Paradigm Financial Advisors: Market Update March 26, 2020
The Coronavirus selloff has been one of the fastest and steepest drops in history for the stock market and it has created a lot of fear and anxiety for investors. However, we have weathered many storms together over the past 25 years and we are confident that our disciplined investment process will help us successfully navigate this crisis also. It was a relief for all of us to see the market bounce back over the past two days on the news that Congress has passed the new CARE Act that will inject over $2 trillion into the U.S. economy to offset the negative impact of the Coronavirus. The S&P 500 Index has risen approximately 16% over the past two days, but it is still down 18.6% year to date.
Short sellers and computerized trading have distorted stock prices and the stock market is at one of the most oversold levels in history. We expect stock prices to make up a lot of lost ground quickly when the short sellers have to start covering their positions. One of the reasons that we have been able to recover from selloffs like this in the past is due to the fact that we have not had to sell stocks while the market is down because we keep enough cash and short term bond funds in our client’s portfolios to pay for their living expenses.
U.S. Coronavirus Cases
On March 25, 2020, the CDC reported 51,914 confirmed cases of Coronavirus in the U.S. and the total number of deaths was 673. New York accounts for more than 60% of the cases in the U.S. Health officials are ramping up testing to identify people who are infected so that they can make sure that they do not infect anyone else. New York has ordered everyone to shelter in place and that will help curb the number of new cases. The media has created a public panic with their doomsday predictions that 150 million people in the U.S. are going to be infected with the Coronavirus and 5 million people in our country could die of the Coronavirus. However, these dire predictions are not supported by the data that shows the total number of cases in the U.S. is still less than 100,000 and there have been less than 2,000 deaths!
Michael Levitt, a Stanford biophysicist and Nobel laureate, has been analyzing the number of Coronavirus cases in China and South Korea since the outbreak began in January and he was the only medical expert that correctly predicted that the number of Coronavirus cases would plateau in both countries in March. Levitt has been studying the real‐time data in the U.S. and he predicts that the number of U.S. Coronavirus cases will plateau in April. Levitt said that even though the number of cases in New York continues to rise each day, he predicts the percentage increase each day is going continue to fall in New York and around the rest of the country over the next 3 to 4 weeks. Levitt warned that the media is causing unnecessary panic and he says that their dire predictions are not possible based on the actual data that he has been studying. Levitt predicts that the mortality rate of the Coronavirus will keep falling as more younger people become infected and it could end up being as low as .50%, which is a lot closer to the mortality rate of the Flu. Levitt believes the number of Coronavirus related deaths to be significantly lower than the 60,000 Flu related deaths that occur in the U.S. each year.
The Coronavirus crisis began in January when the CDC & WHO issued a warning that the Coronavirus outbreak had turned into a pandemic and they said the mortality rate was going to be as high as 5%. As the Coronavirus continued to spread the CDC & WHO urged government officials around the globe to implement social distancing measures and shut down restaurants, bars and other businesses to reduce the spread of the Coronavirus. Less than 10% of Coronavirus patients need to be hospitalized and most of them have symptoms that are very similar to the Flu. The total number of Coronavirus related deaths in the U.S. as of today (March 26, 2020) is 1,063. The mortality rate has fallen to around 1% in the U.S. and it will continue to drop as more younger people get infected. Doctors across the country are starting to use a number of existing drugs to treat severely sick patients and some medical experts believe that these treatments could help reduce the mortality rate to less than a half a percent (.50%) in the U.S.
When the containment measures were implemented, the primary goals was to reduce the number of deaths. Many states have shut down businesses and have ordered everyone to stay home even though they only have a small number of Coronavirus cases. There will be a lot of second guessing about the enormous cost of shutting down businesses if the number of deaths from the Coronavirus are significantly less than the 60,000 people that die of the Flu every year in the U.S. Here is a summary of the latest data on the number of cases of the Flu in the U.S. over the past four months:
- 44 million people in the U.S. have been infected with the Flu over the past four months
- 350,000 new cases of the Flu occur every day in the U.S.
- 500,000 people have been hospitalized over the past four months in the U.S.
- 39,000 people have died over the past four months because of the Flu
- 300 people have died every day over the past four months because of the Flu
Missouri Coronavirus Cases: As of yesterday morning, there were 255 cases of the Coronavirus in Missouri. The chart below shows the breakdown of where the Coronavirus cases are located.
