If behavioral economists and psychologists wanted to conduct an experiment into consumer savings and spending patterns under extreme constraints, the last three months provided a convenient laboratory. Deprived of many of their most familiar spending activities, Americans got a chance to think long and hard about the various priorities in their lives.
April’s 33% savings rate may be a statistical anomaly subject to revisions. However, professional observers like PGIM Fixed Income’s chief global economist Nathan Sheets expect the rate to remain in the double digits for the remainder of 2020. Other economists think that savings will remain at elevated levels for several years.
Time and money, in that order, are often clients’ most precious resources. As the nation gradually emerges from lockdown, advisors are counseling anxious clients, some of whom have seen their lives upended and others who are considering major changes in their lifestyles, to use the experience as one of reflection.
In March and April, Americans had long hours to revisit the alignment between their desired and actual lifestyles. Where they want to live and work, how they invest and who they want to spend the rest of their lives with are all on the table.
“It’s been a great way for clients to learn how little it takes to get by, even without running the numbers,” says Lisa Brown, chief strategy officer of Brightworth in Atlanta. “When they saw how much money was left in the bank, it was eye-opening.”
Different clients faced disparate issues. Corporate executives wondered if a comfortable retirement was suddenly in jeopardy, while some small business owners worried about survival, according to Brown.
Changing Careers And Lifestyles
One of her clients had talked for several years about leaving corporate America and taking a serious pay cut to join a non-profit. After simulating the two options on a Monte Carlo program, Brown told him that the net result of switching careers meant the chances of his portfolio surviving into his 90s fell from 98% to 96%.
Small business owners, who provide 49% of all private-sector employment, should be so lucky. Many companies in the retail and hospitality sectors have been deemed non-essential. Some won’t reopen. Consumers have been forced to purchase necessities at Amazon, Walmart, Costco, Target and other retail giants.
Justified or not, the government-mandated shutdown of many small businesses that were viable in the pre-pandemic world could translate into the most massive transfer of wealth in modern history from Mom and Pop businesses to much larger companies. Sadly, several advisors report helping clients liquidate their firms and, in some cases, referring them to bankruptcy attorneys.
Resentment over the lockdown is likely to outlive the virus. The finger of blame will be pointed in many directions.
Consumers over 60 years old are likely to be especially cautious about going out and spending until there is a vaccine or a potent anti-viral drug. “The tendency is to blame government for shutting down the economy but, in many cases, private individuals shut down the economy themselves,” says David Kelly, chief global strategist at J.P. Morgan Asset Management. “A large chunk of the population is genuinely scared of this disease.”
Chapter 11 attorneys won’t be the only beneficiaries. Divorce lawyers in Wuhan, China, did very well after the quarantine was lifted, PGIM’s Sheets says. From a technical standpoint, this recession may be over, as it appears the economy bottomed in mid-April. But it’s hard to see the road back.
Most of the employment damage since March has occurred in vulnerable low-wage sectors. Inequality, as shown by both the virus and the preponderance of layoffs, has been exacerbated. However, some observers like DoubleLine CEO Jeffrey Gundlach expect that as big companies start the long climb back they are going to evaluate whether white-collar workers earning over $100,000 are pulling their weight.
Companies inevitably will re-evaluate their workforces as a new abnormal takes hold. Delta Air Lines recently offered early retirement packages to all its employees. If moves like these gain momentum, a wave of white-collar layoffs could further slow the recovery—and affect many advisors’ businesses.
But there could be a counteracting trend if the plentiful supply of global labor quickly becomes a shortage, according to Karen Harris, managing director of Bain & Co.’s global macro trends group. The labor force is “dramatically shrinking in China and Germany,” she said at John Mauldin’s Strategic Investment Conference in May. In America, the baby boom generation will move into retirement “en masse” in the next decade.
Where To Live
One offshoot of the pandemic is that more people are reconsidering where they want to live. Going into the office every day is no longer viewed as a necessity. So-called Tier 1 mega-cities like New York, Chicago, Houston and Los Angeles are losing some of their luster, Harris observed. Indeed, the appeal of paying a premium to live in these cities disappears when the superior restaurants, entertainment, museums and other cultural activities go away and someone is confined to a relatively small apartment.
All this comes at a time when many baby boomers are becoming empty nesters and already considering downsizing. With interest rates near historic lows, many clients also are asking advisors about second homes.
Many advisors consider multiple dwellings a recipe for trouble. In his book Retirement Fail, Sullivan Bruyette Speros & Blayney co-CEO Greg Sullivan cites second homes as one of the three primary reasons clients fail at retirement. The other two culprits are grey divorce, which has doubled since 2000, and adult children living at home, whom clients are supporting perhaps permanently. Sullivan has noted that all too often second homes are located on waterfront property, areas subjected to regular climate catastrophes that can cause extreme damage.
Brightworth’s Brown shares his view, noting that a second home takes a client’s biggest single expense and multiplies it times two. All too often, it turns out that a few family members can’t make it to those long-anticipated family reunions.
