Good News, Bad News

First, the bad news: Gross Domestic Product fell by $2.15 trillion during the second quarter. The 34.3% annualized drop was the worst ever.

The good news, or at least the driver for a more positive perspective, is that this contraction was on purpose. Social distancing and lockdowns intended to abate the spread of Covid-19 have impacted every community and every industry. Businesses based on group settings, such as restaurants, theaters, travel, and non-essential shopping have been hit particularly hard.

On the disease front, masks and distancing efforts have been working. Where enforced, infection and death rates have slowed and then dropped. Where not enforced, and especially where removed, though, we have seen the reverse. As mentioned in our last report, until a vaccine or mortality-reducing medicines are widely available, life and commerce cannot get back to where they were pre-Covid.

However, on balance, adjustments have been made in behaviors and massive government relief has been availed, the benefits of which are reflected in reports from May onward. Industrial production rose in May and June, and during the last three months about 9.1 million people went back to work. The importance of federal assistance in these strengthening numbers is highlighted within the GDP data, which showed disposable personal income rising by $1.53 trillion last quarter – driven completely by “government social benefits”.

Going forward, the picture is still uncertain. It is hard to imagine fears rising to levels they hit in late March, but it is also hard to imagine social and work life returning to normal anytime soon. Many companies are making changes to grow with new life patterns; many others cannot and will fail barring a miraculous occurrence – such as the virus disappearing like SARS-CoV-1 did even before vaccines were tested on humans. Moreover, there is a presidential election just ahead which may bring about important fiscal and policy changes, some of which may not be business friendly. On the other hand, stimulative Fed policies and public assistance already doled and likely to be doled may keep things nicely astride; albeit with massive dislocations.

In the markets, this uncertainty has led to continued volatility, though the direction has varied and the net result so far has been continued recovery from the depths of early spring. For more complete discussion of the stock market I include (attached via email) a generic version of our letter to 100% stock investors.

Among bonds, briefly put, if an investor wants both safety and yield, there is practically nothing available in the markets right now. A worldwide quest for safety has led to massive purchases of U.S. Treasury securities. This has led yields down toward zero among short-term T-bills, less than one percent on 10-year notes, and under 1.5% on 30-year bonds.

In the corporate world, though liquidity has improved in recent weeks, value has not. Yields on bonds issued by very good quality investment grade issuers are not much above Treasuries. Google just sold $10 billion of a 5-year bond at 0.45%. Solid issuers rated BBB+ to A+, the range in which we often find better returns, offer returns of about 1% with maturities of 3 years or more. Less credit-worthy names within the investment grade world present better yields, but given the uncertain forward environment this might not be the time to grab an extra half a percent when the downside risk is 100%.

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