massachusetts Wage Act stands as a testament to the Commonwealth's commitment to ensuring fair and just compensation for its workforce. By outlining clear guidelines for payment of wages, setting minimum wage standards, and providing legal remedies for violations, this legislation bolsters employee rights and contributes to a more equitable workplace. As workers continue to play a pivotal role in the state's economic growth, the Massachusetts Wage Act remains a cornerstone of labor law, championing the rights of employees and fostering a more balanced employer-employee relationship.
In the modern gig economy, the classification of workers as either employees or independent contractors has become a significant legal and economic concern. In Massachusetts, the issue is addressed through the Massachusetts Independent Contractor Statute, found under Mass. Gen. L. c. 149, s 148B. This statute plays a pivotal role in determining a worker's classification, affecting their rights, benefits, and the obligations of employers. In this blog post, we will delve into the key aspects of the Massachusetts Independent Contractor Statute, exploring its implications for both businesses and workers. Understanding the Massachusetts Independent Contractor Statute The Massachusetts Independent Contractor Statute, often referred to simply as Section 148B, was enacted to prevent worker misclassification and protect individuals by ensuring proper classification and fair treatment. Under this statute, individuals are presumed to be employees unless all three prongs of the "ABC Test" are met: A: The worker is free from control and direction in performing the service, both under the contract for the performance of service and in fact. B: The worker performs services that are outside the usual course of the business of the employer. C: The worker is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the service performed. Implications for Businesses For businesses operating in Massachusetts, correctly classifying workers as employees or independent contractors is essential. Misclassification can lead to legal consequences, including back payment of wages, taxes, and potential fines. By adhering to the requirements outlined in the ABC Test, businesses can ensure compliance with the law and avoid potential liabilities. Additionally, businesses must be cautious about reclassifying employees as independent contractors without substantial changes in the working relationship, as this may be seen as an attempt to evade employment-related responsibilities. Implications for Workers Workers in Massachusetts who are classified as employees enjoy various legal protections and benefits, including minimum wage guarantees, overtime pay, workers' compensation coverage, and access to unemployment benefits. On the other hand, independent contractors may not be entitled to these benefits, but they have the advantage of greater flexibility and control over their work. It's crucial for workers to understand their classification accurately, as misclassification can lead to them being denied their rightful benefits and protections. Challenges and Controversies The Massachusetts Independent Contractor Statute has been the subject of debates and challenges, particularly regarding its potential impact on businesses and the gig economy. Critics argue that the ABC Test can be too restrictive, making it difficult for some businesses to classify workers as independent contractors even if the working relationship genuinely aligns with such a classification. Proponents, however, emphasize the importance of protecting workers' rights and preventing exploitation through misclassification. The Massachusetts Independent Contractor Statute, Mass. Gen. L. c. 149, s 148B, plays a vital role in defining the working relationship between businesses and workers in the state. Its implementation through the ABC Test ensures that workers are correctly classified, granting them the appropriate benefits and protections. Businesses must be diligent in understanding and adhering to the statute's requirements to avoid legal consequences, while workers should be aware of their classification to assert their rights effectively. As the world of work continues to evolve, the statute's significance remains undeniable in maintaining a fair and balanced labor landscape.
