Any low-cost basis stock or real estate?  If so, you have 6 weeks for Long Term Capital Gains tax at 15% before it goes up next year above 30% LT Capital Gains.  Check with your tax advisor, you may benefit by selling low cost basis stock or real estate, pay the capital gains at 15% and establish a higher basis.

  • Roth Conversion this year before year end 2020.  Make sure to stay on track for using this year to convert another chunk of your IRA to Roth.  Make sure we do not raise your tax bracket by doing so.
  • The SECURE Act eliminated the stretch IRA. The estate tax exemption and lifetime gift exclusion could be substantially reduced next year, and the step-up basis may be eliminated, which could hit heirs with substantial capital gains taxes. Annual gifting and split gifting could be more important than ever. To help maximize inheritance and minimize potential estate tax concerns, review gifting strategies and beneficiary designations. High-net-worth clients may want to consider leveraging the lifetime gift exemption to reduce their taxable estate. If both parents and grandparents are wealthy, consider transfers to grandchildren in anticipation of changes to the generation-skipping tax.

 

US Economy

 

  • The September job openings report was roughly in line with market consensus. The quit rate (voluntary resignations) ticked higher while layoffs continued to decline.
  • Job openings in retail and construction sectors declined, while vacancies in transportation/warehousing and business service sectors climbed further.
  • The hiring plans index declined.
  • Small firms are increasingly reporting elevated business uncertainty.
  • The NFIB index is likely to weaken in November. Many small firms are increasingly unsure whether they will survive.
  • S&P expects slower retail sales this holiday season (which contradicts some other forecasts).
  • Here is a list of retailer holiday hiring plans. Delivery drivers are in high demand.

 

 

  • The election outcome put some pressure on consumer sentiment.
  • With more employees working from home, companies are increasingly trying to sublease office space (flooding the market). Despite the rally in office REITs, this sector will continue to struggle.
  • While inflation indicators will rise next year due to base effects, Goldman sees the core PCE inflation ending 2021 at 1.65%.
  • The Pfizer vaccine announcement has been good for crude oil.

 

 

  • Corporate loan demand is now at its weakest since the financial crisis. Small business demand is particularly soft.
  • The October CPI report showed a slowdown in price increases, with both the headline and the core inflation figures coming in below consensus.

 

Core CPI Inflation Numbers

 

Over the years, many Americans have become skeptical about the official CPI figures. That mistrust of inflation data became more pronounced this year after the lockdowns. We decided to ask a number of people across the US about their experience with inflation and why they don’t believe the CPI figures. Below are some responses and the corresponding data from the latest CPI report.

  • “When I walk into a grocery store, these inflation numbers you report make me laugh.”
  • “Have you gone food shopping? It’s hyperinflation out there. ”

While meat inflation (which spiked earlier this year due to supply bottlenecks) is off the highs, prices are still well above last year’s levels.

 

 

And here we have the CPI for cleaning products.

 

 

“I am paying much more these days when I eat out.”

Indeed. Fast-food restaurant prices are up sharply.

 

 

“It’s costing me way more to get a drink these days.”

 

 

“I had to pay more for a washer and dryer than the prices I saw last year. It’s a ripoff.”

That’s correct.

 

 

“Car prices are up. Your inflation numbers are a joke.”

No question about that. Especially used cars.

 

 

Technology and Computer prices have fallen dramatically.

 

 

Gas prices are lower

 

 

You can buy men’s suits at a much lower price than last year.

 

 

Healthcare inflation is slowing.

 

 

 

 

Hotels and airline fares are cheaper.

 

 

Movie tickets.

 

 

Pets and pet products.

 

 

Slower population growth tends to correspond to lower inflation.

 

Market’s Expected Returns Over the Next 10 years

 

U.S. stock valuations are at ridiculous levels against a backdrop of a global pandemic and global recession, and CAPE3 levels are well above 2007 levels, within shouting distance of the foreboding highs reached in October 1929. But it gets worse. U.S. Treasury bonds – typically a reliable counterweight to risky equities in a market sell-off – are the most expensive they’ve been in U.S. history, and very unlikely to provide the hedge that investors have relied upon. We believe the chances of a lost decade for a traditional asset mix are dangerously high.

