What’s New

September 15, 2020

While this blog has been quiet for a while, it isn’t because there is no news. This is just a short note to highlight a few updates.

First, there is no new stimulus for the US, at least not anything significant. The president has offered some modest benefit for unemployed people, and signed an executive order banning evictions for the rest of the year. These seem to be having limited impact.

In Canada, there has been an extension of benefits for those affected by COVID-19 and attempts to improve rent relief program that few seem to appreciate.

These policy actions are staving off a collapse in the economy, but as expected some of the effects are still showing up.

In the US, bankruptcy filings continue to pile up and more is expected as the year progresses, with a probability that next year will be horrible, once many of these programs are gone. Look at Real Estate, one of the hardest hit sectors. Yesterday 48 Regus affiliates (rental office space) filed for bankruptcy, Jeff Winick, one of the largest real estate brokers filed for personal bankruptcy (that’s $10MM owing, we all wish we had those problems), and those are just from this morning’s news.

Beyond that, there is a lot of strain. A US call center and collection service went into bankruptcy over the weekend, with $1 billion in debt. A seafood company (Cooke), another gym (New York Sports Clubs), a retailer (Century 21), and the list continues . . . This morning I was dismayed by the addition of Mountain Equipment Co-op, a company that has served my adventures well for over 30 years. They were acquired by a private equity firm to escape bankruptcy.

There is a lot of hope however, and it is driving up markets, it is creating a bubble in assets. The S&P 500 has risen to new highs before settling down a little bit, but very near it’s February peak. Some companies have achieved crazy valuations, and some have reached into beyond reason.

Cases in point would be companies like Apple. They have a new product announcement event today, and had a stock split a couple of weeks ago, but those events have driven the company to a high of $137 per share, although it has settled back down to the $115 area. Meanwhile the crazy stuff is happening with companies like Tesla which also split and has reached as high as $500, before settling near $440 currently.

Apple’s valuation puts the P/E at 28 times forward earnings, which would be hard to sustain for a much smaller company. For a company of that size, it is nearly impossible. That’s not to say things will go badly for Apple, just that they would be hard pressed to grow into this large of a valuation.

Tesla on the other hand is valued at $450 billion, which is 105 times forward earnings. This only seems a little crazy at first blush, but when you consider that the valuation for Tesla, who currently makes about 500,000 cars is more than ALL other major carmakers combined, it shows how manias can progress. The assumption has to be that Tesla would sell every car in the world at some point in the near future.

The crazy isn’t relegated to these two companies however, you can see it in many corners, but it is profound only in that it ignores the real risks to the world.

  • California is suffering from massive wildfires that are literally destroying entire communities. There are five hurricanes in the Atlantic ocean, with Hurricane Sally about to hit Louisiana, Mississipi and Alabama. The breaking of the ice shelf in Antartica is also in the news, but it is not an immediate threat, just another example of the long term risk to coastlines and environments.
  • The US election is just 55 days away and all indications are that the current president will try to install himself as a dictator no matter the results. There are few if any examples of this being good for the people in any society. It will certainly be disruptive to the USA.
  • People around the world are going hungry. This rarely gets much notice until it is too late, but even in the US, this is becoming a problem. The key concern is that hungry people, in time, always cause political turmoil.
  • People’s livelihoods have disappeared. Of course we measure unemployment in most modern economies and the numbers appear to be getting better. They are still terrible, but they don’t really capture the ‘gig economy’ nor private enterprises that in many areas have simply stopped producing income, stopped producing goods, stopped their services. Details of this problem are reported sporadically, but statistics are harder to find. (The chart below shows continuing claims for unemployment for the week ending August 24th, the latest data available).
  • Beyond that, there is a pandemic going on. There is a great deal of hope that the pandemic is receding, but a more likely argument is that we have flattened the curve. Here are case charts for the US, for Canada and the world.

There are plenty of other risks facing the world. Greece and Turkey are stepping back from one of the most dangerous conflicts in decades, while China and India appear to be doing the same. This while Russia pushes for more control in Belarus, one of the last dictatorships in Eastern Europe. These all speak to rising geo-political tensions that come with economic hardships.

These won’t appear to many for many quarters, perhaps years, but they are occurring. China is said to need 7% growth to avoid social unrest. They are at 3.5% this year, and unrest is growing. Again, highlighting border issues with India, but also their treatment of Uighurs, their actions in Hong Kong and their aggression in the South China Sea, throughout Africa and more.

Much of this blog is focused on the ‘unusual’ things you should consider. The vast majority believe that the stock market will provide them with financial security in retirement. A US brokerage recently found, during the height of the COVID crash, that investors expected 15% annual returns over the next five years. The numbers were somewhat lower in other nations, but a substantial part of the world expected returns > 10% annually. This after a 12 year bull run. This is highly, highly unlikely.

The bull run has been financed by government debt. It has provided massive liquidity to the wealthy, while appeasing the poor. This has caused a significant distortion in wealth in the US, where 72% of wealth is in the hands of the top 10% of the population, and fully 99% of wealth is in the hands of the top 50% of the population. Things in Canada are not quite that distorted, but other parts of the world are more so.

The US government debt has increased from about $9.2 Trillion (62% of GDP) in Q4-2007 versus 26.5 Trillion (108% of GDP) in Q1-2020. By contrast the total market capitalization in the world grew from about $32 Trillion during the 2008 decline to about $68 trillion in 2018. Quantitative Easing has added even more (about $6 trillion since 2008). That’s a total of $22 trillion of capital thrown at the economy to raise equity markets by about $30 trillion. It’s clear the wealthy have won, and the average individual is losing.

US Public Debt has exploded to $26.5 Trillion
Federal Reserve Balance Sheet – Increased by $6 trillion

Perhaps a better way to look at this is the value of the largest market index, relative to the economy. The Wilshire 5000 captures (essentially) all US equities. Comparing that to the size of the economy, we get a chart like this.

Valuations are over 2x higher than average

The thrust of all this is that while you want to participate in the markets in general, you don’t want to be heavily invested when things are expensive. You want to invest when things are inexpensive. It is worth noting that these divergences can last for months and years. Note the ‘depressed’ markets from 1975 through 1985! The same could happen on ‘exuberant markets’, perhaps expect minimal returns in future instead.

The contrast is to build up cash reserves, protect your assets, enjoy your life, but don’t worry about your portfolio.

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