Auto accidents are an unfortunate reality that many of us might encounter at some point in our lives. Understanding the intricacies of auto accident liability and insurance coverage is crucial, especially if you're a driver in Massachusetts. The state's unique legal framework and insurance regulations play a significant role in determining how liability is established and insurance claims are processed. In this blog post, we'll delve into the key aspects of auto accident liability and insurance coverage in Massachusetts. Determining Liability: Comparative Negligence In Massachusetts, the concept of "comparative negligence" is pivotal when it comes to assessing liability in auto accidents. Comparative negligence means that each party involved in an accident may be assigned a percentage of fault. This percentage determines their share of the financial responsibility for the damages incurred. If you are found to be partially at fault for the accident, your compensation may be reduced by the percentage of your assigned negligence. For example, if you were deemed 20% responsible for the accident and the total damages amounted to $10,000, you would only be entitled to recover 80% of that amount, or $8,000. No-Fault Auto Insurance System Massachusetts operates under a "no-fault" auto insurance system, which means that after an accident, you first turn to your own insurance company to cover medical expenses and other losses, regardless of who was at fault. However, this doesn't absolve the at-fault driver from all liabilities. Minimum Insurance Requirements To legally operate a vehicle in Massachusetts, you must have certain minimum insurance coverages. These include: Bodily Injury to Others: Covers medical costs, legal expenses, and damages if you're at fault in an accident resulting in injury or death to others. The minimum coverage is $20,000 per person and $40,000 per accident. Personal Injury Protection (PIP): Covers medical expenses and lost wages for you and your passengers, regardless of who was at fault. The minimum coverage is $8,000. Bodily Injury Caused by an Uninsured Auto: Protects you if you're injured by an uninsured driver. The minimum coverage is $20,000 per person and $40,000 per accident. Damage to Someone Else's Property: Covers damages you cause to someone else's property. The minimum coverage is $5,000. Optional Coverages In addition to the mandatory coverages, Massachusetts drivers have the option to purchase additional insurance, such as: Collision Coverage: Covers damages to your vehicle in the event of a collision. Comprehensive Coverage: Covers damages to your vehicle not caused by collisions, such as theft, vandalism, or natural disasters. Underinsured and Uninsured Motorist Coverage: Provides coverage if you're in an accident with a driver who doesn't have enough insurance or is uninsured. Navigating auto accident liability and insurance coverage in Massachusetts can be complex, but having a clear understanding of the state's regulations can help you make informed decisions and protect yourself financially. Remember that insurance requirements and regulations may change, so it's essential to stay updated with the latest information. If you're ever involved in an auto accident, consider consulting legal and insurance professionals to ensure you're properly informed about your rights and responsibilities.
INVESTMENT QUARTERLY $5200 This not insignificant amount is the estimated increased annual cost to the average American Household as a result of the earlier inflation results reported by Bloomberg, the large provider of market data and commentary. As inflation creeps up, or roars up, this cost is likely to increase. Our discussion of inflation last quarter has played out more vigorously than anyone hoped. At 10%, which seems to be a consensus target, this inflation cost will be even higher. Of equal importance are the forecasts for economic growth in the first and second quarters of 2022. The Atlanta Fed’s 1st quarter GDP forecast is for 1.1% growth and the Blue-Chip Economic Group’s forecast is for 0.9%. Some other economists are forecasting modestly negative GDP for the second quarter. If this comes to fruition we will be in a stagflation, high inflation with stagnant economic growth. The diminished economic results will be partially caused by the projected inflationary cost increase of $5200 annually per household. We are overwhelmed by reports of inflation driven cost increases in food, cars, energy and other commodities. The expectation that inflation will be transitory has lost credibility as reports have started to indicate a longer lasting problem. Cost push inflation, brought on by earlier $30,000 annual wages, has morphed into $40,000 as employers have had to go to $20/hour to attract needed workers. These wage increases are now being built into our economic system through increased product costs and are not likely to be reduced whenever inflation does subside. As frequently happens with inflation, it gets hotter as consumers want to buy now, before the price goes higher. A good example of this is the housing market. If you combine this behavior with the shortages brought about by the supply chain problems, it is easy to see how consumer markets can get red hot. Of course, the buying surge only causes inflation to move even higher. Inflation of 8.5% does not sound bad when compared to the 16% figures during our last inflation surge in the 70’s and 80’s. But how many know that there really is no difference. If we used the earlier calculation formula instead of the current revised one, we would be at 16% today. So, we do have a genuine problem. There is a question as to whether we are united in working on a cure as the Fed and Administration seem to be pushing conflicting policies. The Fed is looking to increase interest rates over the next seven meetings and pull back some of the liquidity it introduced earlier to keep the economy