Think Twice Before Speculating on a COVID-19 Cure
As hundreds of companies race to develop vaccines and drug therapies that could help end the COVID-19 pandemic, news reports on successful or failed trials affect individual stock prices and can trigger swings in the broader market.(1) Understandably, this highly contagious virus — and its severe economic repercussions — has a knack for stirring up investors’ emotions.
By May 27, 2020, COVID-19 was responsible for more than 100,000 deaths in the United States and about 355,000 worldwide. (2) Investors are human beings first, and most of us are waiting anxiously for a cure that would stop the suffering and allow normal life to resume.
Governments and nonprofits have provided billions of dollars in support, and some red tape has been loosened, all to help speed a costly, complex, and time-consuming drug development process.(3) Even so, this influx of public funding — along with a concerted humanitarian effort — suggests that some of the most important discoveries may not generate profits for investors.
High hopes for a vaccine
A vaccine prepares the body’s immune system to recognize and resist a specific disease, preventing it from causing sickness and spreading to others. As of May 27, the World Health Organization (WHO) was tracking 125 experimental vaccine candidates globally, 10 of which had advanced to clinical evaluation. Another 115 candidates are still in the pre-clinical stage, which involves testing in cells and/or animals and waiting for regulators to review results and grant permission for human trials. (4)
Clinical studies are conducted in three phases. During Phase I, a small study of healthy people tests the safety and immune response of the vaccine at different doses. Phase II is a randomized, double-blind, controlled study of hundreds of people that further assesses safety, efficacy, and optimal dosing. If all goes well, clinical studies expand to include thousands of people in Phase III. (5) These larger studies can be challenging because they test how well the vaccine works in an environment where the virus is spreading. (6)
Despite the urgency, COVID-19 vaccine candidates can’t skip any of these crucial steps, but timelines have been accelerated. (7) Health officials have said it could take 12 to 18 months before a vaccine may be available. (8)
The U.S. government has struck supply deals with several pharmaceutical companies to support research into leading vaccine candidates and boost the manufacturing capacity needed to produce 300 million doses by fall of 2020, should a candidate prove effective. (9)
Other nations and well-funded nonprofits have made similar deals. Massive public investment allows drug makers to get a head start on manufacturing doses while waiting for human trials to conclude and approval to be granted. In return, at least one drug maker has promised to sell an approved vaccine without making a profit during the pandemic. (10)
A COVID-19 vaccine is not imminent — a point made by the fact that there is no vaccine to prevent HIV after several decades of research. Still, early progress on several fronts offers reasons to be cautiously optimistic. (11)
Testing old and new therapies
The development and approval process for experimental drugs is similar to the one for vaccines. Companies that develop successful treatments are likely to face the same manufacturing challenges and pricing pressures. In the meantime, doctors are testing existing therapies that might help COVID-19 patients. (12)
One existing antiviral drug was approved for emergency use by the U.S. Food and Drug Administration after it was determined to help hospitalized patients with severe COVID-19 recover faster. The pharmaceutical giant that makes the drug has ramped up production and is donating about 1.5 million doses as a public good. (13)
Scientists are also working on targeted antibody therapies, which depend on the identification of specific antibodies that bind with and neutralize the novel coronavirus. At high doses the right antibodies might prevent the disease from worsening in hospitalized patients, and at lower doses the same antibodies could provide short-term immunity for front-line workers.
Effective antibody drugs are easier to develop but more complex to manufacture. Thus, there is limited global capacity to produce the large amounts needed. Governments, nonprofits, and companies that are normally competitors are reportedly discussing ways to share manufacturing plants if one company’s antibody proves to work better than the others. (14)
Antibody treatments could help save lives as long as COVID-19 is a threat, but widespread vaccination could make them obsolete. If a successful vaccine materializes, many valiant efforts to develop beneficial therapies may never make much money.
More implications for investors
As of May 21, 2020, the U.S. government had invested at least $2 billion for the development of coronavirus vaccines and $300 million for antiviral and antibody therapies. (15) New biotechnologies, generous financial support, and unprecedented cooperation between governments and industry leaders could shave several years off typical development timelines. (16)
It’s rarely easy to predict which new products will perform well enough in multiple rounds of studies to earn regulatory approval. Moreover, the stock market’s mid-May rally and high valuations for biotech and pharmaceutical shares imply that success in developing COVID-19 treatments might already be priced in — especially for newsmakers. (17)
Headline-induced price swings suggest that investors are making decisions driven by hopes and fears, and possibly based on limited information, instead of a realistic assessment of an investment’s longer-term earnings potential. Now more than ever, it’s important to have a well-researched investment strategy based on your own goals, time horizon, and risk tolerance.
All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.
(1), (17) The Wall Street Journal, May 18, 2020
(2) Johns Hopkins University, May 27, 2020
(3), (5), (7), (8), (16) World Economic Forum, 2020
(4) World Health Organization, May 27, 2020
(6) Bloomberg News, May 7, 2020
(9), (10) The Wall Street Journal, May 21, 2020
(11) NPR.com, May 12, 2020
(12), (14), (15) Bloomberg Businessweek, April 20, 2020
(13) STAT, April 29, 2020
Coping with Market Volatility: Cash Can Help Manage Your Mindset
Holding an appropriate amount of cash in a portfolio can be the financial equivalent of taking deep breaths to relax. It could enhance your ability to make thoughtful investment decisions instead of impulsive ones. Having a cash position coupled with a disciplined investing strategy can change your perspective on market volatility. Knowing that you’re positioned to take advantage of a downturn by picking up bargains may increase your ability to be patient.