Exhibit 1 lays out the long and sad history of these numerous lost decades for 60/40 portfolios. What they all had in common was that each began with stocks or bonds being expensive. Today, stocks and bonds are pricey. This frightens us and it should frighten you. Few investors want to hear this because the 60/40 portfolio has worked so wonderfully for the past 10 years. Unfortunately, they were saying the same thing back in 1999, right before it failed them for a decade. 

 

 

Jobs Data

 

The summer jobs bounce only restored about half the lost jobs, and now the pace is slowing again. The latest vaccine news gives hope for next year, but we have to get through winter first. Filling that jobs gap will likely take many more months.

 

 

The Labor Force Participation rate is (with a few exceptions we’ll ignore) the percentage of the adult population who are either employed or at least seeking work. It’s never 100% because some people are always retired, disabled, or otherwise not looking for a job. This long-term chart shows how participation increased as social changes in the 1960s and 1970s brought more women into the labor force. It began falling in the early 2000s and dropped even more during the 2007–2010 recession. Demographic factors contributed as well. Longer lifespans mean more retirees. Also, the Baby Boom generation began reaching retirement age around 2010.

 

 

This year’s pandemic brought an unprecedented plunge in the participation rate, followed by an unprecedented recovery. But even with the recovery, it is now back where it was in the late 1970s. Look for significant consequences if this persists.

The “pandemic + recession” combination is hitting state and local governments hard. They are seeing expenses rise at the same time tax revenue falls. This matters because their spending is a significant part of Gross Domestic Product. The chart below shows it can be either a boost or a drag.

 

 

Notice the difference between the 2007–2009 recession and the current one. Back then, state and local spending actually added to GDP in five out of six quarters. That does not appear to be happening this time, at least so far. It’s more evidence this recession is a different animal.

Restaurants may be the sector most hurt by the coronavirus pandemic. The data support this, too. OpenTable, an app that tracks restaurant traffic, showed business slowed to practically zero in March, stayed there several weeks then slowly improved, though not fully. The chart shows it returned to the previous normal only in Florida, and only briefly.

 

 

More troubling, though, is a sharp decline in the last month. This may reflect rising virus concern but could also relate to weather. Restaurants are trying to save the colder months with tents, heaters, and other such measures. The data suggests diners may not be convinced. This matters to employment, GDP, and the economy in general.

Urbanization has been a global megatrend which the pandemic may slow but seems unlikely to stop. These GZero charts show some interesting regional variation. North America’s population was half urban or more in the 1950s. Europe was next, followed by Latin America, and then East Asia. North Africa is just now starting the process while Sub-Saharan Africa has a long way to go. If urbanization indicates growth, this tells you where the next gains will be.

 

 

Major Potential Credit Problem

 

We’ve warned about this approaching storm for a while. There is serious trouble facing the U.S. economy and most businesses due to the blows to our economy from COVID-19 and the subsequent response to the pandemic. A wave of bankruptcies is coming in the months and years ahead and has already started happening.

According to credit-ratings agency Standard & Poor’s (“S&P”), 124 U.S. companies have defaulted on their debt so far this year.

The default rate has steadily climbed from 3% at the start of the year to around 6% today. That means 6% of all U.S. corporate borrowers have defaulted over the past year.

But it’s going to get much worse.

S&P currently predicts that the default rate will rise to 12.5% by next June. That would be the highest default rate since the Great Depression in 1932. A 12.5% default rate means that another 240 companies in the U.S. will go bankrupt over the next year. That’s a conservative estimate. By his count, a default rate between 12.5% and S&P’s pessimistic forecast of 15.5% would work out to between $100 billion and $250 billion in defaulted debt – and worse, billions of dollars of credit losses for unsuspecting investors.

It would be the worst period for corporate defaults that we’ve ever seen.

 

Corporate Debt

 

Debt also acts like a power generator for corporate earnings. It allows companies to produce much higher profits on a given amount of equity investment.

Let me give you a quick example to show you what I mean…

Assume a brand-new company needs to raise $100 million in new capital to invest in a business that will earn $20 million per year in operating profits.