afloat. The former Fed action led to an extensive period where the monetary base grew at unprecedented high rates for years. As we have indicated in earlier QUARTERLIES, this led to stock market inflation as there was too much money chasing too few stocks and not enough demand for capital expenditures to sop up some of the money. Now that the Fed has changed its course, the Administration is looking to provide stimulus to the economy through its spending proposals and potential future forgiveness of student loan debt. Unemployment is at all time lows and inflation is at the highest level in 41 years and still climbing. Something is going to have to give and the give may not be the best solution. The “R” word is starting to surface in economic forecasts, particularly when 2-year Treasury yields exceeded 10-year yields recently. When that happens, it is called an inverted yield curve and almost always is a precursor to a recession. What the alarmists fail to mention, however, is that there is generally a lead time of seven to 18 months before the recession hits. A lot can happen during that time-period, particularly when all the variables that have come into play this time around are at, or near, extreme historical levels. We can’t look forward without considering the impact of Russia’s genocidal war against Ukraine. The potential damage to energy supplies and commodities through sanctions and devastation is huge. Ukraine is one of the larger sources of a broad range of commodities that have been set back operationally because of the Russian destruction. Europe relies heavily on Russian natural gas, a source that sanctions are attempting to curtail. Over the short term there is little Europe can do to make up any shortage in energy supply, so they are likely to be hit much harder than the United States. Russia and Ukraine are large providers of wheat which will be in short supply. The economic effect on the European Union is going to be significant. Germany has lowered its GDP projection for 2022 to 1.8% and the World Bank has lowered its EU estimate by 1.2%. All of this is before seeing the impact of future problems from the war. Not a pretty picture. At this point in my QUARTERLY, you might be ready to sell out everything and hide your money in a mattress or in a can buried in your backyard. Not yet. Some contrarians and technical traders see a strong upside to new highs coming soon. It is said that a bull market often climbs a wall of worry and there sure is plenty to worry about. It has not been uncommon for the markets to disconnect from the economy in recent years so a weak economy may not set off a market decline at this point. There is still significant liquidity around and will be for a while under the Fed’s gradual approach. In trying to achieve a soft landing for the economy the Fed may provide a reason for investors to feel they are protected on the downside. Event news has and will continue to have a significant and positive effect on short term market psychology. If Ukraine and Russia find a way to end hostilities, there could be a significant rally in the market. Some analysts see the potential for a strong hockey stick shaped rally graph similar to what occurred in the early 2000’s. This would move any recession further down the road, but not eliminate the possibility. For the first quarter the Dow Jones Industrial average showed a negative return of 4.16%; the S&P 500 a negative 5.20% and the Russell 3000 a negative 4.52%. The bond market, reacting to the Fed’s early projections and actual moves to increase the Fed Funds rate, returned a negative 3.43% for the 1-5 year Corporate/Government index and double-digit negative returns for long term bonds. Better performance than one might have expected under the circumstances. Robert B. Needham, CFA
INVESTMENT QUARTERLY TINA At the end of the third quarter this year, stocks, as measured by the S&P 500 index, were up 15.9% while intermediate bonds were off 3.8%. Fed established interest rates were still at 0.25%, an all-time low, and early Gross Domestic Product estimates came in at 2 percent versus a 6 percent growth expectation when the quarter started. The drop in GDP was greatly influenced by shortages and supply chain difficulties to the point that analysts are predicting significant shortages and late deliveries of Christmas products. Since holiday sales are a big part of the retail industries’ performance, this could be a big drag on fourth quarter performance as well. Inflation has reared its ugly head to a solid 5.4% this year. Most of us know that this statistic does not really represent what we are seeing in stores and at the gas pumps. Economists are debating whether this inflation is transitory or indicative of longer lasting negative economic impact. Optimists say that as soon as the supply shortage ends, price inflation will return to normal. One economist sees the inflation as a supply problem. With the government pumping up the monetary base of the country, 20.4% this year through August, there is currently too much money chasing too few goods, resulting in strong inflation pressure as prices get bid up due to the scarcity of goods. This economist does not see production increasing sufficiently in the near term to offset the supply shock we have experienced. There is evidence that we may be approaching a wage driven inflation pressure as many jobs are going unfilled around the country and unions are beginning to strike for higher wages to keep up with rising costs. With large consumer companies, like Procter and Gamble, announcing significant price increases because of increased costs, it doesn’t look like inflation will be transitory. As inflation takes hold and extends its visit, it is likely that businesses will find their profit margins squeezed. Margins today are at all-time highs, one of the reasons for the high price earnings ratios of stocks. If these margins are reduced there