Then there’s the timing of the purchase, often in a bull market when clients are flush. “Many people [end up] feeling guilty about not using it and selling it at a lower price,” Brown says.
Brown and Sullivan aren’t alone. Both Ross Levin of Accredited Investors and Harold Evensky of Evensky & Katz/Foldes Financial think second homes could take a serious hit in the post-pandemic world.
But it’s the client’s money and the client’s choice. In recent months, Brown has been talking with a number of clients in the congested Atlanta suburbs eyeing a second home in North Carolina’s scenic Smoky Mountains. Other advisors are hearing clients contemplate total relocation.
How it will all play out remains to be seen. The New York Post recently reported that several of the Big Apple’s diaspora were already suffering survivor’s guilt—and they’d only been gone for two months.
Implications Of Zero Interest Rates
Record low interest rates, combined with a desired change in lifestyle, make moving or purchasing a second home a seemingly attractive proposition. But ask a bond market professional about this choice and many would tell clients there is no need to rush.
Colin Robertson, executive vice president and head of fixed income at Northern Trust Asset Management, believes the Federal Reserve could keep short-term interest rates near zero for five years, possibly even 10 years.
Ten years is a long time about which to make predictions. But Robertson’s view is shared by Lacy Hunt, former Fed governor and current executive vice president at Hoisington Investment Management, and many others.
That’s because economic growth and inflation both were muted even before the pandemic surfaced. An aging population and weak economic growth have been conspiring to keep interest rates very low for the last decade even as central banks around the world tried to rekindle inflation. All of this causes pain for retirees, banks, pensions and insurance companies.
However, central banks seem far more concerned about deflation and, after the pandemic, depression-level unemployment numbers. “The Fed learned its lessons from the financial crisis when they tried to thread the needle,” Robertson says. “This time they took a bazooka to the gunfight.”
More ominously, the Fed is discussing yield curve control, or using their own reserves to manipulate the market and bring down yields at the long end of the curve. “Right or wrong, investors are counting on the Fed to come into the market if there is a second wave in the fall,” Robertson argues.
JP Morgan’s Kelly questions how far the Fed can effectively go. “There is a limit to their ability to hold down the long end of the curve,” he says.
President Trump, no fan of Fed chairman Jay Powell, has called for negative interest rates. Most bond market professionals don’t like the idea, believing it would create all sorts of distortions.
The experience of both the Bank of Japan and the European Central Bank with zero interest rates isn’t encouraging. Sheets compares both to the Hotel California. “Central banks can check in but they can’t check out,” he says.
Future Fed policy hinges in large part upon the upcoming presidential election.
Kelly thinks that if President Trump is re-elected he will fire Jay Powell in favor of a true soft money advocate. That’s in spite of the Fed’s move to increase its balance sheet to $11 trillion by year-end.
If former Vice President Joe Biden wins, the Fed will try to reassert its independence. Biden has also said he would raise income taxes on people who earn over $400,000 annually. Kelly notes that since the top 10% of earners account for virtually all the savings in America, a Biden administration could ultimately result in a lower savings rate.
How Clients Spend And Invest
The prospect of very low interest rates for the next decade will leave retirees challenged for income. How America spends in the new abnormal may partially dictate how it should invest. Early evidence from May unemployment and retail sales results suggests that some type of V-shaped recovery is still a possibility.
Indeed, the 17.7% jump in May retail sales implies that pent-up demand is already building. “We’re social beings. It will be hard to stop people from partying when this is over,” Kelly says. “I can’t wait to jump on a plane and go to a Broadway play. By late 2021 and early 2022, the economy will be growing very rapidly.”
But Kelly also acknowledges that inequality could be a serious constraint on the recovery. “In the last expansion, poorer people couldn’t borrow and wealthy people wouldn’t spend it,” he says.
When it comes to investing, Sheets sees two sectors that are emerging as clear winners. “On the one hand, technology will become more central and critical to our future,” he says. Still, there remains “enormous uncertainty about how these companies should be valued.”
Sheets also thinks the U.S. could enjoy a productivity renaissance. For the last 20 years, it’s been largely absent. He believes that’s because technology wasn’t diffusing itself through the economy the way it has been during the pandemic.
If people decide to permanently spend more time working at home, consumer staples should benefit. Some packaged goods companies are enjoying unit sales gains they haven’t seen for decades, thanks to housebound consumers. For retirees, many of these businesses pay generous dividends.
On the downside, Sheets thinks that more people will become more aware of safe health practices and virus transmission among large groups. That could inflict long-term damage on industries that rely on face-to-face contact.
The most obvious solution to the retirement income problem is to work longer. Surveys suggest many Americans want to, but research by Morningstar’s David Blanchett revealed that’s not always an option. The average American retires at 63.
Kelly believes clients’ fixation on avoidance of principal withdrawal is misplaced. “Don’t assume you have [to be] paid by dividends and coupons,” he says. “There is nothing wrong with systematic withdrawals and annuities when asset prices are so high.”