There is no way to sugarcoat the fact that the month of September was a real stinker for the stock market. Even though there was no fundamental reason why the market went down, I guess the weight of seven straight “up” months finally meant the traders needed to reestablish their dominance. But it has still been a great year for investing so far and I certainly anticipate that it will be for the rest of 2021.
There were so many “reasons” why the market went down in September that I need to address a few of the main culprits. We had the infamous Evergrande collapse in China which, for some reason, put some level of fear in U.S. investors in the market. And as occurs every couple of years and means nothing, we had the debt crisis of extending the Federal borrowing limit. We also endured the typical textbook move of traders selling tech due to a small increase in interest rates. This argument is so full of holes, it is laughable that they even continue to quote it.
I have a lot of other things I want to talk about in this posting; the effect that potential Estate tax changes will have on you as investor, the current crisis in energy and how it was self-created, the incredible job the government did in 2020 to bring the country out of recession in comparison to the 2008 recession, and many other topics I hope you will find of interest.
C-A-R-O-L-I-N-E Schultz, Age 7,
ready for the big game
Before I get into those truly interesting subjects, I must discuss the very negative month of September. The Standard & Poor’s Index of 500 stocks ended down 4.7% for the month of September but is still up a very satisfying 15.9% for the year 2021 and up 30% for the one-year period ended September 30th. The Dow Jones Industrial Average was also down 4.2% during September but is up 12.1% for the year 2021 and is up a very satisfying 24.1% for the one-year then ended. The NASDAQ Composite was down 5.3% for the month of September but is up 12.7% for the year 2021 and is up 30.3% for the one-year period then ended. So even with the huge loss that we lived through during the month of September, the year-to-date numbers are all double digits and continue to be outstanding. I fully expect that we will add positively to these numbers as the year progresses.
The Bloomberg Barclays Aggregate Bond Index was also down 0.8% for the month of September. If you thought being in bonds during a market sell-off was a good idea, you would have found it was not. The bond index is down 1.7% for the year 2021 and for the one-year period it is down 0.9%, as compared to the double digits increase in the equity indexes. It was somewhat surprising for the month of September that bonds actually got crushed as much as they did. Not only were taxable bonds down, but the muni-bond market took a big hit during the month. While it is true interest rates increased marginally during the month, this overreaction seems to be based on fear rather than economics.
I guess the biggest event during the month was the potential failure of the Evergrande company, which is a huge real estate developer in China and was at the point of total default during the month. There was a lot of handwringing here in the United States thinking that the failure of Evergrande would be the equivalent to the bankruptcy of Lehman Brothers in 2008. Apparently, the analysts that drew that comparison did not live through the 2008 debacle, as I did, as certainly this was nothing compared to 2008.
If you read the history of Evergrande, you will see how it got into trouble. The Chinese government believes that to keep their citizens happy, they must keep them working. It had been reported that China built entire cities with no one to move in just so the workers could stay busy. While Evergrande is a semi-public company, it is heavily influenced by the Chinese government. You have to wonder if all of these empty projects built by Evergrande were their own doing or at the insistence of the Communist government.
As the day of the default came around, there was huge selling on the U.S. market for reasons not clear to me. I can only assume that the traders thought that they could build up enough volatility and fear in investors that they would force them out of their positions so that they could buy into them cheap. What was not reported was that the day after, Evergrande sold an interest in its banking subsidiary to the Chinese Communist government. Surprise, surprise, the Chinese government injected $1.5 billion into the company to keep it from defaulting. The most likely outcome of the Evergrande debacle, will be that the government will end up buying the company (or forcing another company to buy it), as it does with so many other companies on the verge of failure in China. In my opinion, there is no way the Chinese government is going to put this many workers building real estate out of work.
It appears that the Chinese Communist government is really scrambling now to reduce the positive aspects of capitalism on their economy. They are proposing, in my opinion, restrictions that could not possibly be enforced. One of the new ones that is fairly interesting is that Chinese children are not allowed to play video games during the week and then only three hours on Saturday and Sunday. Good luck trying to enforce that one. Interestingly, some of the most successful companies in China are video game providers.
La Vie en Rose! Ava and Dakota
on a beautiful day in Paris
Another one that came out during the month was that China will outlaw all crypto currencies, making it illegal to both buy them and even hold them. This has more to do with the ability of crypto to be untraced and money moving out of China to a more stable economy like the United States. There is no question that the Chinese government is scrambling to try to reduce the strength of the capitalist in China, which is pretty easy to do as the government can basically just step in and take over your company. As you know, virtually all companies in China are owned partly by the Chinese government and, therefore, they will do as told.
