Podcast: Episode 6

How will the markets define a successful reopening?

Join our experts to learn how various economic recovery scenarios may play out, and the impact on your planning in the months ahead.

Podcast: From here to recovery: What will it take?

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TIAA Perspectives Podcast Episode 6: From here to recovery: What will it take? Hosted by Jim Daniello, CFP®, wealth management director for TIAA. Joined by John Canally, Jr., CFA® charterholder and Managing Director with TIAA, and Dan Keady, CFP®, Chief Planning Strategist with TIAA. - [Jim] Hi everyone, I'm Jim Daniello, a wealth management director for TIAA. Thank you for joining me for another installment of TIAA's "Perspectives Podcast", where we'll talk about financial planning strategies, money management tips, and steps you can take now to remain on track towards your goals. Since the COVID-19 pandemic gained steam in late February, we've witnessed a series of unprecedented events that carry both short and long-term impacts for financial markets and the economy, as well as your personal finances. Joining me today to talk about all of these and where we find ourselves along the path to recovery are my colleagues, John Canally, and Dan Keady. John is our Chief Portfolio Strategist and is a CFA charterholder. And Dan is a Chief Planning Strategist and a Certified Financial Planner professional. Great to have you with us, John and Dan. - [John] Good to be here. - [Dan] Thanks, Jim. - [Jim] John, I wanna begin with what we're seeing in the marketplace as countries around the world reopen their economies to a new normal, and what that means for us here in the United States. - [John] Jim, I think the key here is that the virus is still here with us, it truly does impact financial markets each day. If you see the market up one day, it's probably because of good news on the health front. If the market is down, it's probably because it's on bad news on the health front. So even three or four months after it began impacting the US economy, and six months after it began impacting economy overseas, it's still here, and I think it will be for quite some time. So let's run through a couple of cases that we've laid out, a base case, an upside case, and a downside case. So in our base case, the US and global economy endure a sharp but brief recession, basically, the first half of 2020 was a recession. And then we have a cautious recovery that starts in the third quarter, just as long as rates remain low from central banks, and just as long as governments continue to provide stimulus in the form of tax cuts and spending increases. In this base case scenario, we do see corporate profits falling by 20% this year, that's pretty much already baked into the cake. And then in this base case, as well, interest rates and inflation remain low, not just this year, but probably next year as well, and that has implications, those low rates. And then on the upside case, COVID-19 passes quickly, and economic activity gets back to normal, and by normal, we mean where we were back at the start of 2020, that we get back to that case by early summer, so call it July or August. Now, this seems unlikely but it's still a possibility. And so under that scenario, you do still have a ton of global monetary and fiscal stimulus in the system, so in other words, if the economy does begin to surge here, there's no way that central bank and governments are going to be able to take back all the stimulus that they've put into the system, in the form of tax cuts, and spending increases, and quantitative easing, and rate cuts, so in that environment, what the investor should be concerned about is an uptick in inflation, and then how to protect against that rise on inflation. And in this scenario, as well, in the upside case you'd see that the US and China would continue to de-escalate their trade war. Now, how about the downside case, though? So the downside case would be akin to that second wave that we hear so much about. So COVID-19 continues to linger here, not just in the second quarter, but into the summer and fall, and then it merges with the traditional start of the fall flu season in October or November, that would prolong the US and global recession. The economies that have reopened would have to shut back down, as the social distancing decreased, if you see an increase in cases, the governments around the country and around the world may rethink reopening, and force businesses to close again, and force people back into quarantine. That's your downside risk here. Piling on with that, if China and the US escalate their trade tensions, that would intensify the downside case. And then in this downside case, rates would remain low, not just for the next year or two, but could remain low for the next decade, and that, of course, has implications for investors as well. - [Jim] So John, you just outlined three possible cases. How soon will we know which scenario we're looking at? - [John] You know, let's just provide here a quick history lesson of how we got here to the point that we are now, here in early June. So the US economy began to lockdown in March but mainly by the end of March. Couple of states did it in mid-March but by the end of March and early April, 90% of the economy was pretty much closed in the month of April. May was more of a transition month, several states began to reopen in stages in early May, and then by the end of May, 90% of the economy was open. So May is a key month. Here in June, 100% of the states are reopened, but as we mentioned before, if we get a spike in cases, that might shut down again. So in terms of the markets, the market is currently priced for a smooth opening, no second wave, so that's what you're seeing with equity markets and bond markets, they're