Here are some things I think I am thinking about.
1) The Mask Controversy.
I manage risk for a living. It’s something I obsess about every minute of every day. Understanding risk helps you optimize risk and reward by understanding when things have an asymmetric payoff. We all want to do things that have a high payoff and low amount of risk.
COVID is obviously a very high risk virus. We don’t know exactly how to stop the transmission of the virus, but it is becoming clear that mask wearing is consistent with reduced rates of transmission. Mask wearing is also a very low cost and low risk act. It is, in the current environment, one of the perfect asymmetric trade-offs. So, there’s your trade of the year – if you want life to return to normal and the economy to recover then do your part and wear a mask when you might expose other people to the virus and ignore all the political bias around this issue. It’s just silliness.¹
2) Stressed Banks
The Fed capped bank dividends and banned buybacks after the recent results from the stress tests. This leads me to believe that the Fed is somewhat concerned about bank capitalization going forward. Makes sense in my view. The way the virus seems to be playing out I think we’re very likely to see the economy remain under pressure into year-end. Without another big stimulus package it’s likely that we’ll start to see rising real estate defaults (especially in the commercial space) in the Fall and Winter. There’s just no way all these commercial spaces can remain empty with falling aggregate incomes and not begin to experience stress. And this will inevitably filter into the banking system.
All that said, I think it’s wrong to look for the next crisis in the last crisis. The Fed was a bit caught off guard by the financial crisis. They’re not making the same mistake here. The Fed is on top of this one, perhaps even to a fault. They’ve made it very clear that they’re willing to do whatever it takes to make sure the banking system doesn’t collapse and impact the real economy too much. So we might experience a bank panic at some point assuming the virus and economic weakness linger, but don’t expect a repeat of 2008.
3) 3% really is the new 4% withdrawal rate
I had a really strange conversation with a client last week. They were asking me for a super safe 4% return and I spent an entire day cranking numbers and trying to make something work. But I just couldn’t make it work. This was the first time in my career I could remember saying that to someone. 4% has always been a somewhat easy number to hit if you take just a little risk. But the math just doesn’t work anymore.
In early April I wrote that long-term stock investors should be licking their lips at the market decline and that my future expected return on stocks had jumped significantly from 4% to 7%. But the big market rebound has me feeling pretty bearish going forward. We’re back to about a 4% ten year expected return.
So, if an aggregate bond fund is generating just 1.5% and the stock market is likely to generate 4% then a 60/40 stock/bond portfolio is generating a 3% return. This means if you want a 4% withdrawal rate then you very likely need to accept that your portfolio will shrink over time. The problem with this is that it makes liability control that much more important going forward because high returns are unlikely.
¹ – There was this unbelievable video going around from Trader Joe’s over the weekend. Despite all the Fed’s “money printing” and the huge stimulus spending TJ’s STILL has $19 cent bananas. CAN YOU EVEN BELIEVE THAT????
NB – There was this great video going around from Tokyo yesterday. The thing I loved most from my visits to Japan was the sense of respect for others. I’ll never forget asking someone how to say “excuse me” and they explained to me how the term is a bit different in Japanese. While Americans say EXCUSE ME, the Japanese say sumimasen, which means, I am SORRY FOR BOTHERING YOU. I noticed it everywhere. When a waiter came to your table they were apologetic for bothering you. I was like “YOU’RE SERVING ME, WHY ARE YOU APOLOGIZING??” It is this subtle, but different perspective that I found so refreshing. They’re so respectful of other people. But that’s the point of the video. The Japanese are all wearing masks in the video because it would be disrespectful to OTHER people not to. But here in the USA we’re all like “WHAT ABOUT MY PERSONAL FREEDOM?”. As if the world has asked for this enormous sacrifice by asking people to wear an inexpensive piece of linen over our mouths for a few minutes when we’re in crowded places….Come on people, let’s be better than this. Oh, also, Japan has 18,000 COVID cases. TOTAL.