Another interesting aspect of China right now is that they are suffering a huge power shortage. A great deal of the manufacturing in China has been restricted since there is not enough power to run the factories. In Europe there is a huge shortage of natural gas. The price of natural gas over the last several months has gone up four-fold and natural gas providers in Europe are failing daily. Going into the cold winter months, all of Europe is concerned about having enough natural gas to heat their homes. Most of the natural gas in Europe comes from a pipeline from Russia and they’re also a huge importer of natural gas from, of all places, the United States. Even in the United States, the price of gas has gone up from $2 per thousand cubic feet to well-over $6 per thousand cubic feet, just in the last couple of months – the highest rate in over a decade. Do you have any idea why the world is suffering an energy crisis?
Economics 101 is pretty simple. If you reduce the supply, then prices will increase. Given equal demand, but less supply, unquestionably the price will go up in any economy. The very first act of the new President was to put a stop to the Keystone Pipeline out of Canada, not over time, but that day. Keystone is now suing the U.S. government for an excess of $10 billion for stopping this pipeline. Also, the current Administration stopped all drilling in Alaska and would not issue any additional permits for drilling in the Gulf of Mexico. Coupled with the hurricane season which took offline a lot of drilling capacity in the Gulf of Mexico, we have a supply constraint.
Did anyone really believe that if you change the supply overnight, you wouldn’t have an increase in price? Not only have we seen a dramatic increase in the price of gas and oil in the United States, but it is also clear that the entire world is suffering from a shortage of natural resources from the United States. Do you realize that China is the largest importer of coal out of the United States? China has such terrible problems with air quality because their principal source of energy is coal. If you restrict coal and natural gas and you also prevent additional drilling for oil, you are going to have shortages around the world and the prices are going to go up. We worked for five decades to divorce the U.S. from Middle Eastern oil. Overnight we are now totally dependent on them again.
Reid Schultz celebrating his
6th birthday with friends Rex & Rattles
It is also hard to believe that our elected officials know so little about economics. If you took the time to watch the questioning of Federal Reserve Chairman Jerome Powell and Secretary of Treasury Janet Yellen by Congress last week, you could see the economic wasteland that is in Congress. Honestly, some of the questions were so ill-informed, I was embarrassed for them. If you recall, former Federal Reserve Chairman Alan Greenspan used to make up flowery language to answer Congress without an answer. I felt the same way this time with Powell and Yellen. Some of the questions were so naïve as to not even merit a response, but trying to respect Congress, they gave articulate answers to inarticulate questions.
Josh, many moons ago, finding fame
on the Jumbotron at Turner Field
It is hard to believe, but the projection now for increasing earnings for the third quarter of 2021 over the third quarter of 2020 is a projected increase of 27.6%. It is true that it is comparing current earnings with a prior COVID quarter but if you look back into 2020 you will notice by the third quarter of 2020 the economy had already recovered. Interest rates, while somewhat higher during September, were by historic standards extraordinarily low and the economy continues to expand at a more comfortable level.
There is no question that the economy has slowed down from the second quarter. At that time, we were running a GDP greater than 6%. It is now believed that the GDP for the third quarter may be half that or 3%. But it is extraordinarily important that we understand that we cannot run the economy too hot without creating higher interest rates, inflation, and other negative aspects. A 3% economy is much better than a 6% economy where we would have capacity overloads and shortages in almost every industry. Therefore, the trifecta of components leading to higher stocks are now in place and after the sell-off in September, we should see higher prices for the rest of the year. Assuming no major economic event, of course.
Ava chopping it up on the Jumbotron
at Truist Park – Go Braves!
I looked at the listing of over 125 mutual funds run by Fidelity Investments. During the month of September, less than 10 were actually higher. This includes not only U.S. stocks but also international securities, bonds, and other types of investment products. When you see that virtually every mutual fund was down, you must realize that this was not a natural move by investors. So, when you get these types of selloffs that occur, which are principally concentrated by the hedge funds and the traders, your best investment advice is to do nothing. As is often the case during selloffs, your best strategy is typically to look the other direction.
