There are a lot of people, apparently, who don’t understand that when a business owner takes a loan, they are personally on the hook for that loan. And if there is a forgiveness feature, as is the case with the Payroll Protection Program, that forgiveness feature has to be applied for and approved. And if forgiveness is applied for and not approved, or if no forgiveness is applied for, then the individual who owns ...
The Covid 19-driven selloff created immense volatility and dislocations across fixed income markets. As investors de-risked their portfolios and sought liquidity at nearly any price during the selloff in March, opportunities were created for longer-term investors. Today, we believe that the fundamental outlook remains somewhat uncertain, as the economy, by and large, remains closed and the economic fallout from the government lockdowns has been severe. As the calendar turned in May, we began to see some hopeful signs regarding the course of the virus, which has been accompanied by immense monetary and fiscal stimulus. Given the significant amount of uncertainty ahead related to how all of this comes together, we think itâs still quite efficient today to take advantage of dislocations in fixed income markets by pursuing allocations to high- and mid-quality spread assets.
High/mid-quality spread assets attractive today
Today, across higher-quality fixed income, yield spread levels to comparable U.S. Treasury maturities are still near historically wide levels (see Figure 1). However, we think the opportunity today resides more in high and medium-quality spread sectors than in the riskiest assets, or in rate-heavy universes, such as the one defined by the U.S. Aggregate Bond Index. As displayed in Figure 1 below, the vast majority of the yield in corporate indices comes from spread risk today. Across all ratings cohorts, more yield comes from spread than from the risk-free component than weâve seen historically. While spreads are also high in the Aggregate Index, less yield comes from spread and more from interest rates, which of course are historically low at present.
Whatâs happened in the past when spread makes up the majority of the yield in these indices? High and middle quality assets benefit. On average, the forward one year spread change in investment-grade corporate bonds is nearly 70 basis points (bps) tighter when spread/yield is above the 90th percentile; BB high yield spreads can tighten by as much as 125 bps in an environment where spreads are a large percentage of yield. At the other end of the spectrum in the rate-heavy Aggregate Index, spreads are tighter but by a competitively small amountâonly 23 bps.
So, if spreads are so attractiveâwhy avoid the riskiest and highest yielding assets? Isnât there more return potential in the higher-yielding parts of fixed income? Perhaps, but we think that the risk/reward favors higher and medium-quality assets at this point in the virus progression and ensuing economic damage, particularly in certain industries and leveraged structures with uncertain levels of future cash flow. And, importantly, we think that the return potential of these assets is good enough that one can be satisfied with the returns available and that chasing excessive risks isnât required to achieve attractive returns.
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Optimizing risk/return through hypothetical portfolios
To illustrate this point, we examine three hypothetical portfolios. The first is a high-quality portfolio consisting of investment-grade corporate debt, the mid- to high quality-rated securitized assets and the âright industriesâ in the High Yield market. The second portfolio consists of a wider mix of assets, going further down the capital structure, but avoiding the riskiest assets, and the last portfolio was designed to be riskier and would own a portion of the riskiest assets.
In Figure 2, we look at the historical yields of these portfolios, and itâs clear that the yield of all portfolios is high relative to history. The yield offered today in the two higher quality portfolios is competitive with what riskier portfolios have offered through time. In other words, to achieve an attractive yield, relative to recent history, one doesnât need to reach down-in-quality today.
The core of our argument, however, is that total returns may be quite attractive today for some of the higher yielding, but better quality, or industry-specific, sectors. In Figure 3, we look at price return potential. Here, to estimate price return, we assume that spreads tighten to their average level over the last 12 months and assume that yields stay constant. (We also conservatively assume that the tightening happens immediately and that investors then receive the new, lower yield for the rest of the year).
Figure 3: Potential Total Returns for High/Mid-Quality Assets Look Appealing, with Less Tail Risk
The hypothetical total returns are impressive for all asset allocations under these assumptions, but we think itâs noteworthy how large the absolute return potential and yield are for the portfolio option not owning the very highest yielding asset-classes in the riskiest portfolio. The less risky two portfolios are meaningfully lower in our measure of left tail risk; we believe they offer a safer return stream. Still, even if there is no price return (if risk premia stay high and economic concerns remain for longer than anticipated), yields are still quite attractive.
These returns may also be attractive when looking across the capital structure, even looking at equities. In Figure 4, we look at what the price return of the S&P 500 would be were it to return to its average price over the preceding one year. This measure is analogous to the price return potential figure we show in the Figure 3 above. Given the sharp rally in equities in April, the index would actually be lower in price if it were to return to its one-year average. Equities can still go up since they donât have the upside cap that we see in fixed income, so mean reversion doesnât define upside perfectly. The juxtaposition of the equity and spread price return potential figures flatters the upside available in the right parts of the spread market. We think the potential returns in spread assets means that investors donât need to go down in quality to find a good return these days.
Rick Rieder, Managing Director, is BlackRockâs Chief Investment Officer of Global Fixed Income and is Head of the Global Allocation Investment Team. Jacob Caplain, Director, is a member of the Fixed Income Portfolio Management team focusing on portfolio construction, analytics, and emerging markets fundamental research.Investing involves risks, including possible loss of principal. Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks may be heightened for investments in emerging markets. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of May 15, 2020 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain âforward-lookingâ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Prepared by BlackRock Investments, LLC, member Finra Â©2020 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States or elsewhere. All other marks are the property of their respective owners. USRMH0520U-1196464-1/5.
Josh Brown’s last chance trade: EFG from CNBC. ...
Rather than trying to do this individually, I just wanted to say a huge thank you for the outpouring of support we’ve received from my post about bringing the firm through the coronavirus pandemic so far. We heard from many clients, whose words I can’t reprint here because of the “testimonial rule” but it meant a lot to get their notes and calls. I also heard from business leaders around the countr...
The coronavirus shock is likely having profound impact on how the economy operates over coming years. It is reinforcing structural trends and introducing new ones, such as the policy revolution, surging sustainability wave and accelerating deglobalization. In many ways, it is accelerating the arrival of the future. This has led us to change our long-term return expectations â and shift our strategic asset class preferences away from nominal government bonds and toward credit.
The latest update to our capital market assumptions, or return expectations across asset classes, reflects market price moves as well as the virus shockâs potential impact on fundamentals, such as corporate earnings, default rates and medium-term inflation expectations. Our expected government bond returns have fallen across the board, and those for credit and equities have broadly risen compared to the end of 2019. Our five-year expected government bond returns are now negative across developed markets, as the chart shows. Yields have dropped sharply, and we expect only a gradual rise as we see monetary and fiscal policy coordination suppressing rates in coming years. This diminishes the strategic case for holding nominal government bonds.
Read more in our Weekly commentary.
The significant price moves this year have played an important role in shifting return expectations. Potential changes in medium-term fundamentals also drive our return expectations. Take corporate earnings. The global equity market selloff earlier in the year had mechanically pushed up expected equity returns, but this repricing has been partly offset by a deteriorating earnings outlook. We see significantly reduced earnings per share this year before a gradual reversion over several years toward the prior trend of rising earnings. We also account for potentially higher corporate credit defaults and downgrades. Yet over a five-year horizon the sizeable widening in credit spreads that weâve seen should compensate for increased losses due to defaults and downgrades, driving up expected returns for credit, in our view.
Another key factor is a nuanced inflation outlook. Inflation expectations have plummeted, yet we believe markets could start to price higher inflation risk once the near-term shock starts to dissipate. We see todayâs extraordinary policy measures as increasing inflation risks over the medium term. Central banks could be more willing to tolerate inflation overshoots despite the upward pressure on rates from high debt levels, as monetary-fiscal policy coordination has become key. Accelerated deglobalization could add to inflation risks. The overall impact is not yet clear, and the greater risk of higher inflation in the long-run is so far not reflected by market pricing. This is why we favor Treasury Inflation-Protected Securities (TIPS) as a rising allocation in strategic portfolios versus nominal DM government bonds. We also see a case for Chinese government bonds as an increased strategic allocation. They offer higher expected returns just as DM bond yields have hit record low levels, and diversification in a world of increasing U.S.-China de-coupling.
Our strategic asset views are broadly aligned with our tactical views â with two important exceptions: TIPS and regional equities. We are neutral on TIPS over the next six to 12 months due to the collapsed near-term inflation outlook despite the more favorable outlook on a strategic horizon. Over the tactical horizon we hold a modest overweight on Asia ex-Japan equities on the prospects of a growth pickup in the region, likely led by China, which is gradually lifting lockdown measures. We are also tactically overweight U.S. equities for their relative quality bias and the strong policy response to date, and underweight euro area and Japanese equities for the limited policy space to safeguard the economy against the virus shock. We prefer credit to equities on both tactical and strategic horizons, and see private markets playing a core role in portfolios.
I like a quick fix as much as the next person. One-pot meals? Sounds great. 10-minute workouts? Sign me up.
But when it comes to building resilient retirement savingsâ¦ thereâs no silver bullet.
In part, thatâs because we face a number of challenges all at once. Lack of access to workplace retirement plans, low saving rates, gaps in participation and employment, withdrawals to meet more pressing needs â all these undermine the ability of hardworking people to retire with dignity.
Now combine that with the economic fallout from COVID-19, and youâve got the makings of a major crisis.
The good news? There are things we can do to improve retirement security.
Thatâs exactly what my group focuses on at BlackRock. Weâre developing innovative solutions to address the most pressing retirement challenges. One of the toughest challenges has been to replace the security of the traditional pension: the need for guaranteed income. Not having enough money for retirement was already a primary financial concern for most Americans â one that will likely be exacerbated by the current crisis. We believe employers will increasingly recognize that thereâs an urgent need for new retirement solutions that provide steady, reliable sources of income for their employees â a paycheck in retirement.
Follow Anne Ackerley for more commentary on retirement.
Thatâs precisely the kind of innovation weâre working toward at BlackRock â and weâre bringing together expertise from across the retirement ecosystem to do it. Drawing on cutting-edge product design, behavioral finance and technology, we are building solutions to confront the accelerating retirement crisis in the United States. We are grateful to our partners for their participation in this journey.
Hereâs my take: If youâve worked hard all your life, you should be able to count on a lifetime of stable and secure income, without fear of running out of money in retirement â even if thereâs turbulence and volatility along the way.
If we want to provide millions of American workers with a secure retirement, we must focus our efforts on creating new, modernized solutions that seek to provide the opportunity for guaranteed income where employees are already saving â in the target date fund, which is the default investment option in most 401(k)s.
I believe a future like this is within reach. But we must act to make it a reality. Now more than ever, this is a time when we all are increasingly concerned about our long-term financial futures. And we deserve retirement investment solutions that we can all count on â no matter what. Now that is a resilient retirement plan.
Josh here – once upon a time it was totally normal to be sitting face to face with a friend and talking across a table, and then they locked down New York City and you know what happened from there. Anyway, my friend Brooke Hammerling was the last person I met with before the shutdown and we taped this conversation about the importance being up on Pop Culture. Lots of business leaders struggle to understand what...
Economy appears able to recover faster than expected from Covid-19 lockdowns, says Stephanie Link from CNBC. ...
I wrote this on my birthday, February 25th. I knew it would happen. Hundreds of S&P 500 component companies, like my Mastercard example, cut their full-year guidance for 2020 or eliminated it outright. The bears like that. But then, enough time goes by and everyone forgets what the original estimates were. And then the companies start “beating” the new numbers, which have been revised lower months ago. An...
The year 2020 is, for many obvious reasons, going to be a year none of us will forget anytime soon. But for those who were born in 1960, even if the coronavirus came nowhere near you personally, 2020 will have a lasting impact on you, regardless.
If you were born in MCMLX (1960), the year 2020 is when you’ll reach age 60. For anyone, this is a momentous occasion. Reaching six decades of age is a wonderful event, opening the passageway to retirement, grandparenting (and great-grandparenting) among many other favored activities. For our purposes in this article, you should know that age 60 is also a very important year for your Social Security benefits. Age 60 is when your wage index is set, which determines many things about your Social Security benefits.
The year 2020, with the severe economic downturn, is going to have a long-lasting impact on you newly-minted sexagenarians, specifically on your Social Security benefits. This is because of the way Social Security benefits are calculated – and the economic figures that are most likely to be written in stone a bit later this year.
I’m not going to go into complete detail on how Social Security benefits are calculated in this post – my primary message here is to help you understand why 2020’s economic results will have such a lasting impact. If you’d like a complete description of how Social Security benefits are calculated, see this article about the Primary Insurance Amount or the AIME, as starting points in your education.
The problem is in the calculation
When Social Security determines your benefit amount, a very complicated set of calculations occur. One portion of that calculation is an averaging of your lifetime (the top 35 years) of earnings. The calculation isn’t a simple average, however – it’s an indexed average, and the indexing year is the year you reach age 60.
Let that sink in for a bit… I’m guessing that didn’t help much, did it? How about if I work through a simple example to illustrate the problem?
Rather than working with 35 years’ worth of earnings (because that gets unwieldy in a hurry), let’s work with an example of only 5 earnings periods. And I’ll simplify the numbers so it’s a bit easier to grasp. Look at the table below for starters:
Simple enough. Year 5 is representing the year 2020 for 1960 children, your indexing year. When Social Security determines your benefits, they look at your overall earnings history – and for our example the above brief table will suffice.
Since Social Security is not simply based on what you’ve earned, but rather what you’ve earned relative to the rest of all earners in your age group, we need another column in the table. This column is the Average Wage Index for all people earning in any given year.
Briefly, the Average Wage Index is determined by totaling all wages earned in the US in a given year, and then dividing that number by the number of people who earned those wages (all who received a W2). Self-employed folks are counted as well, just in a slightly different manner based on their tax returns.
So for the purpose of our example, let’s fill in an Average Wage Index (AWI) for the record:
These AWI numbers represent that nationwide average for the year in question – don’t get hung up on the numbers themselves, I just randomly generated some numbers to fill in the slots. The point is that these are the averages for those years.
The next step in the process is to index your earnings against the averages. To do this, we set year 5 as the “index year”, and we make all of the other averages simply a comparison to that index year. To fill in the first year’s index, we simply divide our index year by the AWI figure for that year – $1,353 / $1,050 = 1.28857. And so we fill in the rest of the table:
Hopefully the way the index column is determined makes sense. Again, this simply shows the AWI figure in terms of each year’s relative value compared to the AWI figure for the index year, Year 5. So Year 5 is of course, 1.00000, since it is equal to itself.
Now that we’ve determined the Indexes, we apply each year’s index to your actual income for that year. We do this by multiplying the Index column by the Income column, to come up with an Indexed Income column:
Taking a look at the figures in the Indexed Income column, you can see that, for example, the $1,100 that you earned in Year 2 is equivalent to $1,311 when compared to the AWI for the periods, with Year 5 as the Index year.
The last bit is to average these numbers – so we add up the five years’ worth of Indexed Income, and divide by 5, the number of periods in our example. Adding up we come up with $7,040, and dividing by 5 we have $1,408 as our result. This is our Average Indexed Earnings. (Keep in mind my example is much more simplified than Social Security’s actual calculation, which works with Monthly earnings, rather than yearly, and the total years in question are 35 rather than 5. The concept is the same, however.)
Alright – so now we’ve gotten this far, let’s get to the point of the problem: since the Indexing year is kinda the foundation of the whole process, what happens when that figure is adjusted? And by adjusted, in the context of this problem we’re covering, I mean adjusted downward – perhaps significantly.
For the year 2020, it is anticipated that the AWI figure may be less than was anticipated, and most likely less than it was in 2019. To see the affect this will have on our example, I’ll adjust the AWI figure downward by the projected 6.7% less than the prior year:
The only figure that was adjusted was the Year 5 AWI – but this changed both of the following columns, since their values are based on the Indexing Year’s AWI value. The result is that the Indexed Income, when totaled, comes up to only $6,396, and when divided by 5 the result is $1,279 – which is $129 less than the figure we got the first time around – nearly a 10% reduction!
Hope that example helps you to understand what is so important about the Indexing year AWI value. Now let’s put this into the context of your own Social Security benefit.
Your own Social Security benefit
I explained briefly above how your Social Security benefit is calculated, and the example should have helped you understand the importance of the Indexing Year’s AWI. Now let’s talk about what’s about to happen in 2020 – real life.
Back in the first quarter of 2020 (remember way back then?) the economy was booming. Employment was at all-time highs, based on the number of people employed. And then, the coronavirus pandemic hit. More people than ever before have been affected by layoffs and furloughs, as well as complete evaporation of their jobs.
So – two takeaways that are important to the process – remember how I explained that the AWI is determined by taking the total wages earned by everyone in the year and dividing that figure by the number of people earning? The first part of that equation is very, very likely to be smaller in 2020 than it was in 2019 – because there has been a period of more than 8 weeks so far (out of 52, 15% of the year and climbing) where a significant number of those people who were earning at the beginning of the year have not been earning, or are earning significantly less than before. And the second part of the equation hits just as hard: more people than ever before were in the workforce, so the divisor is that much larger.
As a result, it is projected at this time that the AWI for 2020 is likely to be as much as 6.7% less than the anticipated AWI for 2019. (These figures are produced 1 year in arrears, and so the 2019 AWI will be released in October, 2020, and the 2020 AWI won’t be released until October, 2021.)
So the result is that, for those folks who are reaching age 60 in 2020, your Indexing Year AWI will be lower than anyone could have possibly guessed it might be. Social Security’s actuaries had projected an increase for 2020 of approximately 3.5% over the projected 2019 figure.
In addition to affecting your overall average indexed earnings, the AWI Index Year also impacts the final calculation of your benefits (see Primary Insurance Amount for more details.)
It is estimated that this anomaly across these two calculations will result in a loss of more than $2,500 a year in Social Security benefits for the average person, when compared to the previously-anticipated AWI figures. Assuming this person receives benefits for approximately 18 years, a total of more than $45,000 in benefits is lost. The figures will be higher or lower depending on your benefit amount, the age you start benefits, and how long you receive benefits, of course.
What can be done about this?
Each person individually can’t do much about this situation. Starting Social Security benefits earlier or later won’t help. The only way this can be resolved is if Congress takes up the matter to make a one-time (hopefully!) adjustment to the AWI series.
How likely is it that Congress will take action? First, consider that this situation has occurred twice in the past: in 1977 through 1981, due to a change in the process, and more recently in 2009, from impact of the Great Recession.
During 1977 to 1981 – this is the infamous “notch babies” period – since the anomaly was a result of an intended change to the rules, it’s not surprising that no Congressional action was taken.
So we have the Great Recession as a recent economic downturn to use as a guide – and once again, Congress did not take action to resolve this situation. So folks who reached age 60 in 2009 (born in 1949) had the exact same issue that those reaching 60 in 2020 are facing, and Congress did not make any changes then. So the outlook isn’t good.
However, one thing that is working in favor of a possible adjustment for folks born in 1960: it’s an election year, and Congress has been throwing money around like drunken sailors. If we can get them to pay attention to this problem, maybe they’ll do something about it – if for no other reason than to buy favor from this group of folks born in 1960. I suggest contacting your congress-people immediately, and get this issue on their plates ASAP.
I should also note – given that we have no idea whether the economy we’re seeing up to this point in 2020 will recover over the remainder of the year, or whether it will continue to languish and unemployment remains high, there’s certainly no guarantee that this same situation won’t continue for folks born in 1961 and beyond. It’s way to early to start worrying about that, and of course, worrying about it isn’t going to resolve it.
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