How the Stock Market Differs from the Economy – Part 2

 

In Part 2 of our blog, we again thank Jonathan V. Bever for the thoughts and Jim Falcone, Managing Director of Fulcrum Wealth Advisors in Bellevue WA for permission to publish in our blog.

In the following paragraphs, we will lay out the case for the new bull market and identify the risks and consequences of money printing that began in 2008.

 

MONEY SUPPLY LONG TERM TREND …

For many years, the money supply long term trend has gone up while the fed fun target rate long term trend has been down.

The Federal Reserve balance sheet was under 4 trillion the end of 2019, went over 7 trillion in June of 2020, and has come down a little. We expect it will be higher by the end of the year. The Fed target rate which is 0.10 percent; practically zero.

Taken together the Fed policy went 180 degrees, from tightening to massive stimulation.

We argue if the velocity of money goes up so will the CPI, and we will have a lot of inflation. We believe the reason we haven’t seen monetary inflation because of the Fed money printing is the fact that the money velocity has gone lockstep down with it. Interesting to note the commodity index has gone down as well. The Fed money printing has been essential in providing liquidity as well as fight deflation.

 

DOWNWARD SLOPING TREND …

The Fed uses the PCE (Personal Consumption Expenditure Core Price Index) rather than the CPI (Consumer Price Index). It is easy to notice a downward sloping trend which illustrates deflation rather than inflation. Some are concerned that the Fed is all in regarding the fight against inflation and has little chance of fighting inflation should it come in hotter than desired. Some think the Fed not only put the gas pedal to the floor, taking his foot off the brake but has also dismantled the emergency brake and tossed it out the window. We are not in the camp who believes we will have hyperinflation; although, we don’t rule it out completely.

 

A GOLDILOCKS TIME …

As stated in the beginning, we believe we are headed into a Goldilocks time for our country. Social issues are at the forefront of our populous. We believe the collective consciousness will gradually bring the changes our country needs regarding social issues.

While they will always be with us, we believe the severity will ease. This will bring peace back to our streets, and commerce back to the corner retail shops. Also, low-interest rates in conjunction with moderate to increasing inflation will coexist in peace.

Political economic policy will be accommodating to economic growth. Technology in all sectors, to name a few: healthcare, energy, mining, etc. will be accommodating to economic growth without explosive costs.

 

PREDICTING MARKET VALUATIONS …

As we look at the valuation of the S&P 500, there is no doubt that it is at an above-average P/E ratio.

If we consider the Black Scholes model for pricing a stock option, the denominator is the risk-free rate or the short-term Treasury rate. The lower the denominator the higher the final number. The Treasury rate may turn negative; if so, we are entering a new paradigm for risk asset valuation. As the stock market is an auction each day, we know what the perceived value of each stock is. Where are we going with this? We would not be surprised to see a long period of higher than average P/E ratios on the S&P. So, expecting a market correction because of the perceived lofty valuation may prove frustrating.

 

A HISTORICALLY QUICK END …

In February we wrote that the market would have a total return of around 10%. It looked as if the pandemic would make it impossible. However, the speed of rate cuts and QE brought the bear market to a historically quick end.

Further, finding historical value in the market may be a challenge but should be full of rewards for the patient investor. In the next blog, we will illustrate economic pockets of strength, which we believe is just the beginning of economic robustness.

Finally, as commodities have underperformed for years, we expect they may finally be moving into the spotlight in the years ahead. Ultimately, where to invest? Our answer is simply: there’s no place like home.

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

How the Stock Market Differs from the Economy

 

After reading the last Revitalization Partners blog, a friend of ours sent us some thoughts regarding the stock market. The point was how the financial market can and does differ from the economic conditions we see every day.

Our thanks to Jonathan V. Bever for the thoughts and Jim Falcone, Managing Director of Fulcrum Wealth Advisors in Bellevue WA for permission to publish in our blog.

Casey Stengel: “Never make predictions, especially about the future.”  We will heed his advice.

 

A NEW ERA …

In the following pages, we are going to argue that we are transitioning to a new era in the investment world; a paradigm shift is taking place. 

We see it highly probable that a period of increasing inflation, moderately rising bond yields, an improving economy, modest commodity prices, and a new bull market.

Not so fast; we can hear your objections!  What about the next presidential election, possibly more social unrest, the recession, bankruptcies, and last but least, the coronavirus?  

We understand. The negative news is abundant; however, shake it off and look around the corner.  Are we not saying volatility is going away?  Not a chance.

 

PROBLEMS REMAIN … SEVERITY DOESN’T

We are optimistic, while the problems we face today will not necessarily go away soon enough, the severity will. The solutions being implemented have long term consequences, and they are awesome.

