Second Quarter Newsletter
Responsible Guidance: Second Quarter 2020 Newsletter, July 2020
Planning for Multiple Outcomes
The first six months of 2020 have been a long decade…well it at least seems like a decade. We hope you have been able to stay safe and healthy through these times and want to share our condolences to anyone experiencing health or financial challenges.
Per usual, for our quarterly letter, we will continue to remain "in our lane", so to speak, and focus on the capital markets and Your Personal Economy. So far this year, we have experienced multiple periods of popular equity benchmarks making all-time-highs and sandwiched in between those periods, we've seen the fastest sell-off of equities during the month of March. With the help of the CARES Act, the Federal Reserve (Fed) asset purchasing program and advances in healthcare, markets regained some confidence and stabilized in the second quarter of the year, helping to improve the mood of some investors.
As we review information and data from the second quarter, many of you may be wondering how we are going to come out of all of this. We suggest thinking about planning for multiple outcomes and not just getting too fixated on any one situation. This approach may help provide comfort and keep your emotions in check, focusing on Your Personal Economy, regardless of the environment around you.
A Global Perspective
A core objective for our customized Baron Financial Group investment strategies is global diversification. Global diversification means including investments based both domestically in the U.S., as well as internationally in developed and developing countries.
There are popular benchmark indexes that provide perspectives about performance of global investments. For equities, we monitor the MSCI ACWI All Cap Index. This index is designed to represent equity investments across 23 developed and 24 emerging markets. The index was up 19.89% in the second quarter, as equity performance rebounded from the downturn most experienced in March, due to the impacts from the Covid-19 pandemic. Year-to-Date (YTD) the index is still down 7.09%. For fixed income, or bonds, we track the FTSE World Government Bond Index. The index tracks sovereign debt from 20 countries, denominated in their respective currencies. It was up 2.04% in the second quarter and performance is positive for the year, so far, at 4.08% as high-quality fixed income investments have performed better than many equity indexes across the globe.
The decade ending in 2019 was the first time a decade passed without a recession. Then 2020 hit. Currently, we would say things are all over the place and you could find both positive and negative news to focus on. On the negative side, virus numbers continue to grow and new "hot-spots" are emerging and some economies are struggling to re-open. On the plus side, May and June had very strong job growth and we believe the healthcare system is much better prepared today and that the pursuit for a vaccine is clearly on an aggressive pace. Looking at the raw data for the economy for the quarter, the numbers are weak, but the most recent data seems to be building positive momentum.
The Bureau of Economic Analysis (BEA) announced in its third estimate for the first quarter of 2020 that real Gross Domestic Product (GDP) decreased 5%. We believe it's pretty obvious that the shift to negative growth was a result of the government issuing stay-at-home orders and shutting down economies in response to the spread of Covid-19.
GDP is a measurement of what has already happened. There are, however, statistical measures that give insight into the future. One of those measures is The Conference Board Leading Economic Index® (LEI) for the U.S. The index is an analytical tool that helps signal peaks and troughs in the business cycle. The May LEI, released on June 18th, improved to 99.8 (2016 = 100), following declining readings in March and April.
“In May, the US LEI showed a partial recovery from its sharp decline over the previous three months, as economic activity began to pick up again,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “The relative improvement in unemployment insurance claims is responsible for about two-thirds of the gain in the index. The improvements in labor markets, housing permits, and stock prices also buoyed the LEI, but new orders in manufacturing, consumers’ outlook on the economy, and the Leading Credit Index™ still point to weak economic conditions. The breadth and depth of the decline in the LEI between February and April suggest the economy at large will remain in recession territory in the near term.”