will likely be a decline in earnings. A decline in earnings is generally followed by a decline in the price earnings ratio resulting in lower prices for stocks. This outcome is projected by those analysts who see “stagflation” as the likely future of the market. Stagflation is when economic growth is sluggish and inflation is above normal, resulting in lower stock prices. As the proverbial economists say after laying out one answer, only to follow it up with “but on the other hand”, if inflation is moderate, it could reflect a growing economy and provide support for better equity prices. The equity market has run counter to the COVID economy prior to this year’s recovery due to the huge growth in the money supply and low interest rates as we mentioned earlier. When the Fed begins to withdraw the liquidity it has added to the market later this year by tapering its bond purchases and ultimately raising interest rates to stop the inflation, it will be reversing all the things that made the stock market defy the economy over the last bull run. If the rule of unintended consequences is still applicable it will likely end the bull market. Until this happens, it is still likely that the market will continue to climb the wall of worry. No, I didn’t forget TINA. The acronym stands for “There Is No Alternative” and is an explanation as to why stocks are doing so well, and bonds are offering dismal returns. With inflation at 5.4% and 30-year bonds yielding 2% for Treasuries and 2.9% for single A rated corporate bonds, the inflation rate turns the current bond yields negative. This phenomenon has caused many investors to rethink the traditional 60% equity and 40% bond portfolio allocation, particularly if the bond portfolio is going to have a negative return. One alternative has been high quality stocks with above average dividend yields that potentially offer a positive total return during this inflationary period. In fact, low bond and savings yields have pushed many investors into the equity markets for better current yields. There are no guarantees in the investment world, so this strategy requires careful monitoring to determine when the fundamentals of the market are likely to turn negative. It is not a “set it and forget it” alternative. One does not want to sacrifice principal for a short-term yield advantage, even though government policies have severely damaged the investment earnings prospects for elderly citizens who heretofore have avoided risk by investing in FDIC insured accounts. Even though bond returns may suffer during inflationary periods, short term bonds will protect principal during corrections. The wild card in all this is COVID and the success of Merck’s new drug in eliminating the worst effects of the virus. If it is approved for emergency use by the end of the year we could be on our way to regaining normalcy after eliminating the effect of shortages and supply chain issues and giving people a positive outlook toward returning to work. Let’s hope for the best. My partner, George Kimball, has been diligently working on updating our website for the last few months. I hope you get a chance to check it out at www.needhamadvisory.com . For those who would like to get their statements from us electronically there will soon be a link to do so. If you do not want to be changed to electronic statements, please let us know. We are also now accepting new accounts. If you know anyone with investment, tax, estate and financial planning, or other financially related questions, we would appreciate your referring them to us. Give us a call at 978-681-8821 to get started. Robert B. Needham, CFA
INVESTMENT QUARTERLY STOCKFLATION Stockflation, the new word in investment jargon, is simply inflation in the price of stocks. It is caused by too much money (liquidity) being pumped into the market by the Federal Reserve. In the current environment, despite the weak economy during the pandemic and a 50% reduction in the number of common stocks over the last ten years, coupled with an outlandish 24% annual growth in the U.S. monetary base has led to significant inflation in stock prices. The weak economy offered little incentive to invest in productive capital, so the money ended up in the stock market, resulting in too much money chasing too few stocks. If current administration proposals for huge stimulus programs continue, it is likely that stockflation will continue to the bubble stage. In the bubble stage speculation takes on the appearance of being reasonable investment. There are a number of examples of crazy speculation going on right now with Bitcoin, GameStop, AMC, and the Robinhood trading platform, SPACs, the extended price earnings ratio of stocks, and now the trading of NFT’s (Non-Fungible Tokens) at unbelievable prices. The nonsense of NFT’s is shown in a painting by an artist, self-named Beeple, who sold an NFT of his digital collage for $69 million. Supposedly he was paid in Bitcoin but immediately converted the Bitcoin to US currency. Copies, including digital ones, of the work already exist so there is no uniqueness to the work of art, and hard, as well as digital, copies already exist. If this makes sense to you then you are probably one of the few who understand this market. You can search Beeple and the buyer Metakovan on-line if you want to learn more. And for those who want to buy Bitcoin, it is now available at the kiosks in your local Stop and Shop Market. The “i” word (inflation) is the new word according to a recent Barron’s issue. Because of shortages resulting from production slowdowns, lower orders, and broken supply chains during the COVID pandemic, there are shortages in everything from computer chips for cars to lumber for home construction. The result is higher prices on almost everything we buy as demand has surged with the rebound resulting from the success of the vaccination program. It is likely that the price increases will settle