assuming that there's not gonna be a second wave, and that the economy is gonna continue to reopen, and sometime in the fall we'll be as close to normal as we were back earlier this year. So that does leave the equity markets vulnerable to a pullback, so you might get a retest of the March bottom if we have to re-shutdown the economy because of a resurgence in cases, so that's something to watch out for. - [Jim] John, there's been a lot of talk about the shape of the recovery. You know, an earlier podcast, you've talked about the shape of the recovery looking like letters of the alphabet, Ls, Vs, Ws, Us, in March and April many people anticipated a V-shaped recovery where the economy would reopen and the job and financial markets would likely race back up to their pre-virus levels. That looks less likely now. What signals are you seeing, and what are they telling you right now? - [John] We're more likely to see a W-shape recovery, a bumpy ride for the economy and markets, and it's really going to be health-dependent. So if we can reopen safely and there's not a spike in cases, I think that's gonna be the key here, is to the shape of the recovery, it's really gonna come down to health. And just in terms of markets, as a reminder, the equity markets are generally gonna lead the economy. So the recent run-up in stocks that we've seen off of the March low, that implies that economy activity is gonna improve in the next six or nine months. So stocks really are not looking at what happened in March, April, and May, they're really looking out to what's gonna happen at the end of this year and early next year. So I think that's important to keep in mind. And the current levels of the stock market and at the valuations, how investors are valuing stocks, the upside and the downside risk for large-cap US stocks are roughly balanced at this point. Now, in terms of the economy, how long does it take to get back to normal, or get back to the prior peaks, so if you look at all the recessions since 1960, it takes an average of nearly two years, around 20 months, to get back to the prior peak on GDP after a recession. So this time, in our base case, we expect the economy to get back to normal by the middle of next year. That's a little bit quicker than normal, and that's kind of what the stock market is pricing in right now, and so you have to keep that in mind. So these financial markets are forward-looking, they're much more worried about what's gonna happen late this year, early next year, the middle of next year, than they are what happened in the first or second quarter of this year. - [Jim] John, I'm interested in hearing what a W-shaped recovery really means for the job market, and what's your take on the surprising jobs reports for the month of May? - [John] I think an important point here is it seems counterintuitive, but employment is typically a lagging indicator of economic activity. So generally, financial markets and overall economic activity, things like industrial production, and gross domestic product, and retail sales, those kind of things are gonna start to improve long before the job market does. And on average it takes about eight months for the unemployment rate to peak after a recession, I would not expect the job market to improve any time soon. And in fact, although we saw a pretty surprisingly strong May Jobs Report, where we added 2.5 million jobs, the unemployment rate did decline to 13.3% from 14.7%, those are still extraordinarily high numbers for the unemployment rate, the highest we've seen in many, many decades. There has been some debate, Jim, as to whether or not the numbers were fudged, one way or the other, I can tell you, I've been in the business now for 34 years or so, and I think it's very unlikely that there's any thumbs on the scale at the Bureau of Labor Statistics for that jobs report that was released in early June. So on the job market, again, just to wrap up that point, it's going to take a while to recoup all those jobs, but on average, just to keep in mind, it takes more than two years for an economy to recoup all the jobs. As an example, during the 2007-2009 recession, it took five years to recoup all those job losses, and of course, the stock market bottomed well before the economy recouped all those jobs. - [Jim] Well, thank you, John. Understanding how the recovery may play out in the months ahead is really helpful for our listeners, as they address different aspects of their planning. I think it's important to remind people, though, that just because the markets may be up, the recovery itself is a process, not an event. I wanna bring Dan, now, into the conversation to talk about how we take the data that John just shared with us and turn it into practical wisdom to address specific planning needs. Dan, let's start with some of the things we've been talking about to clients in recent weeks. - [Dan] Jim, I think the themes include job loss, furlough, and pay reductions. Also, unanticipated spending shock, such as the need to help family members financially, which of course, impacts people's financial plan. Another theme is to balance the opportunity in the good scenario that John was talking about, as well as a measure of protection in that bad scenario. On the positive side, many people have found extra money in their budgets staying at home, I know I have. For some, they can build cash reserves, or that all-important emergency fund, or paid out some of that credit card debt. Remember, predictions of financial fragility include low savings rates and low cash reserves, plus high credit card debt. So reviewing your cash flow is step one in a difficult time. - [Jim] You know, Dan, people have also been reassessing their goals and their values, reprioritizing if you will, considering what's really important and what