We first shared the following chart in our 2018 fourth-quarter letter and believe it is important to continue to track as a potential recession indicator. The blue line represents the LEI, dating back to the year 2000. Since then, we have had two official recessions, which are identified by the shaded gray areas. A recession is typically defined as two consecutive quarters of negative economic growth. Using the last two recessions as a gauge, we believe that the chart suggests that there was significant erosion in the LEI (blue line moved lower) prior to the economy going into recession. Of course, in 2020, the shutting down of economies to help slow the spread of the virus lead to violent changes in economic numbers. Though we have not yet had 2 quarters of negative growth, we think it's safe to say the U.S. has been thrown into a recession. It is hard to see in the chart, but the improvement in numbers for May are hopefully signaling the recessionary period will not last long. Time will tell.
The full release from the Conference Board can be found at:
According to the Bureau of Labor Statistics (BLS), the U.S. added 4.8 million jobs for the month of June and the unemployment rate moved down to 11.1%. The gain in jobs came mostly from economies reopening, after shutting down in March and early April due to the virus. The biggest gains in June were in leisure and hospitality. Other recognizable gains occurred in retail, education and health services, other services, manufacturing, and professional and business services.
The Conference Board Consumer Confidence Index® increased in June to 98.1 (1985 = 100). This came after basically no change in May.
“Consumer Confidence partially rebounded in June but remains well below pre-pandemic levels,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “The re-opening of the economy and relative improvement in unemployment claims helped improve consumers’ assessment of current conditions, but the Present Situation Index suggests that economic conditions remain weak. Looking ahead, consumers are less pessimistic about the short-term outlook, but do not foresee a significant pickup in economic activity. Faced with an uncertain and uneven path to recovery, and a potential COVID-19 resurgence, it’s too soon to say that consumers have turned the corner and are ready to begin spending at pre-pandemic levels.”
The S&P 500, an index consisting of 500 of the largest U.S. domestic stocks, was up a strong 19.89% in the second quarter, but remained down for the year at negative 3.08%. The second quarter produced three solid months of returns for the index. Information from companies' second quarter earnings and forward-looking guidance, as well as abilities for economies to re-open will be some of the determining factors to watch for. For technical analysts and trend followers, for the first time since March, the index was able to close above its 200-day moving average on May 26th and has remained above that level through the end of the quarter
International developed country equities (such as those in the European Union), measured by the MSCI EAFE index was up 14.88% in the second quarter, However, year-to-date performance remains negative, down 11.34%. Non-developed, or emerging countries (such as China, India, Brazil or Russia) measured by the MSCI EM index, was up 18.08% for the second quarter, but, as with most equity benchmarks, it is down 9.78% so far for 2020.
Potential for International stocks to outpace U.S. stocks has been discussed for some time now. Since the end of 2017, we have heard that International equity investments appear cheap, on a relative basis, to U.S. investments. Looking forward, discussions are occurring suggesting opportunities may be improving outside of the U.S. Spreading investments across the globe is a core component to a diversified strategy and contributes to the concept of planning for different outcomes.
U.S. Domestic Fixed Income (bonds), as measured by the Barclays U.S. Aggregate Bond Index, produced a positive 2.90% return in the second quarter driving 2020 performance to 6.14%.
The 10-year U.S. Treasury bond yield was 0.66% at the end of the second quarter, which is lower in yield than where it began the year at 1.88%.
The Federal Reserve (Fed) cut short-term rates to basically 0% once the seriousness of the pandemic set in, and investors continued to buy longer-dated Treasury investments driving those rates lower.
If you plot interest rates versus the time-to-maturity to earn those rates, you have created what we call a yield curve. In previous newsletters we have written in great detail about the changing shape of the yield curve and what that may signal. Specifically, we follow the shape of the yield curve (plot of interest rates for different time periods). Using the U.S. Government 2-year bond rate as a proxy for short-term rates and the 10-year U.S. Government Bond rate as a proxy for long-term rates, we calculate the difference between the rates, which provides a possible indicator for the future direction of the economy. A steep spread (long-term rates higher than short-term rates) indicates possible future economic expansion and fixed-income investors are compensated for taking longer-term risk. A flat spread (long-term rates match short-term rates) is a possible indicator of economic uncertainty and longer-term investors are not being compensated for investing in longer-dated securities. An inverted spread (short-term rates are higher than long-term rates) possibly indicates future economic contraction.