Yet, we do believe the battle with the coronavirus will be a multiyear experience.  Please walk with us as we go down the yellow brick road; together we will navigate the economy, the stock market, and the effects of the pandemic.  Aside from the potential for volatility, we are extremely bullish.

With all the pessimism, one would think the American Dream is over. The American dream has not gone away; it was merely on vacation being revitalized (its version of social distancing). 

Interest rates will be low for the foreseeable future not only for governments and corporations but, we believe, eventually will be so for the rest of us.

 

AS MILLENNIALS FINISH COLLEGE …

As the Millennial generation finishes college, the economy will continue its slow road to recovery, the coronavirus will be managed effectively, new jobs created for increasing demand, and new families formed will accelerate the demands.  So, new homes, new cars, new TVs, new phones, etc. will be needed.

To accommodate this expansion, low-interest rates, low energy costs, low commodity costs, and plentiful liquidity to lend to institutions and the consumer.  We are going to posit interest rates for the consumer will be much lower.  Any politician that can transfer the low rates of the Fed to corporations will be awesome to the consumer, to GDP, and the economy.  

America does not need to be made great; America is great. We simply need confidence, equality, and economic push, and the citizens will do the rest.  The Fed would like to have about 2 percent inflation rather than deflation, and low consumer borrowing rates would easily accomplish this.

The policy of lower rates and lots of money printing began in 2008 and now is the accepted norm.  Many critics think the unintended consequences will derail the whole scheme. We have considered their logic and find it lacking in one thing: truth.  Mostly, it has taken time for the paradigm shift to be accepted by economic tinkerers and public psychology. In short, “the day of reckoning” will be beaten by the innovation of America!

 

ARGUED FOR 2 YEARS …

We have been arguing for over 2 years that our economy and stock market were heading for a slowdown, if not a full-blown recession. 

Our augment: the fed was removing liquidity and putting the brakes on the economy; this was done by raising the fed target rate and unwinding their balance sheet. 

Volatility arrived first in 2018 conjoined with the beginning of an earnings recession; this earnings recession is still being worked through. The stock market had a nice rebound in 2019 as the market had a P/E multiple expansion.

Ultimately, the P/E expansion was popped by the coronavirus in 2020. We all know what happened when the virus arrived: chaos, economic shutdown, and a severe historic decline in the stock market; not just in the USA but around the world.

It would take a steady hand, sharp focus, and emotional discipline to navigate the treacherous stock market environment.

 

NO PLACE TO HIDE …

There is no place to hide in a crisis, and it exposes those who are qualified and those who are not; it exposes the good and bad in people. Those who survived by smoke and mirrors will come to the end of their road. Meanwhile, we will continue toward the Emerald City and ultimately home.

Regarding the SARS Corona Virus: a lot more is known today than just 6 months ago. We are confident it can ultimately be “beat” by following the guidelines while a vaccine or cure is developed. It will take several years to work through the coronavirus and potentially other SARS viruses; the workaround is not impossible-thankfully in part because of technology and a lot of hardworking people all over the world.

The new Fed policy of lowering rates, printing unlimited QE is a 180 degree from their policy 2 years ago. Therefore, our thesis has turned 180 as well.

 

INFLATION & A BOOMING ECONOMY …

Rather than looking for deflation and a recession, we are looking for inflation and a booming economy. We think this will be a process with the likelihood of some short-term pain.

To point out the obvious: the business affected by the coronavirus to emerge in a couple of years-assuming technology come to our rescue once again to beat the coronavirus.

If we look at history as a clue, we should expect good things. I asked a friend of mine: if you were to print 10 trillion dollars and give it to any country in the world, which country would you give it too? After some thought, he answered the USA: because the USA is the proverbial melting pot of the world.

The innovative risk-takers who are willing to work hard seem to end up here from all countries. Sure, we Americans make mistakes, have colossal failures, but we get up, dust ourselves off, and continue toward the good life as we see it.

In Part 2 of these thoughts which we will publish in two weeks, the folks from Fulcrum will lay out the case for the new bull market and identify the risks and consequences of money printing that began in 2008.

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

We Should Have Listened

 

This article, by Revitalization Partners, was first published in the ABL Advisor.

Nine months ago, Revitalization Partners began hearing of ominous warnings from management insiders, many of whom were forecasting a 2020 recession.

It was not that startling to us, given that we had written about the factors that could produce a downturn in various blog posts. However, those collective observations were running counter to the news of the day.

The country was doing great – experiencing full employment, confident consumers, a robust housing market and low interest rates.

To be fair, there were signs of headwinds as well, such as the government’s obsession with imposing tariffs on our trading partners, an upcoming presidential election and considerable uncertainty To in the stock market.

The issue at the time was if and/or when companies started to cut back on spending and reducing inventory levels, those emerging challenges would serve as the forewarning of economic problems to come.

 

OTHER TROUBLING SIGNS …

Other troubling signs started to surface: In late 2019 a Fortune/Survey Monkey surveyed senior managers at companies ranging from Fortune 500 concerns to small businesses in diverse industries.

One of the key findings was that two out of three executives believed a recession was likely within the next twelve months.

While there were several bright spots in the economy at the time, the consensus was that the good times would not last forever.

Coincidentally, it was December 2019 when the first COVID-19 case was reported in China and by the end of January 2020 the World Health Organization declared the highly transmissible virus a global health emergency. The first case in the USA was reported in January as well.

As it turns out, the concern that managers had in late 2019 would translate into a major transformation and upheaval of business much sooner than even they had predicted. A number of key economic indicators essentially crashed in a remarkably short period of time.

The Dow Jones Industrial Average dropped 38% in 40 days, unemployment soared from 3.5% in February to 14.7% in April, and consumer confidence plummeted 29% from February to April.

 

MOST BUSINESSES WERE UNPREPARED …

Most businesses were unprepared to deal with the economic free fall.  In fact, small- to middle market companies experienced the most significant declines and were generally ill equipped to deal with them.

In retrospect, one might ask what could these businesses have done to prepare for such a drastic downturn? 

Given the dramatic rate of change, some might question what, if anything, they could have done to mitigate the financial impact.

Our response to that rhetorical question has never wavered: Always have a Plan B – even in good times.

In the world of business, where both startup and established companies deal with daily struggles and sometimes risk everything to succeed, having a Plan B may be considered a weakness or seen as a lack of commitment to the current plan.  

Having a contingency plan is nothing new, however, especially to those organizations and individuals willing to take great risks for a chance at even greater gains.  

Dating back to the Civil War, the art of contingency planning took on supreme importance in case the optimal plan of attack did not work out.

 

VIEW AS A STRATEGY …

Even though you hope that you will never have to resort to your back-up plan, this does not change its importance since you might have to rely on it in the future.

The process itself will often cause you to rethink your primary plan and be in a position to improve it.

Intentionality is what makes any contingency plan effective.  Executives who are often risking it all to survive in the business world, regardless of sector or industry, should view their back-up plan as a strategy, not an afterthought.

It requires you to take a personal inventory of what is important to you and finding ways other than Plan A to help achieve your goals.

 

CRITICALLY ASSESS YOUR BUSINESS …

The last point is particularly important, as developing a Plan B forces management to assess their business critically.   As part of this process, they must understand where they have vulnerabilities.

This might include assessing the risk of high customer concentration, weakness in their supply chain, determining the risk of losing key management members, the lack of online ordering and delivery systems, as well as weakness in their information technology systems.

By identifying these vulnerabilities, management in fact may decide they must take action sooner, rather than later, to make important changes in advance of the next business decline.

Take it from former CEO’s that have helped numerous companies deal with the consequences of poor planning: You don’t want to be the person in the board or management meeting that says, “We should have listened – and been prepared!”

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Understanding the Small Business Reorganization Act

With Covd-19 and the differing attempts by state and local government to contain the spread by various regulations, smaller companies in the almost every industry have often been negatively affected by state regulations.

As a result of states where small business has been affected by COVID regulations, some companies may find themselves of the brink of insolvency.

Until recently, there have been two chapters of the bankruptcy code for the use of insolvent companies: Chapter 11 and Chapter 7.

 

TWO PATHS YOU CAN TAKE …

Chapter 11 was designed for the restructuring of companies that have a future business.  Chapter 7 is designed for the liquidation of companies without a projected future due to market forces or excessive debt.

For a smaller company, Chapter 11 is often far too expensive.  It requires a source of significant cash and a plan that has been worked out far in advance. 

Chapter 11 professional fees can begin at $100,000 and for a mid-sized company can become five times that figure. Most financially distressed small and mid-sized companies have neither the cash to support the fees nor have done the planning.

 

IN 2019 CONGRESS CREATED …

In August 2019, congress created The Chapter V subsection of Chapter 11.  Known as the SBRA or Small Business Restructuring Act, it is designed to let smaller companies take advantage of bankruptcy restructuring laws in a way that is both faster and less expensive.

To be eligible for Subchapter V, a debtor must be engaged in a commercial activity and its total debts must be less than $2,725,625.

The new CARES act has temporarily (for one year) has expanded that debt level to $7,500,000.

This increase allows larger companies to take advantage of Chapter V. Upon filing its bankruptcy petition, the Chapter V debtor must also file a balance sheet, statement of operations, cash flow statement and federal tax returns.

 

MORE LIKE AN ADVISOR THAN A …

The court will appoint a trustee.  The Sub-chapter V trustee does not take possession of a debtor’s assets and lacks the ability to sell those assets. The trustee is more like an advisor and handler; facilitating the development of a consensual reorganization plan, appearing at hearings, and ensuring that the debtor makes timely payments under the plan. The debtor must also pay the trustee.

The Chapter V process moves at light speed by traditional Chapter 11 standards. The court will hold a status conference within 60 days. At least 14 days prior to that conference, the debtor must report, in writing, the efforts made and to be made to obtain consensual plan.

The debtor and only the debtor must file its plan of reorganization within 90 days of the filing. The plan must include a brief history of the business operation, a liquidation analysis and financial projections demonstrating the ability of the debtor to make the proposed plan payments.

 

CREDITOR ACCEPTANCE NOT REQUIRED … 

To get a plan confirmed in Chapter V, it does not require acceptance by creditors.  It must not discriminate unfairly and must be fair and equitable.

Creditors must receive as much as they would if the debtor were liquidated in Chapter 7. 

Subchapter V includes an option for the debtor to contribute all “projected disposable income” to making plan payments for three to five years. 

Projected disposable income is everything after expenses to maintain and support the debtor and expenses necessary for business operations.

This provides an advantage to creditors to whom the debtor owes money and doesn’t have the ability for immediate payment but is projected to have the funds over the life of the plan.

 

A REASONABLE LIKELIHOOD …

To confirm a plan, the court must find that the debtor will be able to make the payments ordered under the plan or there is, at least, a reasonable likelihood will be able to make the payments under the plan and the plan has appropriate remedies to protect the creditors is payments are not made as proposed.

The SBRA contains many other provisions. A debtor’s attorney and the trustee can help ensure that the filing and plan are compliant with Subchapter V.

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Taking a Break

Over the past number of years, Revitalization Partners has taken the month of August away from our semi-weekly blog.

This year, however, with the Covid-19 issues, moving from our Seattle office to coordaining working from home and making certain that we helped our clients who were also going through similar changes, it appears that the month of July got away from us as well.

We are announcing a slightly longer vacation from our blog this year and our plan is to be back in September. All of us at RP wish you and your families an enjoyable and safe summer and are looking forward to resuming our writing in September.

All the very best,
The RP Gang

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Re-engineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Real Estate Turnarounds to Consider First

 

Although it feels like an eternity, we are only three months into the coronavirus recession and most owners and lenders are still thinking in terms of “blend-and-extend”.

Nevertheless, three kinds of real estate investments need more active intervention now or they are likely to face much greater losses later.

 

 

THESE USUALLY NEED EARLY INTERVENTION

1. Hospitality Properties.

No recession or depression in the last 100 years has come so fast and so utterly stopped travel, not only in the short term for vacations and business trips, but longer-term for conferences and conventions.

Tourism towns like Ashland, Bend, Chelan and Leavenworth have already lost their shoulder seasons and are now losing the group bookings that keep them alive in the fall.

The outlook for conference hotels in downtown Seattle, Portland and at Sea-Tac is slightly less bleak. Some properties are likely to have difficulty covering not only their debt service but their general and administrative expense.

2.  Senior Housing

The second type of real estate suffering acutely is senior housing, especially assisted care homes. 

These facilities turn over about four percent of their occupants a month, but now they must convince prospective residents not only to “give up their independence” and move out of their homes but face the health threat of group living.

The break-even for many is about 75 percent occupancy, but within six months many could down to 50 percent. Smaller, more thinly capitalized companies may soon be unable to pay salaries.

3.  Land-Development Deals

There are land development deals that were already in trouble before the pandemic. 

The last two years a number of new developers and investors entered the market, overpaid for property and underestimated the length of the approvals process, often for urban infill projects in big cities, low-end lots on the metropolitan fringe and second home lot subdivisions in recreation destinations.

Being newest to the business, these developers and investors are the least able to work them out.

 

DROP FARTHER & FASTER …

In most recessions, real estate values drop farther in value and for far longer than most people expect.

While it probably makes sense to finish most projects now in construction, land deals should be liquidated as quickly as possible, since these usually lose proportionately far more of their value than more developed real estate.

 

FEWER BUYERS WITH LESS CASH …

There will be far fewer buyers with the necessary cash and operational expertise for senior housing and hotels, but their numbers, too, will drop as the recession bites deeper. 

Unless you can ride out the recession long term, act now while values are higher, and you have more options.

“Recognizing your problems early will enable you to recover more of your investment.”

That means finding skilled people you can trust to realistically identify conditions, assess what actions will immediately add value, and then manage the sale or liquidation of the property.

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.