Worldwide Coronavirus Cases: The total number of Coronavirus cases worldwide as of March 20 was just over 300,000 and the total number of deaths was estimated to be 209,839. For the first time since January, China reported that they did not have any new cases of the Coronavirus from community spreading for two days in a row. The only new cases in China were 28 people that tested positive at the airport upon returning to China from other countries and they will be quarantined for the next 14 days. As of March 25, Italy had 69,176 cases of Coronavirus and a reported 6,820 deaths. The public healthcare system in Italy has been overloaded due to the large number of new Coronavirus cases. Italy issued a police enforced shelter in place order last week because many people were not following the quarantine recommendations. Italy’s three day average growth rate of daily new Coronavirus cases slowed to a new low of 8%, down from 40% at the end of February. The absolute number of new cases of 5,200 is down from a peak of 6,600 on Saturday.
Doctors are Using Existing Drugs to Treat Coronavirus
The Wall Street Journal is reporting that doctors across the country are using a number of existing drugs that help speed up the recovery time and reduce the risk of death for seriously ill Coronavirus patients. The existing drugs that doctors are using include the following: Remdesivir is a drug made by Gilead Sciences that was originally developed to fight the Ebola virus. The New England Journal of Medicine reported in February that doctors at Providence Hospital in Washington successfully used.
Remdesivir to treat a 35‐year‐old Coronavirus patient who was admitted to the hospital shortly after he returned from visiting his family in Wuhan, China, where the Coronavirus outbreak began. Initially, the patient only exhibited mild symptoms that included a cough and fever, but after a few days he got pneumonia and was critically ill. His doctors contacted the CDC and they told them that Chinese doctors were using Remdesivir to treat Coronavirus patients with pneumonia. Desperate to save the patient’s life, the doctors administered Remdesivir to the patient and he made a remarkable recovery the next day and was discharged from the hospital two days later.
There are a number of cases in the U.S. and in other countries where doctors have had success using Remdesivir. Doctors in Milan, Italy successfully treated a 79‐year‐old patient with Remdesivir and it was also used successfully on 14 Americans who were seriously ill after being infected with the Coronavirus aboard the Dimond Princess cruise ship.
Chloroquine phosphate is a Malaria drug that has been around for over 40 years and it is shown to have no adverse side effects. Chinese medical experts conducted clinical trials on Chloroquine phosphate and they found that it speeds up recovery time and helps prevent pneumonia from developing in Coronavirus patients. The Chinese studies found that drug was successful at treating Coronavirus patients as an anti‐viral and anti‐inflammatory. China’s National Health Commission approved the use of Chloroquine phosphate for treatment of Coronavirus patients in February and doctors in China have reported that they have successfully treated thousands of patients with the drug.
Hydroxychloroquine and azithromycin: The International Journal of Antimicrobial Agents recently published the results of a clinical trial conducted in France that showed a combination of hydroxychloroquine and azithromycin (an antibiotic known as Z‐Pak) was successful at treating Coronavirus patients. The French study was very promising because it showed that 100% of patients who received the combination of the two drugs were cured of the Coronavirus after 6 days of treatment. The study showed that the combination of the two drugs reduces the time period which a patient can spread the Coronavirus. The French study also showed that 57.1% of patients that were treated with hydroxychloroquine alone were cured and only 12.5% of the patients that did not receive either drug recovered. Chinese health officials have already started a new clinical trial on treating Coronavirus patients with hydroxychloroquine and azithromycin.
Coronavirus Vaccine Trials Have Begun
Chinese researchers were able to create the genetic sequence of the Coronavirus and they gave it to the rest of the world in mid‐January. Moderna Therapeutics created a Coronavirus vaccine on February 7 and submitted a request to the FDA to begin human testing on February 26. (This is a remarkable achievement! To develop a vaccine, complete preliminary testing and apply to the FDA in two months is nearly unprecedented.) The FDA approved Moderna’s request in early March and Moderna started their human trials last week. The Moderna trial includes 45 volunteers who have not been infected. If the vaccine proves to be effective and the initial volunteers don’t develop any severe side effects, then Moderna will conduct a much larger human trial on thousands of volunteers. Once the vaccine is approved, Moderna can produce millions of doses of the vaccine in a fraction of the time that it used to take because they have developed a new method to make vaccines which does not require growing huge amounts of the virus, which takes often takes several months. Moderna creates a genetic form of the genome of the virus and puts it in the vaccine, after it is injected into people, their cells process it so immune cells can recognize it and target it for destruction. There are several other clinical trials that have already started on a potential vaccine for the Coronavirus and the President and his team is working with the FDA to try to speed up the process.