The second quarter finished with the 2-year rate at 0.16% and the 10-year at 0.66%. Technically speaking, that suggests an upward sloping or steep curve. The 50-basis point spread (a basis point represents 1/100 of 1%) is larger than where the year began, as well as at the end of the first quarter. Though steeper, we think it's safe to say that the bond market continues to be uncertain about the future of the economy. The changing shape of the yield curve has really been occurring since at least 2014, when the spread between the 2-year and 10-year was over 220 basis points (bp).
Housing and Real Estate
Commercial real estate, as measured by the FTSE NAREIT All Equity REIT (Real Estate Investment Trust) Index recovered about half its losses for the year in the second quarter and was up 13.25%. The index remains down 13.30% on the year. Our investment committee at Baron has spent a lot of time reviewing challenges and opportunities for these investments. We hear opportunities are potentially increasing for areas related to tech, such as data centers and cell towers, self-storage, and healthcare, to name a few. While potential challenges and concerns remain for traditional office space, retail space and senior housing.
According to Freddie Mac (FM), the average 30-year residential home mortgage rate is at or near all-time lows at 3.07%. The rate was 4.51% (close to a seven-year high) near the start of 2019. The lower rates may continue to have a positive impact on the housing market. For those who have a current mortgage and have not refinanced in some time, it may be worth looking at potential options (See our Personal Economy section).
The Bloomberg Commodity Index (BCOM) increased in the second quarter, gaining 5.08%, however, year-to-date performance remained weak at negative 19.40%. Of the indexes we monitor, this had the lowest performance numbers through the first half of 2020.
Natural Resources serve as an expected hedge against inflation and offers statistical benefits to portfolios. Of course, there has been little to no inflation for some time, resulting in few recent benefits for these types of assets. We continue to monitor our investment choices in this asset class and look to make improvements when possible, as we do for all of our asset classes. We should mention that in April, for the first time ever, oil futures traded at a negative price, as structural issues with supply and demand surfaced in that market. If you are curious about the details, feel free to reach out to our team with any questions.
Baron Client Strategies
There has been a lot to do so far this year including, but not limited to, validating investment strategies as markets change, rebalancing as markets have rapidly evolved, tax trading when possible for clients with taxable accounts and evaluating investments versus peers and benchmarks in both up and down markets. These are things we do on a regular basis, of course, but the volatility in the markets have increased the need for these activities to occur more frequently. If two things are clear, it is that your investment strategy should be created with the understanding there can be very different outcomes, not just the single outcome you may feel is the most likely, and that you should have a rebalancing strategy.
No matter the economic environment, our basic principles remain:
Create a globally-diversified and risk-appropriate strategy. Validate the investment choices versus peer investments. Rebalance when needed. Test the strategy in a comprehensive financial plan and obtain regular feedback to update information and advance your financial position.
Your Service Plan
One of our primary roles is to educate our clients to make informed decisions about reaching their goals. Critical to that process are plan reviews, a process that focuses our attention on your goals, takes account of any changes in your situation and allows us to alter the course, as necessary. For more specifics, check out our “What You Can Expect” document by clicking on the button below.
Your Personal Economysm
You may have heard us say that we are happy to help clients with issues outside of investing that may have an impact on their financial lives. We say things like “Lean on us when you are making a decision with anything with a dollar sign involved.” So, we have been including this section as a reminder of all of our services and to share ways in which we can help clients outside of investing.
Mortgage rates are at or near all-time lows. If you have a mortgage and are paying 4% or more, you should consider options such as reaching out to your existing mortgage company to see if they offer a loan modification (i.e. keep loan as is but reduce the rate) or explore refinancing options with a professional mortgage person. We have helped educate and direct clients and friends on this topic. Please reach out to us with any questions.
