Gill Capital Partners Mid-August Update – Red Dawn
No, we are not referring to the 1984 dystopian action movie starring Patrick Swayze, Charlie Sheen, C. Thomas Howell and Jennifer Grey. We are referring to the Colorado skies this past week. Those of us in Colorado have been treated to moments of awe in the early morning and evening over the past week, as nature has been putting on quite a show with stunningly bright red colors. Long-time Colorado residents have seen these sunsets before and sadly know that the beauty is a sign of horrible destruction taking place nearby in the form of wildfires that emit particles into the air, which lead to the beautiful sunsets and sunrises. Red skies and the lore that surround them have been used to predict weather patterns since biblical times. A famous old adage says, "Red sky at night, sailor's delight. Red sky in morning, sailor's warning." The weather phenomenon seems to be a good metaphor for the current economic environment that sees stunning all-time high stock prices in the midst of economic turmoil. More on the current economic and market environment below, but first some humor….
Joke of the Day
A new weight control system was invented during the coronavirus lockdown:
Market Update
As of this writing, U.S. equity markets are at or near all-time high levels. Investors continue to question how this can be, given that we are in the midst of a global pandemic with the highest levels of unemployment we have seen in our lifetime, businesses of all sizes struggling to survive, and parents attempting to balance work with family as schools open in a variety of learning formats. While predicting the sustainability of the current markets is futile, the driving forces are twofold: low interest rates and massive government stimulus.
Interest Rates & The Challenge for Fixed Income Investors
The Market Ain’t What It Used To Be – Many investors look fondly back on the days when bonds paid meaningful interest and prices consistently went up due to falling interest rates. In those days, you could reduce your stock risk by owning bonds and still have a safe portion of the portfolio generating very good returns. In 1982, high-quality bond interest rates peaked at 15.5%. By 2006 it was down to 6%, which seemed low at the time, though investors would jump at the opportunity to make 6% in a low risk bond portfolio today. Currently, a 10-year Treasury bond pays .60% per year; if you buy that bond and hold it until maturity, you will get your money back in ten years and you will receive .60% interest per year. The corporate bonds that paid 6% fourteen years ago are now paying 2.4%, but you must be willing to lend them your money for twenty years. A 5-year CD, one of the primary sources of income for retirees back in the day, will pay you .78% interest per year, and high quality five-year municipal bonds now pay .30% tax exempt interest per year. Unless you are Jeff Bezos, these traditional income sources won’t cover your expenses in retirement. Investors often find themselves looking for alternative sources of income or feel forced to increase their exposure to equities, pushing equity multiples higher.
Stocks to the rescue?
Even a global pandemic and economic shutdown can’t keep stocks down for long, as it seems the Federal Reserve and the U.S. Treasury have finally stumbled onto the secret sauce for producing consistent stock market gains. If the market begins to falter, simply borrow another trillion or two or five from the grandkids. Yes, the gym you used to go to is out of business, your favorite restaurant is either closed or on life support, and movie theaters may eventually only exist in history books, but Apple is now almost a $2 trillion company and Jeff Bezos has a net worth of $181 billion. It seems that we have sidestepped the stock market impact. Patrick Swayze said it best in Red Dawn: “It’s kinda strange, isn’t it? How the mountains pay us no attention at all. You laugh or you cry, the wind just keeps on blowing.” In fact, as the Fed pumps more stimulus into the system and buys bonds (and possibly stocks someday) to provide stability, things feel somewhat normal in an eerie red dawn sort of manner. It’s as if we’ve dodged a bullet. This has led to the feeling that stocks are a safe place and, for now, with fixed income returns near zero, they are the only game in town. This dynamic is largely responsible for the inexplicable move we have seen over the past couple of months.
It is important to remember, however, that the value (stock price) of a company can go up for a couple of reasons. Either its profits increase and drive the stock price up, or the stock simply gets more expensive. As an example, Apple’s stock price has doubled over the last year, moving higher from roughly $200/share to where it sits today at over $450/share. However, Apple’s price/earnings ratio has also doubled from 16.9 to over 35 today. Put simply, the stock has gotten more expensive over the last year, as has the market as a whole. The P/E ratio for the S&P 500 currently sits at a lofty 22.5 times forward earnings estimates, which is roughly two standard deviations above its long-term historical average of 16.4 times, and is now competing with valuations last seen in the late 90’s tech boom. While this clearly does not look like a “safe” entry point for new investors, valuations can remain stretched for some time as investors looking for portfolio growth flock to equities in this incredibly low interest rate environment.
What should investors do now?
While valuations are clearly stretched and appear to be looking past the pandemic to brighter days, equity investors can take solace in the fact that the Federal Reserve and global central banks are squarely in their corner, willing to support equity and bond prices until we can bridge the pandemic gap. That being said, investors must also recognize the possibility for episodic and violent market movements in both directions. We will continue to rebalance portfolios to target allocations, which means we will be selling some of our holdings in the high flying tech space and reallocating to areas that have not appreciated so dramatically, such as cyclical value stocks and international equities. We also continue to work hard to find unique and safe fixed income and fixed income alternatives that can provide our clients reasonable income and a counterweight to equity exposure.
From our team at Gill Capital Partners, we hope you have an excellent weekend and enjoy the sunsets - they are spectacular.
Gill Capital Partners Virtual Client Education Event – Purposed and Prepared: Building a Legacy That Lasts
We are pleased to announce the next event in our speaker series with David R. York, an attorney with York Howell & Guymon on Thursday, August 27th at 11:00 am (MDT).
As we approach the beginnings of the largest financial wealth transfer in history, the surveys of the affluent are clear: undirected wealth is about to be transferred to unprepared and uninformed heirs. David will discuss the changing views on wealth and ways to effectively transfer wealth from one generation to the next.
Topics will include:
What is wrong with current estate planning and how it can be fixed?
How changing views are affecting financial planning
The importance of capturing and transferring both financial and human capital
How to maximize the benefits of financial wealth transfer on a multi-generational basis
Please mark your calendars for this insightful presentation!
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.