down once the surge is over and supply chains will get back to normal according to many economists. Some, however, believe that this is the start of a longer-term inflationary period. If it is short term, there should not be a lot of economic disruption; but if it truly is long lasting it would signify an over-heated economy and likely result in a change in Fed policy that would not be for the better. Historically inflation has been brought on by either cost-push or demand-pull, not at the same time. Cost-push, as it is called, results from rising costs, particularly of labor, but also from raw materials used in the production process. Demand-pull is caused by demand exceeding supply so prices are raised in the face of excess demand because the market will bear the increases. The current situation reflects both of these influences, as well as the impact of disrupted supply chains. When demand fell off the table during the pandemic, manufacturers cut back on production. This cutback worked its way through the economic system as transportation systems cut back on unneeded employees and equipment. Now that demand is back production and delivery systems are still struggling. With unemployment benefits as lucrative as they have been, many unemployed are not ready to give up their benefits for a job that might not pay them more than they are earning on unemployment. This is particularly significant in bringing back truck drivers, many of whom have taken different jobs, and service people for restaurants and bars. So, the pandemic has created an unintended shortage of products and services. This is causing inflation that is not being fully recorded in government statistics. If we can get the supply issues resolved, we should see a reduction in inflationary pressures and an improvement in employment as more people are back to work. In earlier Quarterlies we talked about the Biden administration’s plans for tax increases, particularly the one with the broadest impact, the end to the step-up cost basis on assets a person holds at death. So far nothing definite has come out of the administration but, if the huge deficits are to be minimally dealt with, there will have to be some revenue increasing proposals. The concern is that Biden’s apparent wishes will dramatically change the tax culture of the country and may only be the first step in further erosion of the tax system we have endured, or enjoyed, for many years. Step-up basis has been part of the code for about 100 years. If it is changed it is likely that any exemption amount will be lowered by future administrations to justify additional government expenditures and thus bring higher taxes to the middle class. Capital gains tax proposals are calling for a rate of 43.8% for those making a million dollars a year. While this may not impact the middle class, it could have a big impact on the markets as the habits of investors may change. Generally, the more you tax something, the less you get of it. Unless this change is made retroactive, there could be a significant amount of profit taking at the current 23.8% rather than wait for tax rates to go up. Defensive moves by investors could be a trigger for a market correction. Don’t be surprised if you see more volatility in the markets as talk on the tax proposals continue. In an earlier quarterly we looked at future performance over 10 years starting at various price earnings ratios. The chart showed that high current P/E ratios resulted in lower future growth rates. This makes sense as current high prices tend to steal value from future normalized earnings. Low P/E’s, on the contrary, leave plenty of room for upside surprises and are likely to have better than expected performance. This is the over-riding influence of psychology on the market. Robert B. Needham, CFA
INVESTMENT QUARTERLY 2020: THE YEAR THAT WASN'T Who could have ever imagined we would have to live through a year like 2020? The economic impact of over 23 million individuals losing their jobs, over 50% of restaurants being either temporarily or permanently closed, airlines and hotels operating at a fraction of full occupancy, with people feeling trapped in their homes for safety, couldn’t have been imagined in our wildest hallucination. The second quarter of 2020 offered a horrendous economic result and despite a strong rebound in the third quarter, the fourth quarter will, although positive, leave us with a negative GDP for the year. The results will likely be the worst year since 1946. For 2021 the consensus seems to be just over 4% growth. Goldman Sachs is far more bullish with a recent upward revision to a plus 6.6% forecast, albeit with some significant caveats. Interestingly, their concerns are primarily COVID-19 related, but not significant enough to temper their projections. Looking back at 2020 it seems that economic results hardly influenced the market at all. After the initial COVID-19 scare in the first quarter, the market took off like an Elon Musk rocket and ended up 9.7% on the Dow and 18.4% on the S&P 500 for the year. The difference between the two indices is due to the impact the FAANG stocks had on the S&P average. The construction of the S&P 500 average results in the FAANG stocks having a 25% weighting and their extraordinary, combined performance greatly influenced the final S&P average. The major cause of the stock market’s performance in 2020 was the fiscal and monetary policies of the government. The Federal Reserve continued its Quantitative Easing Policy of adding liquidity to the market through its monthly purchases of government securities. Congress added to this through its broad-based financial program for business stimulus and restrictions on evictions for failure to make rent or mortgage payments as well as other support. Additionally, some of the unemployed were enjoying greater income than when they were employed. This made it hard to call back laid off employees, particularly