Stock Market Update
The S&P 500 Index bounced back by over 15% over the past two days but it is still down 18.6% year to date. The Nasdaq is down 13.1% year to date. The market has turned around over the past two days on the news that Congress has passed the new CARE Act that will inject over $2 trillion into the U.S. economy to offset the negative impact of shutting down a large percentage of the U.S. economy to try to slow the spread of the Coronavirus. March has been one of the most volatile time periods in history and there have been 14 days this month where the S&P 500 Index has rose or fell by over 4.0%.
Stock Market Volatility Reaches Record Levels
Short Selling has Distorted Stock Prices
The Coronavirus selloff has been driven primarily by short selling initiated by computerized trading programs that trigger an enormous volume of sell orders each time the market hits another technical level. However, there is a silver lining to this because the same computerized trading programs will trigger massive short covering on the way back up. Short sellers are going to have to buy $30 billion in stocks to cover every 1% rise in the stock market and that is why we expect the market to make up a lot of lost ground very quickly. Short sellers typically exit their short trades and start buying stocks before the crisis is resolved and that is why we continue to recommend that our clients stay invested!
Stocks Have Recovered Within 60 Days After Past Outbreaks
On Tuesday, we had the first 90% up day since January 4, 2019. A 90% up day is when 90% of the stocks in the S&P 500 finish higher and 90% of the volume was buying stocks. Historically, 90% days have been a reliable indicator that the market has bottomed. The S&P 500 has average returns after a 90% up day as follows:
- The S&P 500 has risen 73% of the time during the next 20 days
- The S&P 500 has risen 80% of the time over the next 60 days
- The S&P 500 has risen 90% up the time over the next 90 days
Investor sentiment has fallen dramatically in March and it hit the lowest level in almost a decade last week. Investor sentiment is one of the most consistent indicators for determining the future direction of the stock market. The stock market has bounced back 76% of the time after the bearish sentiment index has hit 50 in the past and the average return during the following 60 days has been over 20%.
Bearish Sentiment Hits Highest Level Since 2008 as of March 23, 2020
Companies in the Technology, Staples, Communications and Health Care sectors have outperformed the S&P 500 during the Coronavirus selloff. Amazon, Apple, Google, Netflix, Adobe, Facebook and several other companies that many of our clients own in their portfolios have outperformed because their businesses are not going to be impacted by the Coronavirus as much as other U.S. companies.
APPLE has been at the epicenter of the Coronavirus crisis because one of their biggest factories is in Wuhan, China. Apple’s earnings have been revised down by approximately 7% to reflect the potential loss of sales from all of their U.S. stores for 30 days. At the beginning of the year we were forecasting that Apple would earn $13.50 per share and our revised estimate is $12.50. Apple is going to see sales drop in the first half of the year because of the shutdowns but they expect to still be able to roll out their 5G iPhone in September.
AMAZON is benefiting from the closure of brick & mortar stores all over the country and we have increased our earnings forecast and expect Amazon to grow earnings by 24% in 2020. Amazon announced that they are going to hire an additional 100,000 full and part‐time employees in the U.S. to meet the surge in demand. Amazon revenue will be significantly higher in Q1 and Q2 because a lot of people who are working/shopping from home are spending a lot of time shopping online.
GOOGLE is reporting that search volume has increased dramatically because people are working from home and the increased search revenue will help offset lower ad spending by travel companies. Google has ramped up their efforts in shopping and their revenue from product sales will get a boost from people working/shopping at home. We have kept our forecast for Google the same: revenue of $188 billion and earnings per share of $54.25, which equates to 15% EPS growth in 2020.
ADOBE was one of the first companies to report Q1 earnings because their fiscal year ends in February. Adobe reported 33% EPS growth and 19% revenue growth. Adobe said they have not seen any material impact from the Coronavirus through the first two weeks of March and they kept their full‐year guidance the same, which equates to 27% EPS growth.