may be less important, how can advisors help our listeners work through this reprioritization process? - [Dan] You know, Jim, our planning process is designed to match your financial plan to your goals, those goals that are important to you. We talk about needs, wants, and wishes, compared to your assets. So we connect your goals to the time horizon and the purpose, in what we call our asset location worksheet, we can evaluate any needs for additional income beyond social security. And again, it's really hard to do this alone. I have been a CFP since the late 1980s and I still get a second opinion, qualified opinion before making big changes. So discuss your values and goals, and plan with your advisor. - [Jim] You know, Dan, I couldn't agree more. It can be very difficult to make some of these decisions on your own without help. For example, the current low interest rate environment has made it very challenging for many investors, especially those in retirement, to remain on course towards their goals. Dan, what are some of the ways the planning process can help people get back on track? - [Dan] Jim, it's so important, the regular updating of your Life Goals Analysis plan, that's the key. Replanning over time to determine are you still on track to reach your goals and importantly, any course corrections or tweaks needed within your plan, and if the bad case happens, understanding the concepts of buffering to reduce the draw downs from your portfolio. Reduce spending, identify money that you don't need to spend, things that, perhaps, no longer add value to your life. In retirement, can you delay spending on discretionary goals, or reduce current spending to reduce the strain on your portfolio, and consider using the six months of emergency savings we built into each plan, you could that on, so to speak, and use it in order to provide a buffer. - [Jim] Great advice for people in retirement, but what about people who are 10 years or less from retirement, and what advice do you have for those individuals? - [Dan] Years ago, pension and social security formed an income floor, really a base to build on. Now, unfortunately, most people don't have pensions. If you don't have a pension, it's important to start building a future self-pension to build an income floor above social security. Note that a fixed or guaranteed annuity can provide regular income, which is similar to a pension, Jim. - [Jim] Dan, what if you don't have a financial plan in place currently? I'm sure you saw this as well, during the extended bull market where many people thought they didn't need a plan or professional advice. That complacency is now coming home to roost. - [Dan] Exactly, not having a plan, it's like going on a road trip without a GPS, or even an old-style map. Planning builds confidence, and it's really needed in difficult times. By the way, within our Life Goals Analysis, we stress test for extreme market events, so we've incorporated that downside, or the bad scenarios, in those 500 runs that we produced within the Life Goals Analysis. So you can actually see what bad markets look like to your financial plan, it's built in. Now, if downturns occur close to retirement, this has the most impact, and it's called sequence of returns risk. Identifying poorly constructed portfolios with risks that are not understood until a downturn is also critical. - [Jim] Over the course of the past decade, a lot of folks thought investing in index funds was a plan. I often find myself reminding people that investments that track the S&P 500 index alone are not an investment plan. - [John] Yeah, Jim, I mean, 2019 was a perfect example of that. In 2019, every investor was a hero. They really didn't have to think about markets. As a reminder, in 2019, the S&P 500 up 31% total return, bond market up 9%, and just to put that 9% gain for bonds in perspective, that's a typical year for stocks, and bonds were up by that much, so a 60/40 portfolio in 2019 was up 22%, even the last 40 years, been generally good returns, decades of gains in stocks, just put those numbers in perspective. Last 40 years from 1980 to 2019, stocks were up, on average, 12%, bonds up 7 to 8%, so that 60/40 mix is up roughly 9 or 10%, and so really it's been relatively easy certainly in the last decade, certainly in 2019, but recent events have been a big wake-up call. We also went through a prolonged period between 2011 and really late 2018, before we had any meaningful financial market volatility at all. Now, this year, we've seen quite a bit of volatility, and we expect that volatility to continue for quite some time. So I think if the plan in place was just to wake up everyday and hope the market goes up, which kind of was the case in 2019, people are gonna need to prepare for continued volatility and certainly lower returns in the next decade or so. - [Jim] And that's why your investment policy is so important. There are four things you wanna make sure your investment policy addresses. These include, one, tax efficiency; two, optimizing income and yield; three, risk management; and four, the ability to keep your emotions in check. John, can you walk us through each of these and the value that a disciplined investment policy provides? - [John] Sure, so on taxes, people right now are probably not thinking about their investment-related tax bills. They're more concerned with some of the other issues that we've talked about on the podcast today. But having a disciplined, repeatable plan to identify tax lots in your portfolio, doing routine tax loss harvesting to take advantage of market dips, to lower your investment-related tax bill, and then building tax minimized portfolios are all important things to do, and again, having a repeatable, unemotional process to do that is key. And then if you go down to income and yield, and