That doesn’t mean you should convert your portfolio to cash. Selling during a down market locks in any investment losses, and a period of extreme market volatility can make it even more difficult to choose the right time to make a large-scale move. Watching the market move up after you’ve abandoned it can be almost as painful as watching the market go down. Finally, be mindful that cash may not keep pace with inflation over time; if you have long-term goals, you need to consider the impact of a major change on your ability to achieve them.
Having a cash cushion in your portfolio isn’t necessarily the same as having a financial cushion to help cover emergencies such as medical problems or a job loss. An appropriate asset allocation that takes into account your time horizon and risk tolerance may help you avoid having to sell stocks at an inopportune time to meet ordinary expenses.
Remember that we’re here to help and to answer any questions you may have.
All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.
Asset allocation is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.
Although there is no assurance that working with a financial professional will improve investment results, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies.
Government Acts to Blunt Financial Impact of Global Pandemic
On March 11, the novel coronavirus (COVID-19) was officially declared a global pandemic by the World Health Organization, and two days later President Trump declared a national emergency.1 The unknowns surrounding a new virus make it difficult to predict the potential human and economic toll, but unprecedented steps are being taken to help slow the spread of the disease and prepare medical facilities to treat a rising number of cases. Businesses are suffering losses as they spend more to help keep workers and customers safe and/or have closed their doors to the public.
The economy — in the United States and globally — has been interrupted as abruptly as our daily routines, and a downturn is looming. This jarring reality triggered the first bear market for U.S. stocks in 11 years.2 Many people are now working from home, but a record number of workers (3.3 million) filed for unemployment in one harrowing week.3
The financial impact of the health crisis is likely to be more severe for some households, businesses, and industries than others. With lives and livelihoods at risk, the Federal Reserve, state governments, and the federal government have responded with a full slate of emergency measures.
Central bank in action
The Federal Reserve moved swiftly in recent weeks to support the U.S. economy and help alleviate stress in the financial markets. On March 3, the Fed dropped the target range for the benchmark federal funds rate by one-half percentage point to 1.00% to 1.25%, stating that the coronavirus posed evolving risks to the economic outlook.4
Following an emergency session on Sunday, March 15, the Fed slashed the rate to near zero (0% to 0.25%) and committed to at least $700 billion in debt purchases. This policy was later expanded to essentially unlimited debt purchases “in amounts needed to support smooth market functioning.” The U.S. central bank is also extending currency swaps with foreign central banks to keep high-demand U.S. dollars flowing freely around the world.5
Citing emergency powers, the Federal Reserve launched a number of lending facilities to keep credit flowing to households and businesses. These operations required permission from the Treasury Secretary and are protected from losses with Treasury funds.6
The Commercial Paper Funding Facility ensures that companies retain access to an important source of short-term credit (IOUs) often used to fund regular expenses including payroll and rent. The Primary Dealer Credit Facility provides funding to financial institutions that trade directly with the Fed and serve as market makers for U.S. Treasuries.7
The Money Market Mutual Fund Liquidity Facility will help ensure that funds can meet investor demand for redemptions. This backstop was originally limited to prime funds, which invest in short-term corporate debt, but was expanded to include funds with municipal debt. A crisis-era lending facility used to support the consumer and business credit market has also been revived.8
Two facilities have been added to support corporate debt markets. One will provide four-year bridge financing to companies with investment-grade ratings, and the other will purchase highly-rated U.S. corporate bonds. A Main Street Business Lending Program for small employers is also in the works.9
Chairman Powell has said the Fed will do everything in its power to help stabilize the markets, so lending programs could be added or expanded.10
Relief on the way
The federal tax filing deadline has been delayed to July 15, so taxpayers have extra time to file their tax returns and make payments without interest or penalties. Many states have decided to match the new federal deadline.11
An initial relief bill passed in early March provided $8.3 billion in emergency healthcare funding. A phase two relief package, the Families First Coronavirus Response Act, includes free coronavirus testing and increased funding for food security programs, Medicaid, and unemployment insurance.12
This bill also provides two weeks of paid sick leave and up to 12 weeks of family and medical leave for workers at companies with 500 or fewer employees who are affected by the virus. This includes those caring for children whose schools are closed. Small and midsize employers will be reimbursed with tax credits for wages paid to affected workers.13
The $2 trillion Coronavirus Aid, Relief, and Economic Security Act (CARES Act) is the most generous stimulus package in U.S. history. Many households will receive cash payments ($1,200 per adult and $500 per child) from the IRS within weeks if their incomes fall under certain thresholds. Unemployment insurance was prolonged from 26 to 39 weeks and will provide an extra $600 per week for four months. This benefit was extended to self-employed individuals, gig workers, and independent contractors who would not have qualified under the old rules.14
A $500 billion lifeline could backstop trillions in bridge loans and offer some direct aid for hard-hit cities, states, and large employers. The government can seek company equity in extreme cases. Another $349 billion will fund loans for small businesses (under 500 employees); eligible employers can borrow up to $10 million for working capital through an existing Small Business Administration program. Many paperwork requirements have been waived, and amounts paid for mortgage interest, rent, utilities, and payrolls could be forgiven if workers are retained.15
The scope of losses may ultimately depend on how quickly the spread of the virus is controlled and effective treatments and/or a vaccine are developed so the economy can reopen. But there is hope that the government policy response will save lives and help mitigate the economic effects.
Although these times are stressful for everyone, it may help to keep in mind that the U.S. economy is much like the people who live here — resourceful and resilient. We have endured shocks and recovered from serious crises before, and we can do so again.
All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.
1) The White House, March 18, 2020
2) Yahoo! Finance, 2020 (data for the period 3/9/2009 to 3/12/2020)
3) The Wall Street Journal, March 26, 2020
4-10) Federal Reserve, March 2020
11) Bloomberg.com, March 20, 2020
12-13) Bloomberg.com, March 18, 2020
14-15) The Wall Street Journal, March 25-26, 2020
CARES Act Provides Relief to Individuals and Businesses
On Friday, March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law. This $2 trillion emergency relief package is intended to assist individuals and businesses during the ongoing coronavirus pandemic and accompanying economic crisis. Major relief provisions are summarized here.
Unemployment provisions
The legislation provides for:
- An additional $600 weekly benefit to those collecting unemployment benefits, through July 31, 2020
- An additional 13 weeks of federally funded unemployment benefits, through the end of 2020, for individuals who exhaust their state unemployment benefits
- Targeted federal reimbursement of state unemployment compensation designed to eliminate state one-week delays in providing benefits
- Unemployment benefits through 2020 for many who would not otherwise qualify, including independent contractors and part-time workers
Recovery rebates
Most individuals will receive a direct payment from the federal government. Technically a 2020 refundable income tax credit, the rebate amount will be calculated based on 2019 tax returns filed (2018 returns in cases where a 2019 return hasn’t been filed) and sent automatically via check or direct deposit to qualifying individuals. To qualify for a payment, individuals generally must have a Social Security number and must not qualify as the dependent of another individual.
The amount of the recovery rebate is $1,200 ($2,400 if married filing a joint return) plus $500 for each qualifying child under age 17. Recovery rebates are phased out for those with adjusted gross income (AGI) exceeding $75,000 ($150,000 if married filing a joint return, $112,500 for those filing as head of household). For those with AGI exceeding the threshold amount, the allowable rebate is reduced by $5 for every $100 in income over the threshold.
While details are still being worked out, the IRS will be coordinating with other federal agencies to facilitate payment determination and distribution. For example, eligible individuals collecting Social Security benefits may not need to file a tax return in order to receive a payment.
Retirement plan provisions
- Required minimum distributions (RMDs) from employer-sponsored retirement plans and IRAs will not apply for the 2020 calendar year; this includes any 2019 RMDs that would otherwise have to be taken in 2020
- The 10% early-distribution penalty tax that would normally apply to distributions made prior to age 59½ (unless an exception applies) is waived for retirement plan distributions of up to $100,000 relating to the coronavirus; special re-contribution rules and income inclusion rules for tax purposes apply as well
- Limits on loans from employer-sponsored retirement plans are expanded, with repayment delays provided
Student loans
- The legislation provides a six-month automatic payment suspension for any student loan held by the federal government; this six-month period ends on September 30, 2020
- Under already existing rules, up to $5,250 in payments made by an employer under an education assistance program could be excluded from an employee’s taxable income; this exclusion is expanded to include eligible student loan repayments an employer makes on an employee’s behalf before January 1, 2021
Business relief
- An employee retention tax credit is now available to employers significantly impacted by the crisis and is applied to offset Social Security payroll taxes; the credit is equal to 50% of qualified wages up to a certain maximum
- Employers may defer paying the employer portion of Social Security payroll taxes through the end of 2020 and may pay the deferred taxes over a two-year period of time; self-employed individuals are able to do the same
- Net operating loss rules expanded
- Deductibility of business interest expanded
- Provisions relating to specified Small Business Administration (SBA) loans increase the federal government guarantee to 100% and allow small businesses to borrow up to $10 million and defer payments for six months to one year; self-employed individuals, independent contractors, and sole proprietors may qualify for loans
Prior legislative relief provisions
Signed into law roughly two weeks prior to the CARES Act, the Families First Coronavirus Response Act (FFCRA) also included relief provisions worth noting:
- Requirement that health plans cover COVID-19 testing at no cost to the patient
- Requirement that employers with fewer than 500 employees generally must provide paid sick leave to employees affected by COVID-19 who meet certain criteria, and paid emergency family and medical leave in other circumstances
- Payroll tax credits allowed for required sick leave as well as family and medical leave paid
There is likely to be a steady stream of guidance forthcoming with details relating to many of these provisions, so stay tuned for more information. We’re here to help and to answer any questions you may have.
The Coronavirus and the Global Economy
As of February 26, 2020, the death toll from COVID-19 — the official name of the coronavirus first reported in Wuhan, China — passed 2,700, while the number of confirmed cases exceeded 80,000. Almost all were in China, most of them in Wuhan and the surrounding Hubei province. But more than 2,500 cases, including 46 deaths, had been reported in almost 40 other countries. A surge of cases and deaths in South Korea, Italy, and Iran caused new concern that the virus may be difficult to contain.1
Cities under lockdown
By mid-February, at least 150 million people in China were under restrictions affecting when they could leave their homes, and more than 760 million — about 10% of the world’s population — lived in communities under some form of travel restriction.2 Most global airlines cancelled service to and from China, disrupting tourism and business travel.3
The Chinese government enacted restrictions around the time of the Lunar New Year celebration, during which many businesses were closed, lessening the immediate impact. However, as factories and other businesses remained closed after the holiday, the loss of Chinese production and consumer spending began to take a toll on global businesses.4
Lost supply and demand
Many U.S. technology companies have manufacturing operations in China while also selling to Chinese businesses and/or consumers. Companies with substantial exposure to the slowdown in China include big tech brands such as Apple, Dell, Hewlett Packard, Intel, and Qualcomm, as well as many smaller tech businesses.5-6
Vehicle manufacturers throughout the world rely on Chinese-made parts, and many have plants in China. General Motors (which sells more cars in China than in the United States), Ford, Toyota, BMW, Honda, Nissan, Tesla, and Volkswagen all suspended operations in China, while Hyundai and Renault closed plants in South Korea, and Fiat Chrysler closed a plant in Serbia, all due to parts issues.7-9
Global retailers including Apple, Ikea, Levi Strauss, McDonald’s, KFC, and Starbucks temporarily closed stores in China.10-11
In addition to disruptions in the global supply chain and Chinese consumer market, the tourism industry in the United States, Europe, and other Asian countries may be hard hit by the absence of Chinese tourists. One estimate suggests a loss of almost $6 billion in U.S. airfares and tourist spending.12
Although it is too early to measure the full effect on global business, a private report released on February 21 indicated that U.S. business activity had slowed in February to the lowest level in six years, with the biggest hit to the service sector, where travel and tourism are major components. The report also indicated a sharp drop in Japanese business due to lost tourism and export orders. Exports were down in Germany, but the initial impact on the eurozone was minimal.13
Oil pressure
China is the world’s largest importer of crude oil, and Wuhan is a key center of its oil and gas industry. The prospect of lower demand drove oil prices into bear-market territory — defined as a drop of 20% from a recent high — in early February. Prices rose later in the month but dropped again with news that the virus may be spreading. Natural gas prices have also been hit by the prospect of lower growth in Asia. While lower prices may be good for U.S. consumers, oil-exporting nations, including the United States, will face lower revenues, and energy companies that are already on rocky ground may struggle.14-17
Market reaction
In late January, the Dow Jones Industrial Average lost 3.7%, due in large part to concerns about the virus, wiping out gains for the year.18 The market bounced back quickly and set new records in February, but weak business news and a rash of cases outside of China sent it plunging, with a loss of almost 8% from February 19 to 25.19-20 This suggests that the market may be volatile for some time and that future direction might depend on the progress of disease control and emerging information on the impact of the virus on U.S. and global businesses.
Global growth outlook
Anything that affects China, the world’s second-largest economy, can have a powerful ripple effect around the globe. An early February report by Moody’s Analytics estimated that every 1 percentage point reduction in China’s real gross domestic product (GDP) will reduce global GDP outside China by 0.4%. The report projected that disruption caused by the virus would cut more than 2 percentage points off China’s GDP growth in the first quarter of 2020 and result in a loss of 0.8% growth for the year. This in turn would cause a loss of about 0.3% in annual global GDP growth outside China and about 0.15% in the United States. Moody’s lowered its projection for 2020 global growth from around 2.8% to 2.5%.21
In a February 16 forum, Kristalina Georgieva, managing director of the International Monetary Fund, was more optimistic, suggesting that the virus might shave 0.1% to 0.2% off the IMF’s 2020 global growth projection of 3.3%. Georgieva cautioned that there was still a “great deal of uncertainty” and emphasized that the economic damage depends on the length of the disruption. If the disease “is contained rapidly,” she said, “there can be a sharp drop and a very rapid rebound.”22
The immediate concerns are to combat the virus on a human level and normalize business activity, but the outbreak could accelerate the shift of U.S. and European manufacturing away from China, creating a more diversified global supply chain.23-24 The situation remains in flux, so you may want to keep an eye on further developments.
All investments are subject to market volatility and loss of principal. Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.
1) South China Morning Post, February 26, 2020
2) The New York Times, February 18, 2020
3-4, 21) Moody’s Analytics, February 2020
5, 23) The Wall Street Journal, February 18, 2020
6, 10) Los Angeles Times, February 4, 2020
7) Forbes, February 12, 2020
8) Car and Driver, February 4, 2020
9) The Wall Street Journal, February 14, 2020
11-12, 14-15, 18) The Wall Street Journal, February 3, 2020
13) The Wall Street Journal, February 21, 2020
16, 20) The Wall Street Journal, February 25, 2020
17) The Wall Street Journal, February 7, 2020
19) The New York Times, February 20, 2020
22) Bangkok Post, February 17, 2020
24) South China Morning Post, February 18, 2020
Manufacturing Slowdown: What Does It Mean for the Economy?
In September 2019, the Institute for Supply Management (ISM) Purchasing Managers Index (PMI), which measures a wide variety of manufacturing data, fell to 47.8%, the lowest level since June 2009.1
A reading below 50% generally means that manufacturing activity is contracting. The August reading of 49.1% had signaled the beginning of a contraction, and the drop in September suggested that the contraction was not only continuing but accelerating. The index rose slightly to 48.3% in October, but this indicated the third consecutive month of contraction.2 Nearly two-thirds of economists in a Wall Street Journal poll conducted in early October said the manufacturing sector was already in recession, defined as two or more quarters of negative growth.3
Leading indicator
The PMI — which tracks changes in production, new orders, employment, supplier deliveries, and inventories — is considered a leading economic indicator that may predict the future direction of the broader economy. Manufacturing contractions have often preceded economic recessions, but the structure of the U.S. economy has changed in recent decades, with services carrying much greater weight than manufacturing. The last time the manufacturing sector contracted, during the “industrial recession” in 2015 and 2016, the services sector helped to maintain continued growth in the broader economy.4
That may occur this time as well, but there are mixed signals from the services sector. In September, the ISM Non-Manufacturing Index (NMI) dropped suddenly to its lowest point in three years: 52.6%. The index bounced back in October to 54.7%, marking the 117th consecutive month of service sector expansion. Even so, these recent readings were well below the 12-month high of 60.4% in November 2018.5
Global weakness and trade tensions
The slump in U.S. manufacturing is being driven by a variety of factors, including a weakening global economy, the strong dollar, and escalating tariffs on U.S. and imported goods.
In October 2019, the International Monetary Fund (IMF) downgraded its forecast for 2019 global growth to 3.0%, the lowest level since 2008-09. The IMF pointed to trade tensions and a slowdown in global manufacturing as two of the primary reasons for the weakening outlook.6 Put simply, a weaker world economy shrinks the global market for U.S. manufacturers.
The strong dollar, which makes U.S. goods more expensive overseas, reflects the strength of the U.S. financial system in relation to the rest of the world and is unlikely to change in the near future.7 Tariffs, however, are a more volatile and immediate issue.
Originally intended to protect U.S. manufacturers, tariffs have been effective for some industries. But the overall impact so far has been negative due to rising costs for raw materials and retaliatory tariffs on U.S. exports. For example, tariffs on foreign steel, which were first levied in March 2018, enabled U.S. steel manufacturers to set higher prices. But higher prices increased costs for other U.S. manufacturers that use steel in their products.8 Retaliatory tariffs by Canada and Mexico contributed to a $650 million drop in U.S. steel exports in 2018 and a $1 billion increase in the steel trade deficit.9 (In May 2019, the United States removed steel tariffs on Canada and Mexico, which dropped retaliatory tariffs in return.)10
U.S. manufacturers in every industry may pay higher prices for imported materials used to produce their products. An average of 22% of “intermediate inputs” (raw materials, semi-finished products, etc., used in the manufacturing process) come from abroad.11 Tariffs paid by U.S. manufacturers on these inputs must be absorbed — cutting into profits — and/or passed on to the consumer, which may reduce consumer demand.
The uncertainty factor
Along with specific effects of the tariffs, manufacturers and other global businesses have been hamstrung by trade policy uncertainty, which makes it difficult to adapt to changing conditions and commit to investment. A recent Federal Reserve study estimated that trade policy uncertainty will lead to a cumulative 1% reduction in global economic output through 2020.12
On October 11, 2019, President Trump announced that he would delay further tariff hikes on China — including an increased tariff on intermediate goods scheduled for October 15 — while the two sides attempt to negotiate a limited deal. Although a deal would be welcomed by most interested parties, past potential deals have collapsed, and it’s uncertain how any agreement might affect the $400 billion in tariffs on Chinese goods already in place, or the tariffs on goods from other countries.13
Will the slowdown spread?
Manufacturing accounts for only 11% of U.S. gross domestic product (GDP) and 8.5% of non-farm employment, a big change from 50 years ago when it accounted for about 25% of both categories.14-15 However, the manufacturing sector’s economic influence extends beyond the production of goods to the transportation, warehousing, and retail networks that move products from the factory to U.S. consumers. The final output of U.S.-made goods accounts for about 30% of GDP.16
Even so, a continued slowdown in manufacturing is unlikely to throw the U.S. economy into recession as long as unemployment remains low and consumer spending remains high. The key to both of these may depend on the continued strength of the services sector, which employs the vast majority of U.S. workers. It remains to be seen whether the service economy will stay strong in the face of the global headwinds that are holding back manufacturing.
1-2, 5) Institute for Supply Management, 2019
3) The Wall Street Journal, October 10, 2019
4) The New York Times, July 28, 2019
6) International Monetary Fund, 2019
7) National Review, August 22, 2019
8) Bloomberg, March 24, 2019
9) The Wall Street Journal, March 18, 2019
10) Bloomberg, May 17, 2019
11) Federal Reserve Bank of St. Louis, 2018
12) Federal Reserve, 2019
13) USA Today, October 11, 2019
14) U.S. Bureau of Economic Analysis, 2019
15-16) The Wall Street Journal, October 1, 2019
Upside Down: What Does the Yield Curve Suggest About Growth?
On August 14, 2019, the Dow Jones Industrial Avenue plunged 800 points, losing 3% of its value in its biggest drop of the year. The Nasdaq Composite also lost 3%, while the S&P 500 lost 2.9%.1
The slide started with bad economic news from Germany and China, which triggered a flight to the relative safety of U.S. Treasury securities. High demand briefly pushed the yield on the benchmark 10-year Treasury note below the two-year note for the first time since 2007.2 This is referred to as a yield curve inversion, which has been a reliable predictor of past recessions. The short-lived inversion spooked the stock market, which recovered only to see the curve begin a series of inversions a week later.3
From short to long
Yield relates to the return on capital invested in a bond. When prices rise due to increased demand, yields fall and vice versa. The yield curve is a graph with the daily yields of U.S. Treasury securities plotted by maturity. The slope of the curve represents the difference between yields on short-dated bonds and long-dated bonds. Normally, it curves upward as investors demand higher yields to compensate for the risk of lending money over a longer period. This suggests that investors expect stronger growth in the future, with the prospect of rising inflation and higher interest rates.
The curve flattens when the rates converge because investors are willing to accept lower rates to keep their money invested in Treasuries for longer terms. A flat yield curve suggests that inflation and interest rates are expected to stay low for an extended period of time, signaling economic weakness.
Parts of the curve started inverting in late 2018, so the recent inversions were not completely unexpected. However, investors tend to focus on the spread between the broadly traded two-year and 10-year notes.4
Inversion as an indicator
An inversion of the two-year and 10-year notes has occurred before each recession over the past 50 years, with only one “false positive” in that time. It does not indicate timing or severity but has reliably predicted a recession within the next one to two years. A recent Federal Reserve study suggested that an inversion of the three-month and 10-year Treasuries — which occurred in March and May 2019 — is an even more reliable indicator, predicting a recession in about 12 months.5
Is it different this time?
Some analysts believe that the yield curve may no longer be a reliable indicator due to the Federal Reserve’s unprecedented balance sheet of Treasury securities — originally built to increase the money supply as an antidote to the Great Recession. Although the Fed has trimmed the balance sheet, it continues to buy bonds in large quantities to replace maturing securities. This reduces the supply of Treasuries and increases pressure on yields when demand rises, as it has in recent months.6
At the same time, the Fed has consistently raised its benchmark federal funds rate over the last three years in response to a stronger U.S. economy, while other central banks have kept their policy rates near or below zero in an effort to stimulate their sluggish economies. This has raised yields on short-term Treasuries, which are more directly affected by the funds rate, while increasing global demand for longer-term Treasuries. Even at lower rates, U.S. Treasuries offer relatively safe yields that cannot be obtained elsewhere.7
The Fed lowered the federal funds rate by 0.25% in late July, the first drop in more than a decade. While this slightly reduced short-term Treasury yields, it contributed to the demand for long-term bonds as investors anticipated declining interest rates. When interest rates fall, prices on existing bonds rise and yields decline. So the potential for further action by the Fed led investors to lock in long-term yields at current prices.8
Economic headwinds
Even if these technical factors are distorting the yield curve, the high demand for longer-term Treasuries represents a flight to safety — a shift of investment dollars into low-risk government securities — and a pessimistic economic outlook. One day after the initial two-year/10-year inversion, the yield on the 30-year Treasury bond fell below 2% for the first time. This suggests that investors see decades of low inflation and tepid growth.9
The flight to safety is being driven by many factors, including the U.S.-China trade war and a global economic slowdown. Five of the world’s largest economies — Germany, Britain, Italy, Brazil, and Mexico — are at risk of a recession and others are struggling.10
Although the United States remains strong by comparison, there are concerns about weak business investment and a manufacturing slowdown, both weighed down by the uncertainty of the trade war and costs of the tariffs.11 Inflation has been persistently low since the last recession, generally staying below the 2% rate that the Fed considers optimal for economic growth. On the positive side, unemployment remains low and consumer spending continues to drive the economy, but it remains to be seen how long consumers can carry the economic weight.12
Market bounceback
Regardless of further movement of the yield curve, there are likely to be market ups and downs for many other reasons in the coming months. Historically, the stock market has rallied in the period between an inversion and the beginning of a recession, so investors who overreacted lost out on potential gains.13 Of course, past performance does not guarantee future results. While economic indicators can be helpful, it’s important to make investment decisions based on your own risk tolerance, financial goals, and time horizon.
U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid. The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. The performance of an unmanaged index is not indicative of the performance of any specific security. Individuals cannot invest directly in any index.
1-2, 13) The Wall Street Journal, August 14, 2019
3) CNBC.com, August 23, 2019
4-5) Reuters, August 13, 2019
6) Forbes.com, August 16, 2019
7-9) The Wall Street Journal, August 16, 2019
10, 12) CNN, August 14 and 18, 2019
11) Reuters, July 1, 2019
U.S.-China Trade War: Who Pays the Price?
On May 13, 2019, escalating trade tensions between the United States and China sparked a worldwide stock sell-off that wiped out more than $1 trillion in global equity values.1 The markets recovered over the next three days, but tensions between the economic giants continued to drive volatility with no resolution in sight.2 Investors sometimes overreact to short-term events, but the conflict with China has been simmering for decades, and an extended trade war could have long-term economic consequences.
The issues
China was the largest U.S. trading partner in 2018, with $737 billion in goods and services exchanged between the two nations, accounting for 13% of all U.S. trade. The fundamental issue is the imbalance in this relationship; the goods and services trade deficit of $379 billion represented more than 60% of the total U.S. trade deficit. The United States maintains a surplus in services (primarily travel spending by Chinese citizens and software), so the critical concern is the deficit in goods, which totaled $419 billion in 2018 — an increase of 11.6% over the previous year.3-4
For years, U.S. officials have accused China of using unfair trade practices to maintain this imbalance, even as China has grown into a global economic powerhouse. Among the most contentious issues are currency manipulation, excessive restrictions on U.S. companies, forced technology transfers, and theft of intellectual property.
The tariffs
In early 2018, the Trump administration began imposing global tariffs on imported steel, aluminum, solar panels, and washing machines. While these tariffs were intended to stimulate U.S. manufacturing by protecting domestic production, the primary focus soon turned to China. Between July and September 2018, the United States imposed a 25% levy on $50 billion of Chinese goods and a 10% tax on an additional $200 billion of goods, which was set to rise to 25% on January 1, 2019, unless China took steps to level the playing field. China retaliated by placing tariffs of 5% to 25% on $110 billion of U.S. goods, covering almost all U.S. exports to China.5-6
In December 2018, both nations agreed to a truce, and President Trump extended the deadline to raise tariffs. When negotiations broke down in early May 2019, the U.S. raised the 10% tariffs to 25% effective May 10, and the president threatened to levy tariffs on the remaining $300 billion of Chinese goods. China retaliated by raising tariffs on more than half of U.S. goods already being taxed.7
Carrying the costs
U.S. importers of Chinese goods must pay the actual tax, but the question is who absorbs the additional costs. An academic study of the 2018 tariffs found that Chinese exporters generally did not lower their prices, so part of the increased cost was absorbed by the importers, cutting into their profit margins, and the rest was passed on to U.S. consumers in the form of higher prices. The net cost to the U.S. economy was estimated to be $1.4 billion per month.8
A separate study found that prices for nine categories of goods most affected by the tariffs increased by an average of 3% from early 2018 to early 2019, while the prices of other goods (excluding volatile food and energy) declined by 2%. This study also found that some U.S. manufacturers used the tariffs as an opportunity to raise prices, which is the fundamental purpose of protective tariffs — to allow domestic producers to set prices without being undercut by imports.9
The new 25% tariffs do not apply to Chinese goods that were already in transit as of May 10, so the effects may not reach U.S. consumers until later this summer. Based on the 2018 tariffs — only 10% on most imported goods — the increase to 25% will likely raise prices significantly on a wide range of consumer goods from laptops and mobile phones to clothing, furniture, sporting goods, luggage, and fish. Higher tariffs on supplies such as circuit boards, computer chips, and auto parts will likely be passed on to consumers as well.10 A Federal Reserve study estimated that the tariffs will cost the average household $831 per year.11
Shifting supply chains
Many U.S. manufacturers and importers are looking for suppliers in other countries and/or moving production out of China. Over the long term, this should reduce U.S. dependence on Chinese products, but the “Made in China” label is so pervasive in the U.S. market that it will be a slow process. Consumers may not notice the difference in products made in Cambodia or Mexico rather than China, but the long-term effect on consumer prices remains to be seen.12
The Chinese market is far less dependent on U.S. goods, which gives China less of an edge in levying tariffs but also causes less disruption for Chinese consumers. Agricultural products are a major U.S. export to China, and the Chinese have already shifted to other suppliers, drying up an important market for American farmers. The Trump administration has authorized subsidies to affected farmers, but uncertainty about potential markets has disrupted farming operations.13
While U.S. consumers and businesses may bear the brunt of the tariffs in the short term, the United States is better positioned to outlast China in an extended trade war. Despite headwinds from trade concerns, the U.S. economy remains strong. One estimate suggests that the 25% tariffs may reduce gross domestic product growth by 0.3% — enough to slow the current pace but not enough to shift the economy into reverse.14
Market volatility is likely to continue as long as investors react to moves on either side of the conflict. However, many other factors also influence the markets, and it would be wise to focus on your long-term investment goals without overreacting to short-term market swings.
All investments are subject to market volatility and loss of principal. Investments, when sold, may be worth more or less than their original cost. Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, and economic and political risk unique to the specific country. This may result in greater share price volatility.
1) Bloomberg, May 13, 2019
2) Yahoo! Finance, May 22, 2019
3) Office of the U.S. Trade Representative, 2019
4) U.S. Census Bureau, 2019
5) Reuters, May 8, 2019
6) BBC News, May 14, 2019
7) CNN Business, May 13, 2019
8-9) The Wall Street Journal, May 15, 2019
10, 13-14) The Wall Street Journal, May 10, 2019
11) Federal Reserve Bank of New York, May 23, 2019
12) The Wall Street Journal, May 9, 2019
Retirement Confidence Increases for Workers and Retirees
The 29th annual Retirement Confidence Survey (RCS), conducted by the Employee Benefit Research Institute (EBRI) in 2019, found that two-thirds of U.S. workers (67%) are confident in their ability to live comfortably throughout their retirement years (up from 64% in 2018). Worker confidence now matches levels reported in 2007 — before the 2008 financial crisis.
Confidence among retirees continues to be greater than that of workers. Eighty-two percent of retirees are either very or somewhat confident about having enough money to live comfortably throughout their retirement years (up from 75% in 2018).
Retirement plan participation
Retirement confidence seems to be strongly related to retirement plan participation. “Workers reporting they or their spouse have money in a defined contribution plan or IRA, or have benefits in a defined benefit plan, are nearly twice as likely to be at least somewhat confident about retirement (74% with a plan vs. 39% without),” said Craig Copeland, EBRI senior research associate and co-author of the report.
Basic retirement expenses and medical care
Retirees are more confident than workers when it comes to basic expenses and medical care. Eighty-five percent of retirees report feeling very or somewhat confident about being able to afford basic expenses in retirement, compared with 72% of workers. Confidence in having enough money to pay medical expenses in retirement was also higher among retirees than workers: 80% versus 60%. However, 41% of retirees and 49% of workers are not confident about covering potential long-term care needs.