NIKE reported earnings yesterday which were much better than expected and they proved that the impact of the Coronavirus may not be as bad as the doomsday predictions. Nike reported earnings per share of $0.53 for the quarter, which was significantly higher than consensus estimates of $0.25 per share. Nike’s U.S. sales rose 4.4% over the past three months. The most surprising part of their earnings report was that sales in China only fell 5.2% during the peak of the Coronavirus outbreak in China, compared to the 12% decline that analysts expected.
Online sales in China rose 30% compared to the same quarter last year and that helped offset the lost sales from closing 85% of Nike stores in China. Nike said that the normalization phase in China is happening faster than they expected and they continue to see traffic increase in their stores every day. Nike also told analysts that their online sales in China have continued to be higher than expected during the past two weeks.
Economic Impact of the Coronavirus Outbreak
Economist have continued to revise their economic outlooks for 2020 and they are expecting to see an unprecedented drop in economic activity due to the closure of a significant portion of the U.S. economy due to containment measures taken to slow the spread of the Coronavirus. Air travel, hotels, live events, and restaurant spending will fall dramatically. Airlines are operating at 50% capacity and all the major sports leagues have postponed their seasons. Cities and states are forcing bars, gyms, and movie theaters to close temporarily, and restaurants are being limited to delivery and takeout business.
Economic activity will be severely impaired in March and April but we expect economic activity to recover during the remainder of the year. The Federal Reserve and Congress are injecting an enormous amount of money into the U.S. economy to stimulate growth and offset the impact of the Coronavirus.
Consumer spending has been incredibly strong and it has fueled the U.S. economic recovery over the past decade. Retail sales increased 4.30% in February, but we expect to see a significant decline in retail spending in March and part of April due to the shutdown. However, there are a number of factors that could reduce the magnitude of the drop in retail sales:
- Many restaurants are allowed to keep their drive thru open and they have been seeing an increase in the number of people using the drive thru.
- Grocery store sales have risen by 300% over the past two weeks vs. the same time period in 2019.
- Online grocery delivery sales have risen over 275% in the past two weeks.
- CVS and other pharmacies say that sales have risen by over 200% thus far in March.
- Walmart, COSCO, Target and other general merchandise stores are reporting that sales have risen over the past two weeks by 20% to 100%.
- Amazon is reporting that sales are up over 25% over the past two weeks because people that are supposed to be working from home are doing a lot of shopping.
Spike in Jobless Claims Should be Temporary
The most recent jobless claims report came out this morning and it showed a staggering 3.3 million people filed claims for unemployment last week as the Coronavirus outbreak has shut down large parts of America’s economy. This was the highest jobless claims number ever reported, the previous record of 695,000 claims filed the week ending October 2, 1982. This is the first economic report that has shown the impact of the containment measures that the U.S. has taken to slow the spread of the Coronavirus. However, the spike in jobless claims and the unemployment rate will be temporary because most of the jobless claims have been filed by people that work at restaurants, bars and other companies in the hospitality industry. The restaurant and hospitality industry accounts for approximately 10% of U.S. jobs. Keep in mind that most of the people that have filed these claims will be going back to work in a couple weeks. Also, Amazon is in the process of hiring 100,000 new employees to help keep up with the surge in new sales. There are a number of other companies, such as Walmart, Target, COSTCO, Grubhub, Instacart, Dominos, Schnucks, Dierbergs and many others, that are all hiring delivery people. The economic stimulus packages that Congress has passed provides forgivable loans and tax credits for businesses only if they do not layoff any employees for at least 8 weeks.
Outlook for the Stock Market
We think we have reached a turning point for the stock market because of the following:
- The containment measures taken in the U.S., Italy and other countries around the world should help slow down the spread of the Coronavirus.
- Doctors are using existing drugs to speed up recovery time and reduce the risk of death for Coronavirus patients.
- The Federal Reserve has cut interest rates to zero and they have expanded their balance sheet to reduce liquidity concerns in the bond market and stabilize the economy.
- Congress just passed a $2 trillion economic stimulus bill that will help offset the negative impact of the Coronavirus outbreak, which will provide $300 billion in forgivable loans to help restaurants, bars and other businesses that have been impacted by the Coronavirus.
- We believe that Congress will follow up with another stimulus bill over the next two months that includes infrastructure investment.