It still surprises me that the U.S. government has not received better marks for its response to the 2020 pandemic. I follow the trend of COVID very closely. The vast majority of the states are trending down in number of new cases. Although the death rate has remained stubbornly high, most of these deaths are people with preexisting conditions and the unvaccinated. Even Dr. Scott Gottlieb, former head of the FDA, has projected that by Thanksgiving of this year the country will be back to normal due to the combination of the vaccinated (including children) and the people that have some immunity from previously having the virus which will significantly reduce the spread. The economy continues at full speed ahead notwithstanding the virus.
Marti and Mitch Musciano-Howard, Age 17,
looking “TWO-rrific” for
Homecoming 2021
The 2008 recession should be a close approximation to 2020. If you recall in 2008, we had a major credit problem where companies were going out of business daily. Even though the government came along and bailed out the banks and stabilized the economy they did nothing for the out-of-work employees. In fact, it took three years for the economy to come back from its pre-2008 downfall.
However, in 2020, due to the governments intensive funding of individuals and businesses, the recovery was almost overnight. What we found was that the recession in retrospect only lasted roughly 90 days and already today the GDP is at pre-pandemic levels, although why employment is not where it needs to be seems to be a mystery to all economists. Currently as of today there are 10.5 million job openings posted in the United States and there are only 8.5 million unemployed. You have to think that shortly the unemployed will run out of resources and have to actually go back to work.
What is also interesting is that during 2020, which was a so-called recession year, the number of people living in poverty in the United States fell from 10.5% in 2019 to 9.1% during 2020. How ironic is it that the actual number of people in poverty would fall during a recession year? All these positive aspects are attributable to the Federal Government jumping in and bailing out the economy.
There is no question that the negative is that the amount of debt, as compared to the GDP, has soared. Prior to the pandemic the Federal debt was 79% of the GDP. It is now 98% of the GDP and the current Congress is spending at a rate that is unprecedented. I am not exactly sure which economy Congress sees, but it is certainly does not need the $3.5 trillion injection of funds which would benefit some but make the amount of Federal Debt soar. If you believe that the bill would be fully funded by additional taxes, then you don’t understand how the government works.
One of the new provisions of the bill going through Congress is that it will reduce the amount of estate tax from a threshold of roughly $11.7 million per person to roughly $5.7 million per person. If this bill were to pass in its current form, a lot more people would be covered under the estate tax than are currently. In the United States there were only 1,900 Estate tax returns for the entire year of 2020 that were filed and owed estate tax. As you can see, estate tax was almost nonexistent for most Americans. However, if you reduce the exemption amount to the $5.7 million threshold a great many Americans will be affected.
Mia and family catching
a Braves night game
One of the financial concepts that I have always advocated for is that you gift to your children and others during your lifetime rather than at your death. Did you realize that you could give $75,000 per child into a 529 account without gift tax and without it being included in your estate? However, almost no one elects to do so.
If you elect to make a transfer today, all the appreciation of those assets go to the second generation and avoid estate tax. Yet so many people and certainly so many investors that I know refuse to make lifetime gifts. I was meeting with a lady the other day on this subject. She was in her 80’s and concerned about long-term care and her future. Even though she had $8.6 million she was unwilling to gift any of it to her children who were struggling economically. I finally asked her what exactly her concern was in making these transfers. Her voice shrilled when she stated in uncertain terms that it was her money, and she may need it one day. Given the fact that this lady was very frugal and long-term care while expensive is not exorbitant, the possibility of her needing all this money during the rest of her lifetime was strictly remote. However, even with all my persuasive conversation with her she remained unwilling.
I would like to briefly explain why traders believe that when interest rates go up you sell tech. The origin of that axiom goes back to when tech companies had to borrow substantial sums of money to finance their operations. However, large tech companies now hold more cash than probably any other industry by far. If you look at the balance sheets of Apple, Google, and Microsoft you will note that they have cash balances well in excess of a hundred billion. The thought that any of them would be required to borrow money is almost laughable. It is true that all of them have some debt on their balance sheet, but mainly because the debt is U.S. based and the assets are foreign.
Marti and Mitch reassuring Mia
with their best,
"We promise we’ll behave” looks
As always, the above comments are based on my personal research and opinion and certainly no one can forecast the future accurately. However, the realization that the economy has already turned should be self-evident and those who are sitting on cash should be moved to make appropriate investments.
As we get to the end of this year we would love to sit down and go over your portfolio and your investment criteria for the 2022 year and beyond. We never left the office during COVID and have been here since day one of the pandemic. If you would like to schedule an appointment to come in and go over your financial goals, we welcome you to visit with us. In the meantime, stay healthy and stay invested.
As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best Regards,
Joe Rollins