The company has a choice. It can raise the capital by issuing new equity (stock), by issuing new debt (using the reservoir), or some combination of the two options.

First, let’s assume the company raises the $100 million by issuing stock. If the stock is valued at $10 per share, it will issue 10 million shares and its after-tax profits will be $16 million (assuming a 20% tax rate). Its earnings per share will be $1.60 ($16 million in profits divided by 10 million shares). That’s a 16% return on equity ($16 million divided by $100 million in equity).

Now, instead, assume the company raises half of the $100 million by issuing debt at a 6% interest rate. Instead of issuing 10 million new shares, it will issue only 5 million. Because it now must pay interest on the debt, its after-tax profits will be a little lower ($14 million).

But here’s where the power of leverage comes in.

While the company’s after-tax profits are 13% lower when using debt, its earnings per share will be 75% higher. Earnings per share will be $2.80 ($14 million in profits divided by 5 million shares) compared to $1.60 using all equity. The company’s return on equity is also 75% higher. It jumps to 28% ($14 million profits divided by $50 million in equity) by using debt – from 16% by using all equity.

The 75% increase in earnings per share and return on equity is the same no matter what you assume the company’s stock is worth. That’s because when a company uses debt as a source of capital, it has less equity outstanding, so its earnings per share and return on equity are much higher. That makes a tremendous difference.

By issuing debt instead of shares, the company can supercharge its return on equity and earnings per share.

The following table shows the differences between the company’s profits, earnings per share, and return on equity ratios under the two different scenarios. Take a look…

 

 

The more leverage (debt) used, the higher the returns. That’s why the management teams at most corporations love debt so much. It’s a way to amplify their profits and returns.

The problem, of course – as with most things in life – is excess.

Too much of a good thing becomes dangerous. The extra leverage brings added risk. When the sun stops shining, the debt doesn’t go away. It still must be repaid.

 

COVID Update

 

We think a vaccine is coming. But until we see the rival data sets in an open forum for peer review, we don’t know which vaccine maker could come out on top. And even with a vaccine, distributing it to 333 million people will be a challenge. It’s doable. But it won’t be fast. Ninety percent national vaccine coverage could take three or four years.

Until there’s 90% coverage with a 75%-plus effective vaccine, there is not going to be herd immunity in the U.S. Even then, folks are likely to need booster shots.

In other words, tens of millions of Americans will remain at risk for the next four years. And with the prospect of global travel, there’s little reprieve unless everyone wears N95 masks until they get a vaccine.

We know many folks don’t trust or want to receive a vaccine for whatever reason. 90% effectiveness for a vaccine sounds great today, but what happens when it hits the wider public?

Plus, the reality of the situation is that of tens of millions of people likely won’t have access to a vaccine until the middle of 2021 at the earliest, even if they want it.

The earliest vaccines, when they finally arrive, will go to frontline workers like nurses and doctors. For most of us, it’s going to be more of the same with social distancing and mask guidelines and other restrictions, possibly stronger than we’ve seen before.

While Pfizer’s vaccine, so far, seems to be moving along the path, there are several things to consider. Foremost is that while Pfizer did announce the potential effectiveness of their vaccine, it is yet to be peer-reviewed or approved for use by the FDA. While the drug is on a “fast-track” for use by year-end for emergency use, it will not be available for widespread use anytime soon.

But the vaccine’s complex and super-cold storage requirements are an obstacle for even the most sophisticated hospitals in the United States and may impact when and where it is available in rural areas or poor countries where resources are tight.

The main issue is that the vaccine, which is based on a novel technology that uses synthetic mRNA to activate the immune system against the virus, needs to be stored and transported at -70 degrees Celsius (-94 Fahrenheit) or below.

Furthermore, they are only in Phase-3 of their drug trials. As noted, a very high percentage of drugs fail in Stages 3 and 4. Pfizer will have to start Phase IV once the FDA approves the drug. That phase will incorporate testing the drug in limited use on several hundred or thousands of patients. This phase will take quite some time to accomplish, and if unknown side-effects appear, it could stop the production of the vaccine altogether.

 

Interesting

 

The relative size of particles:

 

 

The history of US bank mergers: