In this call recording, Simon Quick CIO, Christopher Moore, Head of Investment Research, Wayne Yi, and Head of Financial Planning, Bill Lalor, discuss the market downturn in light of the coronavirus.
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The below transcript was produced using a transcription software and may not be verbatim. Please refer to the video recording for exact phrasing or increased clarity.
Darcy O'Brien: [00:00:00] Good afternoon and thank you for joining us for today's live call, Weathering the Coronavirus Market Downturn. My name is Darcy O'Brien and I am the chief marketing officer at Simon Quick, and I will be moderating today's discussion. First of all, I'd like to thank each and every one of you for joining us today.
And I would encourage you to submit your questions. Our goal is to make these calls as interactive as possible. So please do not be shy. I also wanted to announce that similarly to this week, next week's call will be held on Thursday the 30th, instead of our usual time on Wednesdays. I also wanted to share that our Head of Financial Planning, Bill Lalor, will be joining us on the call today.
Later, he will respond to a question we have received on gift and estate tax planning. That being said, please feel free to pick his brain on any of the financial planning issues that might be on your mind. On that subject, please note that questions can be submitted through the Q and A function on Zoom.
You may also submit questions by emailing me at email@example.com. Please also note that this call is being recorded and will be posted to the resources section of our website tomorrow and circulated over email. Now, before I dive into the questions, please note the following disclaimers.
This presentation is for information and discussion purposes only. Please remember that past performance may not be indicative of future results. And there is no guarantee that the concepts and ideas discussed during the presentation will be profitable or prove successful. Now let us introduce our panelists.
Today we have with us, our chief investment officer and managing partner, Chris Moore.
Chris Moore: [00:01:55] Thanks, Darcy. Good to be here.
Darcy O'Brien: [00:01:57] Hi, Chris. Great to have you. We also have our head of investment research, Wayne Yi.
Wayne Yi: [00:02:01] Hi Darcy.
Darcy O'Brien: [00:02:03] And lastly, we have our head of financial planning, Bill Lalor
Bill Lalor: [00:02:06] Thanks, Darcy. Happy to be on.
Darcy O'Brien: [00:02:10] Great to have you Bill.
So, I am going to start with the questions that we received over email, and then we will dive into the queue and respond to questions in the order in which they were received. Our first question comes in from Ken. What type of investments will hold up well? Should we enter a deflationary period?
Chris Moore: [00:02:33] I can take that one. Deflationary periods usually benefits bonds. In particular, those that are a lot longer dated bonds, longer duration, or even zero coupon bonds. Being that we are in a zero-interest rate environment, it is hard to get excited about assets that will do well in a deflationary period.
Since rates, you know, can only go negative from here. So, as we think about positioning portfolios, we have included a traditional fixed income in most portfolios, as we do think the low rate environment will continue to support fixed income returns. However, we are certainly mindful of the fact that there's only so much further rates can go.
You know, not really banking on too much deflation in the intermediate term, even if we may get some here in the short term. So, you know, our portfolio is our position, should we get some deflation, but we are cautious to not kind of overweight there because the potential of missing out on returns elsewhere in other asset classes should you be over positioned for deflation and we not get could hurt portfolios in aggregate.
Darcy O'Brien: [00:04:14] Thank you, Chris. Our next question comes in from Deborah and she writes: Bank of America just raised its expectation for a goal to reach $3,000, calling for an 80% rally in 18 months. Is that something we would consider investing in? Why or why not?
Wayne Yi: [00:04:34] This is the Wayne, and I will comment a little bit on that.
It's not a uncommon question that we got in periodically and particularly in periods of volatility. I did see the Bank of America (B of A) piece and I am not saying it is right or wrong, but the number is pretty dramatic in terms of their kind of target expectations. And I think from an equity, south side piece, it is always to one's benefit to be a little bit more aggressive to kind of get kind of reader interest.
But having said that when we think about gold as an asset class, well, it tends to be an ideal asset or investors seek it in periods of volatility as a safe haven over the long-term goals, a kind of correlation to equities is zero, it's essentially flat. So, over the long term there is no consistency in terms of how gold will exhibit its performance versus an equity portfolio.
And I would say, even in time period to sell off, it's not like gold is immediately negatively correlated in those to the volatility. I would say the reason why gold has been taking a big rally recently is because of the amount of dollar printing we are seeing via very accommodative kind of monetary policy.
But if you look at the gold price charts, it's sold off pretty dramatically in the beginning of March as well. Just along alongside equities and then it started rallying alongside equities as people got more concerned about future inflation. So, because it is inconsistent, it is hard to kind of make a conviction call to add gold and how you would actually size that.
I think they raise a lot of questions as well, like I could see the argument, maybe you mix it into a bag basket of kind of portfolio hedges. But, if it is a small position, it is never going to be material enough and you do not want a fickle commodity like that to drive a big portion of your overall return.
So, I think if you stick with traditional asset allocation across equities, fixed income, and some of the alternatives, you will get to the same place over time without needing to have that kind of line item. So, with a volatility level that's kind of in line with or higher than equities, with correlations that are inconsistent versus the equity market.
It is not very useful as a hedge, in this kind of rally or the price target. I do not see how they fully get there. The rationale is that there's so much potential inflation because of money printing across the globe, but that in itself doesn't necessarily mean that's going to rally the 80%.
Like I do not see how they get to the 80% specifically. So, could it be stronger, but equities can be stronger as well in the back of that as well. So yeah.
Darcy O'Brien: [00:07:49] Great. Thank you for sharing that, Wayne. Our next question comes in from our very own Les Quick. Hi Les, and he writes it is looking like the economy will be reopened in stages.
What does this mean for annual GDP? Also, oil has absolutely tanked. What is our perspective on energy markets?
Chris Moore: [00:08:13] This is Chris. I will take the first half of the question and pass the second half to Wayne. We are starting to see some governors open certain states throughout the country.
And you know, some may argue too soon. Some may argue right on time. I think the early kind of projections for economic growth, or I should say decline, we are expecting a likely, longer period of contraction in GDP. And you know, this will likely help some of the estimates for third and fourth quarter in particular, where some states can come back sooner. Whereas other states will likely be, there'll be a longer period of time before they're back up and running particularly kind of New York and New Jersey that were harder hit than some of the other states across the country. So I, I think I haven't necessarily seen in the estimates for second quarter GDP that ranged from call it down 40% to down 20%, a detailed analysis of what the expectations were for certain states going back to work and reopening and which industries in particular. But the fact that the curve has flattened faster than some of the early predictions is a good thing for GDP and the economy overall.
But we are certainly very mindful of the fact that there could very well be a second wave of the virus in the fall. And you know, the impact to some industries and sectors quite frankly, is still not known yet. We will not see that and appreciate that until, in many cases, some of the second quarter data is released.
Some of the earnings calls to date have given us some guidance about potentially how bad certain companies could be impacted. So, it is still too early to tell what will happen with second quarter GDP. I think in short, my answer to the question is: the sooner states are up and running or some states are up and running, the better, certainly for economic growth.
I am not saying for public health purposes, you know, that is really driven by the states and their specific situations. But for the economy we do need people back to work sooner rather than later. So the more states that feel it is safe to open and bring parts of their economy back, the better it will be for GDP growth, whether or not it will be good enough to come in kind of lower than some of those dire or worst case scenarios for GDP.
That we had been seeing in the last couple of weeks. We're stating that we don't know that's kind of, you know, still very much going to be figured out to be determined, fortunately along the way, we've had ample monetary and fiscal stimulus to support small businesses and just to support consumers. The hope is that things work out better than we are projected. And we get through this faster than some were initially thinking we might,
Wayne Yi: [00:12:08] I’ll comment a little bit about oil and I would preface it by saying that generally we want to be able to know all of the kind of topical headlines that hit Bloomberg, New York Times, the FTA, and Wall Street Journal, but we also want to make sure that we understand what's happening behind those headlines, as opposed to just reading the pure headlines itself.
So, the reason why I comment on that is you would get oil on this past week and hearing about oil dropping below zero. And essentially you could be paid to buy a barrel of oil for $37.00. So you get $37 to take on a bottle of oil, like, it's fun and it kind of gives you a lot of fodder to kind of create meme’s off of, but in actuality, there's a lot more going on under the hood of that.
And when you think about oil, the oil pressure has really kind of continued on from the Saudi and Russian kind of pricing and production war that we saw in late February, early March. That really kind of unfortunately coincided with the shutdown and the stay at home mandates that kind of really exacerbated the pain that we saw in the economy and in equity markets and across all markets.
What we have experienced since then is more recently both OPEC and Russia agreed to cutting back production and gradually raising those. Unfortunately, it's a little too little too late, given that we're already in a shutdown mode where there's excess supply, not enough demand, especially as a kind of social distancing remains in places in the summer and impedes travel whether it's for pleasure or for business.
All that way then on the price of oil and particularly that kind of WTI versus Brent, there's some differences there too, but WTI being kind of more domestic and landlocked, if you can't store it and if you don't have offshore tankers or kind of container boats there's nowhere to put it.
So, there is just so much oil out there. So, what happened was, oil is set to be delivered in May. That one contract that, that exploration of that contract, that is where you saw that negative price. And when you look at USO, the ETF, or you looked at the generic pricing for oil, it all kind of gets tied to the most relevant and the nearest term open contract.
And as that contract was about to expire and there was a glut of supply, the contract collapsed and that is where you saw the negative price. When you think about oil prices looking forward, the April contract expired now where the May contracts, the oil prices are positive and had remained positive this entire time.
So, when you look at the latest contract, you look at $17 a bottle. When you look at the summer or late summer, or looking at year end oil contracts, features contracts, you are looking at $29 a bottle. So, that has been relatively more consistent since mid-March looking at that mid to high twenties per barrel.
So that is how I am looking through the near-term volatility. But I would say that it was a little bit sensationalist in the sense that you saw the most recent contract does expire and that's what caused this big kind of push down and now you're seeing that roll into the next contract a little bit.
So, you also see some downward pressure, but it is not across the board and you cannot wait a couple months to get to get paid to own oil. Another interesting phenomenon here is that even though oil collapsed, energy as a sector has been underperforming dramatically through this downturn.
But recently over this time period, while oil is collapsing, energy companies have actually been rallying a little bit. I mean, some of that might be just kind of buy in of cyclicals and value stocks and it might not just be purely, fundamentally driven, but you have seen some dislocation between the commodity and the company that rely on that commodity.
This relates a little bit to the gold question as well. Like if you want it for the gold trade on- How do you do it? Do you do it to the physical? Do you do it through the ETF? Do you do it through minors and there's different kind of sensitivities and reactions across the way you want to express some of these commodity trades.
So, I think that there is a nuance there that needs to be appreciated when looking to take advantage of potential opportunities out there in commodities.
Darcy O'Brien: [00:17:05] Thank you, Wayne. Appreciate that. The next question on our list comes from Todd and he writes. How do you think about the equity markets, reflecting economic reality?
How much of the downturn is built into these markets?
Chris Moore: [00:17:23] I can take that one. I think the equity markets are reflecting stimulus. They are reflecting the response from treasury and the fed and the administration to pump liquidity into the economy. I do not think they are reflecting concern for economic weakness, to the degree that we could see it.
And that is really because we have had support from the fed and the treasury. The equity markets are generally priced six months in advance of economic data. So, you know, equities will likely, at this point here we are in April, they are looking to kind of October, November for what is that happening in the economy. The expectation that things are going to be a whole lot better at that time is dependent on, I think that assumes quite frankly a couple of things. One of which being if there is a second wave of COVID in the fall, that it is not as impactful on the economy, the markets are assuming that if there is that second wave there isn't a national or global shutdown in response to it.
Should we see a second wave that is as bad or worse than the one we've just seen, that forces social distancing to the degree we just experienced it, you know, that would be a surprise to markets certainly. The stimulus to date would not be enough to cover a second round of weakness in the economy.
The second thing that is probably priced in the markets currently is the fact that the curve has largely flattened at this point. And some of the states are reopening for business. That has also been priced into the market. If we see economic weakness for the second quarter, that has been projected to date and guidance on a going forward basis from corporations throughout the U.S. is okay or not awful.
Markets will probably respond okay to that. Fortunately, a lot of the very extreme projections for the economy are kind of widely known at this point. So, it would not necessarily be a surprise to the markets. Unless, it included another major event in the commodity market or credit markets or somewhere else in the economy that forces a crack that was not expected. That would certainly be negative for markets and a surprise to markets that could cause further downside volatility.
Darcy O'Brien: [00:20:50] Thank you, Chris, I am going to shift gears here and move into a financial planning question. This one comes in from Lisa. What gift and estate tax planning opportunities have arisen from this crisis?
Bill Lalor: [00:21:06] Thanks Darcy. You know, although it may seem like an odd time to consider transferring wealth, given that we're in the middle of a crisis and we continue to experience high market volatility, and there's a lot of uncertainty out there. But however, you know, this year may prove to be a unique time to leverage some estate and tax planning strategies before they disappear. Realistically, we need to consider that the Cares Act and other stimulus measures that we have put in place to protect the economy may actually lead to scenarios down road where income and wealth taxes increase the pay for them.
So, if we are looking at strategies to take advantage of it with today's market conditions, you know, we should really focus on strategies that benefit from, current depressed asset prices and low interest rates.
Often the simplest method is overlooked and that is a direct gifting. I mean, we are in a time of very high estate tax exemptions, and this goes for state tax and GST tax. Right now, it is over 11 million for an individual and almost 23 million for a couple. And these are set to sunset, the very latest in 2025 but they could potentially end sooner.
I have mentioned with the upcoming election, you know, I recommend if you are considering gifts, I would look to make them this year. I mean, now is the time to make an outright gift and take advantage of the current exemption amounts and depressed asset prices.
You know, I also recommend that clients look to take advantage of the annual gift tax exclusion. Currently it is 15,000 for an individual and a 30,000 for a couple.
If you gifted depressed asset, you could really maximize the value of this annual exclusion. And then over time it can be a significant wealth transfer.
Think about low interest rates. Another interesting way to take advantage of low rates is intrafamily family notes. I mean, these are loans between family members. This is a very low-cost estate planning technique and if they are properly structured, allows family members to shift wealth from one family member to another, without incurring a gift tax and of course these loans can be forgiven over time.
The IRS also allows family members to charge rates lower than what you would get on the commercial market and this lower rate is not considered a gift. I also recommend that families who have intrafamily loans outstanding, you may want to consider looking into refinancing them to today's lower rates and then this would actually help you maximize the amount that can be forgiven every year.
Two strategies that really take advantage of both lower asset prices and lower interest rates are GRATS and CLATS. In a recent planning article we put out, we discussed GRATS in some detail. GRATS, also known as, grant retained annuity trust.
I mean, they are a great tool and a low interest rate environment. Also, when you couple them with low valuations, marketable securities, and in closely held business assets, they can be a very effective wealth transfer tool. For a GRAT, the grant or fund the trust with a depressed asset and then receives back in annuity plus interest.
It is a fairly simple strategy and a market downturn really creates a great opportunity to fund a GRAT. In order for the grant to be successful and transfer wealth, the assets placed into the graph must outperform a hurdle or interest rate over the term of the trust.
The recent fed interest rate cuts have reduced this annual hurdle rate for GRATS to 1.2%.
I mean, this is a very beatable hurdle rate over the life of the trust and by beating this hurdle rate, you transfer all that excess appreciation to the beneficiary. So again, you know, low interest rates combined with low asset prices, make it an opportune time to consider looking at GRATS. I also mentioned CLATS which are very similar. A CLAT is a charitable lead annuity trust. It is very similar to the GRAT except that the annuity does not go to the grantor.
Instead, it goes to a charitable entity for which the grantor who would get a tax deduction.
For people who make significant charitable gifts, a CLATS really an excellent way to combined charitable intent with family giving. Both of these strategies really have very little downside.
If they do not work and the assets do not outperform you know, for a GRAT they are simply pulled back into the grantor's estate. For the CLAT, less is passed onto the heirs, but again, there's little downside and very inexpensive to set up. A final point I would make for estate planning is that a crisis like this really reminds us that we need to periodically review our estate plan and make sure it is really still consistent with our goals and objectives.
The cause of this crisis, in particular, points out the importance of a living will or a healthcare proxy. It is very important to make sure you have a plan in place and that you have also named the right people to make sure your wishes are carried out. With all these strategies, it is very important to work closely with your advisor and your state attorney to make sure they fit into the overall financial plan.
Darcy O'Brien: [00:27:29] Yeah, thank you Bill. I know a lot of clients have been reaching out to their advisors, making sure their estate plans and wills are up to date. So it's a great, great reminder for people to how use this time, where many of us are working from home to address some of those items. For our participants on the call, we have one remaining question in the queue right now.
So, if you do have a question that you would like answer today, please go ahead and submit that and I will go ahead and move on with that last question otherwise.
So, the next question relates to charitable giving. How has the Cares Act impacted charitable giving?
Bill Lalor: [00:28:16] Right, thanks Darcy. The Cares Act did have some provisions you know, for charitable giving and this is an important year where a lot of people are looking to increase their giving.
Normally in past years or normal times, we often recommend using appreciated securities to fund gifting. It tends to be the most efficient way. If you have a long term appreciate asset, you get the deduction for the full market value. However, this year, with asset prices being depressed, we may look to some other areas and as part of the Cares Act, the act increases the charitable deduction amount for cash contributions made directly to public charities.
Normally it is limited to 60% of an individual's just to gross income. However, this year that limit can be up to 100%. It is important to note though, that these cash contributions can
only be made to a public charity, you cannot make these contributions to a private foundation or a donor advised fund.
As I mentioned, they did not raise the limit when it comes to appreciated stock. So in this particular year with the way asset prices are depressed, you may see a time where cash gifts make more sense and then for taxpayers who don't itemize, there were some smaller things where the Cares Act allowed them an above the deduction for contributions made directly to qualified charities for up to $300 for a taxpayer or $600 for a married couple in 2020.
I would say everybody's situation is very different and I would work with your advisor and your CPA on this to make sure that your gifting is done as efficiently as possible because you really want to be able to maximize the benefits.
Darcy O'Brien: [00:30:19] Thank you, Bill. Our next question just came into the queue from James and he asks, how do you feel about international equity markets versus the U.S. market?
Chris Moore: [00:30:33] I can take that one. We've been overweight U.S. relative to non-U.S and throughout this downturn have actually positioned more of an overweight to the U.S, relative to non U.S and emerging markets. Our view there is that, we think the U.S economy coming into this was stronger than many non-U.S. developed economies and therefore better positioned to weather coming out of this pandemic and the economic impact of it.
Also, our view is that the sectors in particular that will benefit most, technology and healthcare, tend to be kind of leading sectors within the U.S. now representing close to 40% of the S&P 500 index. And for example, we have been of the view that those two sectors would benefit coming out of this more so than others as they likely have less of a correlation to a weaker economy. As investors look to kind of invest more in healthcare in preparation for a second wave or the next pandemic, we think healthcare as a sector will likely benefit too.
So we've maintained overweight to the U.S. relative to the rest of the world and within us a bias towards large cap stocks that tend to be a bit less volatile, lower beta than some of the smaller capitalization stocks to whether what we think is likely more volatility ahead.
Wayne Yi: [00:32:28] Maybe just to add on a little bit more on there. Our thematic view is to focus in on quality companies, kind of defined as being kind of scalable, high quality operating margins, and low leverage. We applied that kind of view the international emerging markets as well, where we are underweight international markets.
But we do have a high quality growth oriented international equity manager that we have high conviction in, and it's one of the larger size positions in our portfolios. But as an asset class we are underweight that specific manager or something that stands out as a unique kind of value return driver for us.
When you look at emerging markets index, a lot of that composition does come from kind of financials or real estate or technology industries and obviously we don't want to have an overweighting towards financials because there is a cyclicality around their real estate.
And in the age of kind of social distancing is definitely going through a transition right technology. When you think that technology and emerging markets it's more often than not a manufacturing-oriented business, as opposed to a an internet or cloud-based. Now there are some specific individual companies that are cloud based, but when you look at it from an index basis, their composition is less so.
So, same thing in emerging markets. We are underweight there. The one exposure we do have is focused on the rise of the middle class and the consumer and not so export oriented because of the concern that if it in a weaker economy, there just won't be as much exporting in trade as we've historically experienced.
So, we get the fact that international and GM is cheaper on a valuation basis, but if the growth opportunity is less visible or looks like it's going to be more of a cyclical story, that will exhibit a higher beta, that's probably not the exposure we want. So, we have been very kind of surgical in terms of where or which managers we use to express the underweight in those portfolios.
Darcy O'Brien: [00:34:45] Awesome. Thank you, Wayne. At this time, there are no remaining questions in the queue. I would like to thank everyone on the line for taking some time out of their day to participate in today's call. Thank you, Chris.
Chris Moore: [00:35:01] Thank you, Darcy was my pleasure.
Darcy O'Brien: [00:35:03] Thank you, Wayne.
Wayne Yi: [00:35:05] Thanks Darcy.
Darcy O'Brien: And thank you to Bill.
Bill Lalor: Thanks Darcy.
Darcy O'Brien: [00:35:12] For those of you on the line. If you have any additional questions that we were not able to address during the call, please do not hesitate to send them to me at firstname.lastname@example.org and we would be happy to address them offline. Thanks again for joining us and have a great evening.
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