Market Update | April 5, 2020

Emotion, which is suffering, ceases to be suffering as soon as we form a clear and precise picture of it.

Viktor E. Frankl – Man's Search for Meaning

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This Week’s Issue

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Last week was a tough one for me, as I am sure it was for many others a well. In my home state of Michigan we are going on two weeks of mandatory lockdown. I have had a front row seat to watch the wreck of the century—and I feel powerless to do anything. As friends, family, and clients have been closing their businesses, laying off employees, losing their jobs, worrying about their future, at the same time we are prevented from gathering together in places of worship, communities, or homes to support one another.

In just a few short (long) weeks the U.S. is almost unrecognizable from how it was a month ago.

Consider the following:

- It is now illegal to attempt to go to church in most states.- Schools have been closed and spring and summer sports are canceled.- Gatherings of any size outside of immediate family are forbidden in most States.- You’re not supposed to leave your house except for trips to the grocery store, doctors office, or

to perform work that is “essential to sustain life.”- 10 million Americans lost their jobs, 16+ million are now unemployed and it is likely to get

worse before it gets better.

This has been an emotionally trying week. Now the question is what do we do? How should we respond to this?

We need to recognise that our emotions are in fact suffering. The emotions that overtake us as we are confronted with news headlines that paint bleak pictures, conversations with friends of family who have been laid off, the look on your employee’s face when you had to tell them they were being laid off, the worry that tomorrow is going to be worse than today, and perhaps the most powerful fear that we are not going to be able to provide the life we want for those we care the most for.

- The CARES Act In Summary

- Coronavirus Updates + Some Good News

- Unemployment Numbers

- Mortgage Defaults

- Credit Markets

- Collapsing Yield Curve

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This is suffering—and we need to form a clear and precise picture of it. We need to face it, follow it down to its worst end, and own it. From there we can see our choice; we can surrender to our fear or find new resolve to be disciplined and forward looking. Viktor Frankl laid this truth out in his book Man’s Search for Meaning, “Forces beyond your control can take away everything you possess except one thing, your freedom to choose how you will respond to the situation. You cannot control what happens to you in life, but you can always control what you will feel and do about what happens to you.”

Regardless of these very trying times or how hard of a week I think I might have had—my choice is to respond to my fears and emotions by recognizing I am blessed beyond what I deserve. I know this to be true; gratitude and a grateful heart is the best way of finding our true north—of navigating the sea of emotions and taking the right action.

So as you find yourself wrestling with emotions, fears, frustrations, my hope for you is that you find a way to show gratitude to those who mean the most to you and that you will find the resolve to stay forward-looking to the better days that lie in our future.

Live above the grind,

Ron S. BullisFounder & President

Derek VermeulenDirector of Business Development

The wonderful thing is that

vision is greater than

baggage. This means that a

sense of what you can

envision for the future—a

better situation, a better

state of being—is more

powerful than whatever

ugliness has accumulated in

the past or whatever

situation you are confronting

in the present.

– Stephen R. Covey

The CARES Acta.k.a. The largest spending bill in the history of the U.S.

Last Wednesday, the Senate approved a historic, $2,200,000,000,000 (that’s a lot of zeros) spending bonanza (stimulus package) to provide a jolt to the economy that is reeling from the coronavirus. Where will this “stimulus” money come from you ask? Elementary my dear Watson. The government plans to issue debt and then have the Federal Reserve print money to buy that debt. This is also what is known in nerdy economic circles as, “monetizing the debt.”

Key spending items in the bill are:

- $454 billion to backstop possible (highly probable) losses from the Federal Reserve Lending programs (these are the same programs I discussed in last week’s market update)

- $500 billion in loans for distressed companies

- $350 billion in small business loans

- $250 billion for direct payments to individuals and families

- $250 billion in unemployment insurance benefits

- $100 billion for hospitals

- $150 billion for State & Local Governments

- $10 billion to the Pentagon (they were short a few billion...after the $1 trillion they will receive this year)

- And some pocket change for completely necessary items like $25m for the Kennedy Center, $75m for public television (Big Bird, you’re welcome), $75m for National Endowment for the Arts, and the list goes on.

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The CARES Act

Economic Income Payments

Under the CARES Act, individuals who have $75,000 in adjusted gross income (AGI) or less would get economic income payments of $1,200 and with married couples with up to $150,000 of AGI will receive $2,400. There is an additional $500 paid for each child of a qualifying individual or family. The economic income payment (free money, helicopter money, universal basic income) will phase out for those at higher incomes levels.

Unemployment Benefits

The CARES Act made significant changes to who qualifies for unemployment benefits. Previously, independent contractors, gig workers, self employed individuals did not qualify for unemployment benefits. The CARES Act changed those rules and now includes individuals in those categories are eligible for benefits.

Retirement Account Changes

The CARES Act also made changes (just for the calendar year 2020) to qualified retirement accounts (IRAs, Roth, 401k, 403b, etc…)

- RMD requirements for 2020 are waived. If you took an RMD within the last 60 days you might be eligible to return that RMD to your retirement account if you didn’t need those dollars and save on taxes.

- Early distributions from a retirement account (pre age 59½) are penalty free (up to $100,000) for those impacted by the coronavirus; and the income taxes owed on any distributions from a retirement account will be spread over the next three years.

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The CARES Act

Paycheck Protection Program

The CARES Act provides small businesses (those with less than 500 employees) and nonprofits (religious groups qualify as well) the ability to get a loan for up to 2.5 times their monthly payroll costs. A portion of the loan would be forgivable if the funds have been used to continue making payroll payments to employees, rent or lease costs, mortgages, and several other qualifying expenditures. Businesses and organizations need to apply for these loans from a local bank and the SBA will be providing the loan guarantee to the bank.

Student Loans

The CARES Act has provisions that suspends Federal Student payments interest free until September 30th, 2020. It also allows companies to pay down their employees student loans without the employee paying any tax on those payments. Essentially, this would allow a business to payoff an employee’s student loans, tax free—we can only hope Congress makes this provision of the CARES Act permanent.

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Unemployment NumbersThe stimulus bill completely changed the rules regarding unemployment benefits in anticipation of the massive number of people who have and will file for unemployment in the coming weeks. It’s not that the economy was doing poorly (like every other prior time unemployment spiked)—it’s that the government politely asked us to stay home and not work. And, for our troubles, they offered up $600 dollars per week of additional unemployment benefits payable for up to 39 weeks (March–December 2020)...if you qualify.

Two weeks ago (3/26) we saw 3.5 million Americans file for unemployment benefits. Then, last week (4/2), a record 6.6 million filed for benefits. For perspective, the prior record for one week was 695,000 (in 1982). Last week we broke the record by a multiple of ten. In less than two weeks America has gone from having one of the lowest unemployment rates in history to the same unemployment rate we had during the depths of the Financial Crisis in 2009. As of last week’s unemployment report, there are approximately 16 million Americans now unemployed.

We have only had three periods in our history history where the unemployment rate has been higher than 10%. During the Great Depression the unemployment rate topped out at 25.59%. Then in 1982 we peaked at 10.8% and in October of 2009 we hit 10%.

Per the Bureau of Labor Statistics, as of March 2020, there are approximately 163 million Americans in the labor force1.To reach the same level of unemployment seen during the Great Depression that would mean we would need to have a total of 41.7 million unemployed. No one knows where this will end—but it is possible that we are looking at unemployment numbers that would be similar to those seen during the Great Depression.

Our team fully expects that the unemployment rate will to continue to soar in the coming weeks and that it will stay elevated even after the lockdowns have been lifted. Contrary to the government’s belief, businesses are not able to just push a button and bring everyone back to work. We don’t have the ability to monetize our debt and print our own money. Many of these jobs are going to be lost indefinitely.

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Key Points

- 3/26 we made history with close to 3.5 million filing for unemployment.

- Last week (4/2/2020) we made history again with 6.5 million filling.

- More people filed for unemployment in two weeks than normally file in an entire year.

- The government is hoping that the additional unemployment benefits will give consumers the confidence to keep spending money and paying their mortgages.

- We believe that is very optimistic thinking… expect spending to decline and defaults to soar.

- We expect to large increases in the coming weeks.

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3/26 — 3.5m jobless claims4/2 — 6.6m jobless claims

10m new claims + 6m already on claim = 16m unemployed

Key Points

- May 1933, unemployment rate was 25.59% and remained elevated above 10% until the U.S. entered WWII

- December 1982, unemployment rate was 10.8%

- October 2009, unemployment rate was 10%

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We needed to stop asking about the meaning of life, and instead to think of ourselves as those who were being questioned by life—daily and

hourly. Our answer must consist, not in talk and meditation, but in right action and in right conduct. Life ultimately means taking the

responsibility to find the right answer to its problems and to fulfill the tasks which it constantly sets for each individual.

Viktor E. Frankl – Man's Search for Meaning

Mortgage DefaultsOne of areas that our team will be closely watching in the coming weeks is the number of mortgages in the U.S. that are in default. A key catalyst of the Financial Crisis of 2008/2009 and the ensuing market crash was mortgage defaults. Now, the cause of those mortgages defaulting in 2008/2009 was a completely different reason than what we will see in the coming months. In 2008/2009 it was subprime loans, loans written with bad credit and/or no income documentation. As the subprime loan market started experiencing defaults it created a cascading wave problems across the entire credit market (auto loans, mortgages, commercial mortgages, etc…). As the number of loans in default increased, financial firms and banks on Wall Street found it almost impossible to sell the financial instruments (derivatives) that were tied to those loans (collateralized debt obligations [CDO], asset backed loans [ABS], mortgage backed securities [MBS]). The investors who had purchased those derivative products from large Wall St. investment banks were left holding assets with little to know value.

For a fun visual that shows how the financial instruments (like mortgage backed securities) work, check out this link: https://en.wikipedia.org/wiki/Collateralized_debt_obligation#/media/File:CDO_-_FCIC_and_IMF_Diagram.png

Now, I know what you are thinking. The Wall St. firms and banks that created those derivative products that played a role in the collapse of the financial markets would have learned their lesson right? No. The same types of products (albeit there are less subprime mortgages today than in 2008/2009) make up a large part of the mortgage market today. As of Q3 2019, there were $11 trillion dollars in mortgages on 1-4 family properties in the United States2.

The coming wave of mortgage defaults will be the result of governments issuing “stay safe, stay home” (lockdown) orders in response to the coronavirus. The lockdowns will shutter huge segments of our economy, which in turn will lead to massive unemployment, some temporary and some permanent, and that will lead to mortgage defaults on a large scale.

The Federal Reserve has already started purchasing mortgage backed securities, asset backed securities, and other CDOs from Wall St. firms to try to keep the credit markets functioning.

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Key Points

- The % of mortgages in default at the depths of the Financial Crisis was approximately 10.5%.

- Unemployment in 2009-2010 was approximately 10.5%.

- After last week (4/3/2020) the unemployment rate will be over 10%.

- Expect massive mortgage defaults in the coming months.

- Mortgage defaults are likely to lead to a issues in the credit markets.

- Mortgage defaults and the mess created by the stimulus allowing borrowers to skip mortgages payments will create a nightmare for banks, lenders, and borrowers.

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Novel Coronavirus 2019As of yesterday, 38 States have “stay home/shelter in place/lockdown” orders3. The result is that almost 300 million Americans are now restricted from going to school, church, gathering in groups of 10 or more, going to a restaurant, sporting event, and for many, going to work. Those activities are apparently “non-essential.” But I digress.

It has been 72 days since the U.S. reported our first confirmed case of COVID-19. As of April 3, 2020, here is a summary of the numbers in the U.S.

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U.S.

Est. Total

Population Total Cases % Infected

Current Mortality

Rate

Total Deaths

(COVID-19)

% Pop. Deceased

from COVID-19

Deaths Per

Million

330,000,000 277,205.00 0.0840% 2.3784% 6,593 0.001998% 19.98

New York

Est. Total

Population Total Cases % Infected

Current Mortality

Rate

Total Deaths

(COVID-19)

% Pop. Deceased

from COVID-19

Deaths Per

Million

19,540,000 102,863.00 0.5264% 2.85% 2,935 0.000568% 150.20

Michigan

Est. Total

Population Total Cases % of Infected

Current Mortality

Rate

Total Deaths

(COVID-19)

% Pop. Deceased

from COVID-19

Deaths Per

Million

10,000,000 14,225.00 0.1423% 3.80% 540 0.000240% 54

COVID-19 Numbers — U.S. vs Key Countries

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Country Est. Population Total Cases % Infected Mortality Rate Total Deaths % Pop. DeceasedDeaths Per

Million

U.S. 330,000,000 277,205.00 0.0840% 2.3784% 6,593 0.001998% 19.98

Italy 60,550,000 119,827.00 0.1979% 12.25% 14,681.00 0.02425% 242.46

China 1,403,500,000 82,511.00 0.0059% 4.03% 3,326.00 0.00004% 2.37

Germany 82,900,000 91,159.00 0.1100% 1.40% 1,275.00 0.00065% 15.38

Japan 126,860,000 2,617.00 0.0021% 2.41% 63.00 0.00043% 0.50

U.K. 66,870,000 38,690.00 0.0579% 9.33% 3,611.00 0.00081% 54.00

France 66,990,000 65,202.00 0.0973% 10.00% 6,520.00 0.00081% 97.33

Spain 46,750,000 119,199.00 0.2550% 9.39% 11,198.00 0.00116% 239.53

Israel 9,152,000 7,428.00 0.0812% 0.54% 40.00 0.00590% 4.37

For a very solid explanation of the complex challenges with the data around the novel coronavirus I would suggest taking the time to read “Coronavirus Disease (COVID-19) – Statistics and Research” by Max Roser, Hannah Ritchie, and Esteban Ortiz-Ospina (2020)4. You can read their work here: https://ourworldindata.org/coronavirus#

Coronavirus – Positive NewsThe following are news articles that we found to be interesting and pointing to the possibility of positive news on the coronavirus front. Please note, we are not medical experts and we are only sharing these articles as they bring a bit of positive outlook to our otherwise sober news headlines.

1. Dr. Vladimir Zelenko has now treated 699 coronavirus patients with 100% success using Hydroxychloroquine Sulfate, Zinc and Z-Pak

2. French researchers completed new additional study on 80 patients, results show a combination of Hydroxychloroquine and Azithromycin to be effective in treating COVID-19

a. Hydroxychloroquine-Azithromycin and COVID-19

3. FDA Grants Emergency Use Authorization for Hydroxychloroquine Sulfate

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U.S. Yield Curve

- One year ago the U.S. Treasury yield on 1 month – 10-year notes was almost 2.5%.

- Today, Treasury yields have collapsed to near 0% for short term, less than 1% for 10-year bonds and just over 1.25% for 30-year bonds.

04/02/2019 Yield Curve

03/02/2020 Yield Curve

04/02/2020 Yield Curve

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Key Points

- Even with the collapse in the U.S. Treasury yield curve, our debt is still yielding more than most of the sovereign debt around the world.

- German Bunds are trading a negative rates all the way out to 30 years!

- Japanese sovereign debt has a negative yield out to 10 years and is barely positive out at 40-year maturities!

- The U.S. might see negative yields on our debt in the coming weeks.

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Footnotes & Disclosures1. https://data.bls.gov/timeseries/LNS11000000

2. https://fred.stlouisfed.org/series/MDOTP1T4FR

3. https://www.nytimes.com/interactive/2020/us/coronavirus-stay-at-home-order.html

4. Max Roser, Hannah Ritchie and Esteban Ortiz-Ospina (2020) - “Coronavirus Disease (COVID-19) – Statistics and Research”. Published

online at OurWorldInData.org. Retrieved from: 'https://ourworldindata.org/coronavirus ' [Online Resource]

5. FactSet was used to generate the data and charts on slides 9, 10, 12, 17, & 18.

Lifeworks Advisors is a registered investment advisor.18

Different isn’t always better. But better is always different.