in the service area. All this was not sufficient to comfort the worried citizenry. With a great deal of consumer insecurity, much of this government largesse did not end up in the economy but did stimulate the stock market. With bond yields at record lows, the only attractive investment opportunity left was the equity market. The result was a market that soared to higher price earnings ratios despite significant declines in earnings of the underlying companies. With dreams of additional stimulus and increased spending by the Biden administration the market has continued to move to new highs early in 2021. The Biden economic plans look to be a combination of selected industry disruption, an increase in corporate and individual taxes, and dramatic increases in spending for new programs, as well as economic stimulus payments to perk up a slowing economy. US government debt, already at highs, will probably set new records as politicians are no longer afraid to go to the well to fund new programs. Biden will have two years with control of both the House and Senate, although he will have smaller margins than prior administrations. So, the success of the progressive overhaul may not be as easily accomplished as originally thought. The argument for renewed stimulus by putting cash in citizen hands raises some interesting questions. In recent rounds the stimulus funds have been evenly split amongst savings, paying down debt, and actual spending. The immediate economic benefit of a debt dollar used for stimulus is now only thirty-three cents under this scenario. The stimulus does not have a multiplier effect. In earlier periods a dollar of debt would multiply to three dollars of economic benefit. This decline in efficacy is the predicted result of a significant increase in debt financing of our economy. A second measure of an increasing, but less effective, money supply is the continuing decline in the velocity of money. The decline in velocity to new recent lows reflects the ineffectiveness of pumping more money into the economy. The US needs to find new policies that will have a more direct effect on the economy if we are to work our way out of this situation. Speculation is on the rise and is reminiscent of the late 2000s as the dot.com dream became a nightmare. Stimulus money ending up in the market because there is no demand for it in other areas has elevated prices to very high and risky levels. New trading platforms, like Robinhood, have brought new, unsophisticated investors into the game resulting in unprecedented and unwarranted price action of some nearly bankrupt companies. At some point these speculators are going to painfully lose, like speculators in similar periods of investment history. The speculators actions can affect the overall markets and, through imbalances they create, cause the markets to crater. Hopefully, this trend will end before it overwhelms fundamentally sound investment activity. With markets already forcing investors into riskier investments to get acceptable returns, any additional speculative action could have a significantly negative impact on the markets and investors. In summary, it looks like COVID-19 and its variants will control the outlook for the markets for a good part of 2021. The variants of the virus that have already started to move around the world will likely take longer to get under control than the original. The longer it takes, the harder it will be for the world’s population to get back to normal activity, and the more stress our already weakened and debt laden economies will have to endure. I think the recovery will happen but more slowly than Goldman Sachs is predicting. Even with a bright forecast for 2021 Goldman is looking for a significant decline in 2022, followed by a further decline in 2023. Successful investing will require analysts to pay close attention to earnings progress and balance sheet development. In 2020 the Dow returned 9.7%, the S&P 500 18.4% and the Russell 3000 20.9%. The Bloomberg Barclays US Government/Credit 1-5 yr. index returned 4.7%. All these returns came in the face of a poor economic year but with a huge financial stimulus from the Government. Robert B. Needham, CFA
INVESTMENT QUARTERLY TAX ALERT - THE STEALTH TIME BOMB IN BIDEN'S PROPOSED TAX PLAN As we head to the finish line in the 2020 elections, we are seeing further analysis of the competing party’s platforms. We are somewhat reconciled to the idea that spending will increase no matter which party wins. The Biden campaign has specified a number of changes they will hope to make, particularly on taxes paid by high wage earners. There are triggers for tax increases at $400,000 and $1 million for different income sources. The impression the public is left with is that tax increases will only affect the top earners and that the middle class will be left untouched. Perhaps the most significant example of this “tax the rich” approach is the proposed change to the estate tax exemption. Currently, on death, an individual is allowed an exemption from Federal taxes of $11.58 million which amounts to $23 million per couple. Estate values above this amount are taxed at 40%. Biden’s plan calls for a reduction of $8.58 million in the individual credit to $3 million and a raise in the rate on the excess to 48%. This will allow a couple to have a combined exemption of $6 million if the estate is correctly set up. However, the increased rate on the excess, which will start at a lower dollar level, will result in a tax increase of over $4 million versus the tax on today’s $11.58 million estate. This is not chump change. The odds of this passing if there is a Blue Wave are pretty high. If Democrats control both the House and Senate in addition to the White House there won’t be much, if any, resistance to this revision. To most people these issues don’t raise much concern or even interest. It is not our money and our estates are still in a $0 tax position. For those who are blessed with a higher net worth these proposals should cause them to schedule a meeting with their estate planning attorneys to see what they can do to lessen the tax bite. You may wonder why this Quarterly is titled “The Stealth Time Bomb”. Well, there is another change, less widely published, that is part of this tax plan. Present estate tax regulations allow the cost of investments to be adjusted to their value on the date of death. This means that a stock you bought for $2 a share that is worth $100 at the time of your death would have its cost basis adjusted up to $100 upon your death. If an heir sold the stock at that time they would have no gain or loss so the $98 capital gain would be avoided. At a tax rate of 20% this would result in a Federal tax saving of $19.60 per share. In Massachusetts one would have state capital gains taxes that would be avoided by the stepped-up cost basis as well. As a result, estates below the exemption amount pay no estate or capital gains taxes if the beneficiaries sell the investments at the time of death. If they continue to hold and sell later there may be some tax ramifications but it will only be based on the gain or loss from the stepped-up basis of the investment. Your parents may have bought a house years ago for $50,000 and it is now worth $400,000 at the time of their death. Under current regulations you would be able to take that $350,000 gain tax free. The changes under consideration would disallow the stepped-up basis going forward. This would mean you would have to pay a capital gains tax on the estate’s appreciated property whenever you sold it. This could amount to a significant tax payment and reduction in the net amount heirs receive from an estate. Perhaps the largest gains for most people of modest means would be their home. In our example above of a $350,000 gain, reversal of the cost basis step-up rule would result in a federal tax of $70,000 plus Mass state tax of over $17,000. For many heirs a family inheritance is used to fund children’s college costs. A loss of $87,000 equates to 2 years of college expenses solely because of eliminating the stepped-up cost basis. After paying for college the balance of the inherited funds are frequently used to supplement retirement for the heirs. So ultimately this will make a comfortable retirement unreachable for more middle/lower income families. Despite claims that Biden’s tax plans will only affect the rich, those with over $400,000 of income, or estates over $3,000,000, the estate tax change would surprisingly hit a number of lower income estates that are exempt from taxes under current rules. There may be some strategies that will be developed over time to help alleviate this tax should it come to pass, but nothing is being discussed at this time. A similar plan was originally proposed in the 1980’s but failed to get support because of the perceived difficulty in administering it. Old records to support cost basis would likely be difficult, if not impossible to locate. The IRS assumes that if you can’t support a cost, your cost basis is zero. This could mean that an entire estate, with the exception of savings deposits, would be subject to capital gains taxes. If the approach is proposed today, a more liberal and progressive party could garner more support in an “end supports the means” world. Be on the alert and ready to write your senator and congress person if you see or hear that this proposal has seen daylight. Looking ahead, most market forecasters are projecting equity returns of 3 to 5 percent and bond returns of 1 to 1 1/2 percent over the next few years in the US. Internationally the forecasts are not much better. The sage Jeremy Grantham’s 7-year projection calls for negative equity returns with the exception of emerging markets. Most of his bond projections are negative because of the potential for rising rates. Covid and government stimulus will be key determining factors. At the ninth month marker the Dow Jones Industrial Average has returned (0.91%); the S&P 500 has returned 5.57%; the Russell 3000 has generated a return of 5.41% and the Bloomberg 1-5 year US Govt/Corp Credit has returned 4.20% so far this year. Robert B. Needham, CFA
INVESTMENT QUARTERLY THOUGHTS FROM A REMOTE COVID-19 BUNKER Sitting in my bunker to comply with the social distancing of Coronavirus or COVID-19 has brought back some personal family remembrances. I never knew my maternal grandfather as he passed in 1918 from the Spanish Flu. Until recent news reports I had no idea this earlier pandemic caused over 50 million deaths world-wide and 675,000 in the United States. All I knew was that my grandfather had died from the flu and my grandmother came down with it as she tried unsuccessfully to nurse him to health. Fortunately, my grandmother survived and lived until her late 80’s. This second-hand remembrance of events from 101 years ago has given me an understanding of the impact this virus can have on families for years. My plea to all of you is to take this situation seriously. Please follow medical and government directives designed to curtail the spread of the virus. We wish you good health. We have closed our office until further notice, but we continue to work remotely from home. We will provide the same responsive service that you, our clients’, have come to expect. It is amazing how much you can do with Facetime and Zoom. We hope you will call on us if we can do anything to help you through this crisis. Before getting into our usual economic discussion, it might be helpful to discuss some important changes that can impact your financial situation. In a recent quarterly we discussed one change the SECURE ACT brought to IRAs. In addition to shortening the years a beneficiary IRA could run to 10 years, the act delayed the age at which one has to start required minimum distributions (RMDs) from 70½ to 72 years old starting in 2020. The