Debt levels
The survey consistently shows a relationship between debt levels and retirement confidence. “In 2019, 41% of workers with a major debt problem say that they are very or somewhat confident about having enough money to live comfortably in retirement, compared with 85% of workers who indicate debt is not a problem. Thirty-two percent of workers with a major debt problem are not at all confident about their prospects for a financially secure retirement, compared with 5% of workers without a debt problem,” said Copeland.
What Are the Costs of the Government Shutdown?
The longest government shutdown in U.S. history ended after 35 days on January 25, 2019. A temporary appropriations bill extended funding for shuttered federal agencies to February 15, 2019, while a bipartisan committee negotiates a new spending bill for the Department of Homeland Security.1
The full impact of the shutdown will not be known for months, but official estimates have been released, and it may be helpful to look at the estimated cost to the U.S. economy, as well as the effect on public safety and other government services.
Nine departments closed
The shutdown began on December 22, 2018, when funding lapsed for nine cabinet-level departments (agriculture, commerce, homeland security, housing and urban development, interior, justice, transportation, Treasury, and state) as well as a number of other government agencies.2
About 800,000 federal workers in these organizations missed two consecutive paychecks.3 Some 380,000 of these workers were originally placed on unpaid leave (furlough), while 420,000 were deemed “essential” and required to report to work without pay.4 As the stoppage progressed, tens of thousands of furloughed workers were ordered back to work without pay.5
All federal employees will receive full back pay as soon as possible — many by the end of January — but about 1.2 million government contractors had no guarantees and may lose income permanently. It has been estimated that contractors faced more than $200 million a day in lost or delayed revenue.6-7
Family hardship and public safety
Missing paychecks was a hardship for many families and especially difficult on lower-paid essential workers. (Furloughed workers in many states could apply for unemployment benefits or seek other employment opportunities.)
The most visible manifestation of this issue was increased absences by Transportation Security Administration (TSA) workers. On January 20, the absentee rate for TSA airport screeners was 10%, up from 3.1% on a comparable day last year. According to the TSA, many workers took time off for financial reasons, such as an inability to pay for child care or transportation. Increased absences resulted in long lines, delays, and gate closures at some airports.8
Air traffic controllers, who are better paid, remained on the job without pay and normal support staff. However, on January 25, an increase in absences by controllers temporarily shut down New York’s LaGuardia Airport and led to substantial delays at airports in Newark, Philadelphia, and Atlanta. This may have been an impetus to reopen the government later that day.9
Other public safety employees who worked without pay include the U.S. Coast Guard, customs and border protection agents, and law-enforcement officers at the Federal Bureau of Investigation, U.S. Marshals Service, Drug Enforcement Administration, and Bureau of Prisons.10
Disrupted services
While essential workers maintained some federal services, furloughed workers left significant gaps. National parks were closed or understaffed, resulting in lost revenue, vandalism, and mounting trash.11 Many federal services were delayed or suspended, ranging from food inspections and civil court cases to consumer protection services, rural home loans, and federal reports used for everything from projecting the economy to deciding what crops to plant.12-16
The IRS called back 26,000 furloughed workers to process tax refunds, but almost 14,000 of them had not reported as of January 22. The IRS is understaffed under normal circumstances, and it may take time to get up to speed, adding to the challenges of processing returns that reflect changes in the new tax law.17 About $2 billion in tax revenue may be lost as a result of reduced IRS compliance efforts during the shutdown.18
Broader economic impact
According to the nonpartisan Congressional Budget Office (CBO), an estimated $18 billion in government spending was lost or delayed during the shutdown. This includes $9 billion of direct spending on goods and services and $9 billion in compensation for federal employees. Assuming the government stays open, most of this is expected to be recouped over the next eight months, but $3 billion in gross domestic product (GDP) may be permanently lost.19
Three billion dollars is a tiny fraction of total U.S. GDP — about 0.02% — but quarterly GDP growth may take a larger hit. The CBO projects an annualized loss of 0.2% growth in the fourth quarter of 2018 and 0.4% in the first quarter of 2019. So the CBO’s pre-shutdown estimate of 2.5% annualized growth in the first quarter would be reduced to 2.1%. GDP growth may be 1% higher than expected in the second quarter.20
Even if delayed spending is recovered, lost productivity by furloughed workers and government contractors will not be regained.21 Consumer confidence dropped in December and January due in part to the shutdown, but may rebound if the government remains open.22 A longer-term concern is the potential loss of federal workers, including those who leave for other opportunities and qualified candidates who may look elsewhere due to doubts about the future stability of federal jobs.23
It remains to be seen whether all government agencies continue to operate with full funding after the February 15 deadline. If so, the long-term economic costs of the shutdown may be relatively small, but the impact on individuals who fell behind financially or missed out on government services could be significant.
1, 9) The Washington Post, January 25, 2019
2, 18-20) Congressional Budget Office, January 2019
3, 23) CNBC, January 26, 2019
4) The Wall Street Journal, December 21, 2018
5, 13) CNN, January 16, 2019
6) Federal News Network, January 28, 2019
7) Bloomberg, January 17, 2019
8) Associated Press, January 21, 2019
10) ABC News, December 29, 2018
11) nationalgeographic.com, January 7, 2019
12) The Wall Street Journal, January 9, 2019
14) Federal Trade Commission, December 28, 2018
15) CNBC, January 9, 2019
16) CNN, January 8, 2019
17) The New York Times, January 25, 2019
21) S&P Global Ratings, January 11, 2019
22) The Conference Board, January 29, 2019