So far 2020 has made it clear - be prepared for many different outcomes, not just one. We think it is best to maintain a positive mental outlook, but make sure you understand how Your Personal Economy may change in different economic environments. At Baron, scenario planning is a core part of creating a comprehensive financial plan. Knowing how you are positioned if the economy is doing well or poorly helps to avoid being overconfident or too focused on fear. If you haven't done so already, reach out to us to help you best understand Your Personal Economy and how scenario planning can help you prepare you for your financial life and hopefully help keep your emotions in check.
Because meeting in-person is not as easy as it used to be, we are suggesting clients consider a video meeting if you have not done so already. You do not have to be on camera, but we can be, and we can share our screens to help review reports and other information.
With less in-person meetings we have been creating more video content, to help keep you informed and maintain a connection with your Baron Team. Hopefully, you have seen our video thanking the Healthcare workers and sharing some great photos of the Baron Team working form home. We have shared other videos recently (some will launch soon), instructing use of our Baron Portal, explaining cybersecurity and ways we protect client identity and data, answering questions about Your Personal Economy, and reviewing recent market performances.
We look forward to sharing additional educational, as well as fun videos throughout the year. Keep a look-out for these on the small screen and let us know what you think.
Remember that you can visit our website to gain access to your client portal. Just click on the client-portal tab, which will allow you access to view your account information. The client login requires a username and password to gain access through the portal. Please let us know if you would like to create your portal login or if you would like to learn more about what the portal provides.
Would you like to enroll in paperless Baron statements? Paperless statements will be accessible through our online client portal in the “Documents” section. You must be enrolled in the client portal in order to view your paperless statements. You will receive an email notification each quarter your statements are posted. Contact Baron at 1-866-333-6659 or at email@example.com to enroll.
For more educational content, please visit our Website Blog. The Baron Advisors are often called upon by journalists for their insights on financial planning and investing. They are quoted in such prestigious media outlets as The New York Times, CNBC.com, and NJMoneyHelp.com, among others.
Look for our Form CRS (Customer Relationship Summary) to arrive in the mail shortly. This new SEC-required form gives a brief summary of our firm with answers to questions that a client or prospective client might have. Please contact us if you would like a copy of our current registration (ADV) with the Securities and Exchange Commission. You can contact our firm at 1-866-333-6659 or at firstname.lastname@example.org. You can also find our ADV through the Investment Adviser Public Disclosure system at www.adviserinfo.sec.gov.
We are proud of our philanthropic efforts, which include pro-bono work, as well as monetary donations to The Fair Lawn Food Pantry, the All Faiths Food Bank in Sarasota, the Adopt-A-Soldier Platoon, Spectrum for Living (serving adults with developmental disabilities) and the SCARC Foundation Capital Campaign (serving people with developmental disabilities). In addition, we are proud to continue our ten-year tradition of providing a Baron Financial Group Scholarship to two deserving Fair Lawn High School graduates (1 female and 1 male), who plan to further their business education. We are proud to help!
Unfortunately, we are not able to hold our usual holiday celebrations this year, due to the pandemic. We hope we will be able to resume our special events next year and see you soon!
We miss seeing you in person!
Baron Financial Group, LLC
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of July 8, 2020, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Baron Financial Group to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client or prospective client’s investment portfolio. Historical performance results for investment indices and/or categories generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. Inclusion of index information is not intended to suggest that its performance is equivalent or similar to that of the historical investments whose returns are presented or that investment with our firm is an absolute alternative to investments in the index (if such investment were possible). Investors should be aware that the referenced benchmark funds may have a different composition, volatility, risk, investment philosophy, holding times, and/or other investment-related factors that may affect the benchmark funds’ ultimate performance results. Therefore, an investor’s individual results may vary significantly from the benchmark’s performance.