CARES ACT grants a waiver to all IRA or 401k owners who skip their required minimum distribution in 2020. It even allows those who have already taken a distribution in 2020 to put it back in the IRA as long as it is redeposited within 60 days. All funds redeposited in this manner are not subject to income tax in 2020. If you do not need your annual distribution for your annual living expenses, you might want to consider this benefit. We hope all of you have established estate plans to provide for yourselves and your families. It is probably a good time to review these to make sure you are utilizing them to the fullest extent. You should review your Health Care Proxy and Durable Power of Attorney to be sure that they still reflect your wishes. These two items are primarily for your benefit but can also help avoid family disputes if you are incapacitated. If you have a trust or trusts, you should be sure that there are not any changes you should make as your family has aged. If you have trusts you also want to be sure that your assets are properly registered so that they end up where you want them without having to go through probate. And, if assets are not properly registered you could end up with unbalanced estate values and lose the federal or state estate tax exemptions that your plans were originally designed to capture. If you haven’t put plans in place, there is no time like the present to create them for you as well as for your children over eighteen. It looks like COVID-19 will be with us for a while so hopefully you have some time to get this done, but starting early is the best approach. The economic problems caused by COVID-19 are likely to be significant and long lasting. It is likely that there will be significant changes in personal and corporate behavior as a result. It is also likely that the world will fall into a recession in 2020. What are the chances of a depression with potential 20 percent unemployment, and how do you tell the difference between the two? Someone once said, “If you lose your job it’s a recession, but if I lose mine it’s a depression.” A recession is defined as two back-to-back quarters with negative Gross Domestic Product. A depression is a longer lasting and deeper recessionary period. The world-wide economic impact of this pandemic is so severe that any recovery will likely take longer than normal. The speed of the latest market decline set a record as the shortest time for the market to decline over 30%. This gives credence to the Wall Street adage “The stock market goes up on an escalator and down on an elevator.” The Dow Jones Industrial Average dropped 38% from its February highs only to quickly rebound by 26% after the Treasury and Fed announced their programs to flood the market with liquidity. Volatility is the order of the day. The strength and speed of the rebound has caused some analysts to project a swift economic and Coronavirus recovery leading to a strong equity market. A recent chart comparison of today’s decline and recovery with a chart during the Great Depression shows a similar early pattern. In the depression period the initial market recovery was really a bear market rally following which the market declined over 80% and the economy required years to recover. Only time will tell which of these scenarios will prevail. If we look at the economic damage already caused by the COVID-19 it is severe. While the Atlanta and New York Fed GDP formulas project first quarter GDP of between 1.5 to 1.7 percent, the Blue-Chip Consensus forecasts a negative 2%. For the second quarter an early forecast by Goldman Sachs projects a horrendous decline of 34 percent. If the Blue-Chip and Goldman forecasts are true, we will be in a recession with two negative quarterly GDP results. We need to see first quarter results, paying close attention to corporate guidance on revenue, to get a good idea of where the economy is likely to go. With streets empty, people aren’t buying so sales will continue to be weak. First quarter results will not reflect a full quarter of declining sales so second quarter results could be worse. People’s consumption behavior changed in the Great Depression so it will be interesting to see what develops from the current environment. The consumer is 69% of our economy historically and 84% of the period since 2014 so consumer spending will determine how rapidly the economy recovers. Balance sheets will be more important than income statements now. Companies can never cut expenses fast enough to keep ahead of falling sales so there will be a huge negative impact on earnings and cash flow. Lower earnings and cash flow could lead to dividend cuts if companies don’t earn their dividend, or need the cash to make interest payments on outstanding debt. Focusing on high stock dividend yields could be treacherous without an understanding of the effect of falling revenue on earnings. Even if the economy is slow to recover though, current and future stimulation programs could provide enough liquidity to move the market to short term highs if there is any good news on the rate of infections, discovery of a treatment or the development of a vaccine. It is a dangerous time if the market does one thing while the economy does another. Right now, with all the economic uncertainty, chasing yields is like trying to catch a falling knife. For the quarter the Dow Jones Industrial Average returned a disturbing -20.0%, the Russell 3000 Index a negative 18.4% and the S&P 500 a modestly better, but still disappointing, -17.2 percent. The Bloomberg 1-5 year Corporate/Government bond index returned a positive 2.1% as the Fed’s move to a near zero rate posture provided one of the few bright lights for the quarter. The unexpected landing of the COVID-19 Black Swan caught the market by surprise and took no prisoners. Early forecasts for the second quarter may not give the equity market much support either. Robert B. Needham, CFA