so the question there is, how can I generate income in and near retirement while preserving principle, and managing inflation, and volatility, and as Dan talked about earlier, that sequence of return risk, those are all key in figuring out how to draw income from your investments. As we talked about earlier, even in our base case, rates are likely to remain low for the next couple of years. In our downside case, rates could remain low for a decade. So having a disciplined, repeatable, unemotional plan to draw income from your investments is key. And then on the risk side, you have to consider many risks when you're investing, and I think the key there is, again, having that disciplined, repeatable process for doing things like strategic asset allocation. You have a lot of choices as an investor, there's probably 50 or 60 asset classes that you could invest in. Okay, then how do you narrow down the 50 or 60 into the 15 or 20 or 25 that you should own? And then from there how do you combine those together to help manage the risk of your portfolios and keep you on track to reach your goals? Once you then have those asset classes that you're going to invest in, how do you access them? Are you gonna do it with an active manager? Are you gonna do it with a passive investment? Some combination of the two? All those things are key to managing risk. And then one final point here on the risk side is rebalancing. Earlier this year in March, there was a tremendous opportunity to rebalance your portfolios after that big drop down in equity prices, between the middle of February and the middle March equity prices fell 34, 35%. What were you doing then? Were you selling out of stocks because you're afraid they're gonna go lower, or were you doing rebalancing in a more nuanced way where you were buying the things that went down and selling the things that went up, to keep your particular target allocation on track? And then finally, having an ongoing process to monitor and review everything you do on the investment side is key to managing risk. And then finally, kinda wrapping up on the emotional taming side, what you really wanna do on investments is to help reduce poor decision-making. In order to do that, you have to remove the emotion as much as you can from your investment decision-making. It's difficult to do, but having that unemotional, repeatable process in place before a crisis hits is key. - [Jim] That is such an important point, John. While we continue to grapple with the current crisis, we don't know when the next crisis may hit. That goes back to Dan's point about stress testing your plan for extreme events. That provides a level of confidence that no matter what happens you have a plan to deal with it. A number of people are facing that challenge right now, if they've lost their jobs, or have been furloughed. Now, Dan, what should people facing a job loss be thinking about right now? - [Dan] Jim, it's easier for people to feel out of control in that situation, so control what you can control by taking action now. Review your cash flow, what's coming in and out. Understand what's in your emergency fund to give you that cash reserve. Get out there and apply for unemployment benefits right away, including that extra $600, and other potential benefits. Also, understand and leverage your spouse's income, or severance payments, if they apply to you. Reduce or eliminate non-essential expenses, start with the big expenses first. Contact your mortgage lender, student loan provider, and other debt servicers for options for relief. Know your options for COVID-19 retirement plan loans and withdrawals, but only use this as a last resort and not a first because big transactions can greatly impact your long-term plan. - [Jim] Now, Dan, on this same topic, a lot of employers are, right now, introducing early retirement packages, so what about people close to retirement who are considering one of these early retirement packages? - [Dan] Jim, so important, before deciding, update your Life Goals Analysis plan with your advisor as soon as possible. This will help you understand the impact to Social Security and the funding of your goals. Also, it's so important to understand, what will your next chapter look like? What are you going to do? How are you going to spend your time? What do you love to do? Also, understand healthcare costs. These can be big and that's why we include them in your Life Goals Analysis so you can see how they impact your retirement planning. - [Jim] Thank you, Dan, and thank you, John. We've covered a lot of information today in our discussion. To recap, we discussed the likely upside and downside scenarios for the markets and the economy in the months ahead. The importance of comprehensive planning to help protect against future uncertainty, and how your advisor can help you adjust your plan to stay on course in any economic environment. If you have questions about any of the information we covered today, be sure to contact your TIAA wealth advisor to schedule time to talk about your needs. Thank you for listening in, and for spending a few minutes of your time with us today. Have a great day, everyone. [END] Jim Daniello is a Registered Representative of TIAA-CREF Individual & Institutional Services, LLC. This material is for informational or educational purposes only and does not constitute investment advice under any securities laws. This material does not take into account any specific objectives or circumstances of any particular investor, or suggest any specific course of action. Please consult your Financial or Tax professional before taking any action. 2020 and prior years. Teachers Insurance and Annuity Association of America College Retirement Equities Fund. New York, NY 10017 1206825

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