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|10-Yr Treasury yield was 0.63% at the end of April and 0.65% at the end of May|
As states reopened in May, economic damage from the coronavirus pandemic continued to mount. It was another chaotic month, yet the financial markets remained calm. The Dow ended the month nearly 2,000 points higher than it started, and the yield on the 10-Year Treasury rate was also up slightly by month’s end. As a result, some Wall Street cheerleaders continue to argue that a V-shaped recovery from the coronavirus recession is possible.* Other analysts disagree,** as do I. As I’ve stated before, I believe a W-shaped recovery is more probable, and the fact that the market is now down only about 10% from its peak highs reinforces that belief for several reasons. For one thing, it illustrates more clearly than ever the dangerous disconnect between the stock market and economic fundamentals.*** What’s more, the argument for a V-shaped recovery conveniently ignores the possibility of another major virus outbreak.
However, even without another outbreak, consider this: Let’s say economic growth does get back on track in the third quarter. That would be great, but remember the GDP was only at about 2.5% before the crisis. Then, in the first quarter it shrank by nearly 5%, and is forecast to shrink by as much as 30 to 40% in the second quarter.**** So, how will all of that balance out by the end of the year? Mathematically speaking, a GDP of about -10% for 2020 would probably be a best-case scenario!
Does that sound like it should justify steadily-rising stock prices or a V-shaped recovery? Not to me, and I continue to believe the stock market will experience at least one more major pullback before it truly starts to recover. It may not be as precipitous as the first one, but it will return the market to bear territory and possibly test its low point from March. I also believe the drop may be more gradual and more segmented. In March, there was a flight to cash, and everything dropped: stocks, bonds, and bond-like instruments. This time, investors and advisors will have had time to analyze what should and shouldn’t be sold, meaning riskier holdings may drop more than conservative ones.
In the midst of all this chaos and uncertainty, income-based investors can continue to take comfort in the knowledge that their portfolios are, generally, better protected from loss and shrinkage than those of growth-based investors, as I’ve explained previously. If you do have riskier stock-based investments elsewhere, the current irrational calm means you may still have time to reduce your risk before the next shoe drops!
When managing your portfolio at SIS, we look for one of four possible “enhancement” trades while reviewing securities and possible transactions. Income generation is our primary goal for our clients, and we consider the following four portfolio enhancements before transacting: current yield, yield to worst (minimum projected annualized total return), interest rate risk, and default risk. The intents of these transactions are categorized as follows:
- Pay Me Now – Enhancing current yield
- Pay Me Later – Enhancing yield to worst
- Cover My Assets I. – Managing interest rate risk
- Cover My Assets II. – Managing default risk
We evaluate the transactions by determining whether they meet one, two, three, or all four enhancements. A baseball analogy for this: SINGLES, DOUBLES, TRIPLES, and HOME RUNS.
There were no swaps for the month of May.
*“US Economy to See V-Shaped Recovery: Morgan Stanley,” Fox Business, May 11, 2020
**“A V-Shaped Recovery is ‘Off the Table,’ Fed’s Kashkari Says,” MarketWatch, May 14, 2020
***“A Dangerous Gap: The Market vs. The Real Economy,” The Economist, May 7, 2020
****“What is a V-Shaped Economic Recovery & How Likely is It,” MercuryNews.com, May 27, 2020
Note: The above trades were recent block trades and do not reflect all trades done on an individual specific basis. Sound Income Strategies, LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Past performance is not an indication of future results. Be sure to first consult with a qualified financial advisor or tax professional about your specific financial situation before implementing any strategy discussed herein.
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