Federal Reserve Monetary Policy Actions
The Federal Reserve has acted quickly in this crisis and they have pledged to do whatever is necessary to help the economy recover from the Coronavirus outbreak and to ensure the stability of the bond market and money markets. The Federal Reserve has cut interest rates to zero and they have implemented monetary policy actions that should help offset the economic impact of the Coronavirus outbreak. Here is a list of the monetary policy actions that the Fed has implemented in the past two weeks:
- On March 3, the Fed cut interest rates by 0.5%. This was the largest interest rate cut since the 2008 financial crisis.
- On March 12, the Fed massively expanded reverse repo operations, adding $1.5 trillion of liquidity to the banking system. The Fed also extended the amount of short‐term loans to banks to keep money market fund prices stable.
- On March 15, the Federal Reserve cut interest rates by a full percentage point to zero and they restarted quantitative easing with the purchase of $500 billion in treasury bonds and $200 billion in mortgage‐backed securities.
- On March 16, the Federal Reserve increased reverse repo operations by another $500 billion to reduce liquidity concerns in the bond market.
- On March 17, the Federal Reserve created a “Commercial Paper Funding Facility,” which allows the Fed to purchase commercial paper and corporate bonds. The President also authorized up to $10 billion from the Treasury to help cover loan losses incurred under this program.
- On March 17, the Federal Reserve also re‐launched the Primary Dealer Credit Facility that will offer short‐term loans to banks secured by collateral such as municipal bonds and corporate debt.
- On March 18, the Federal Reserve announced the Money Market Mutual Fund Liquidity Facility, which is a new program that is designed to reduce liquidity concerns related to money market funds.
IRS Extends Tax Return Deadline by 90 Days
The IRS has extended the tax filing deadline for individuals and corporations for an extra 90 days to July 15, 2020. Taxpayers will also have an extra 90 days to pay their 2019 tax liability and estimated tax payments for the first quarter of 2020. The extension is automatic so taxpayers do not need to file an extension. The IRS notice states that the 90‐day extension for tax payments is available to individuals that owe $1 million or less and to corporations that owe $10 million or less. The IRS is also going to waive interest and penalties for people that are impacted by the Coronavirus outbreak. Missouri, Illinois, and all of the other states are going to extend the due date for filing state tax returns and making tax payments until July 15, 2020 also.
The Family First Coronavirus Response Act (FFCRA)
Congress passed the FFCRA on March 18th and it goes into effect on April 2, 2020.
- The FFCRA extends unemployment benefits, provides free Coronavirus testing and food and medical aid to people impacted by the Coronavirus.
- It also requires business owners to provide employees two weeks of paid leave if they cannot work because they have the Coronavirus or have to care for a family member that has the Coronavirus, as well as two weeks paid leave if the employee is quarantined or if they have to stay home to take care of a child because their school or daycare is closed because of the Coronavirus. Paid leave is limited to a maximum of $511 per day and $5,110 for the two weeks per employee.
- Employees who work part‐time are eligible for paid leave and their pay is based on the average number of hours they worked during the prior six months.
- Business owners will get a tax credit equal to 100% of the amount they pay to employees for paid leave.
- The FFCRA also provides $1 billion emergency grants to states if they have an increase of over 10% in unemployment claims.
- The Act also requires insurance companies to pay 100% of the cost for Coronavirus testing for insureds and their covered dependents, without any deductibles, copayments and coinsurance through December 31, 2020.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act
Congress approved the CARES Act last night and it will inject an additional $2 trillion into the U.S. economy to help offset the impact of the Coronavirus outbreak. The bill is supposed to be approved by the House today or tomorrow. President Donald Trump says he will sign the bill into law immediately following House approval. The CARES Act will provide much‐needed resources to the American people and businesses as we confront the Coronavirus pandemic.
The CARE Act provides the following assistance for individuals and families:
- Recovery rebates for individuals: Recovery checks of up to $1,200 will be put into the hands of most taxpayers, providing cash immediately to individuals and families. Married couples who file a joint return are eligible for up to $2,400. Those amounts are increased by $500 for each child. These checks are reduced for higher income taxpayers and begin phasing out after a single taxpayer has $75,000 in adjusted gross income and $150,000 for joint filers. The IRS will base these amounts on the taxpayer’s 2018 tax return. The rebate amount is reduced by $5 for each $100 a taxpayer’s income exceeds the phase‐out threshold. The amount is completely phased‐out for single taxpayers with incomes exceeding $99,000 and $198,000 for joint filers, again based on the taxpayer’s 2018 tax return.
- Delay of certain deadlines: The bill extends the April 15 filing deadline to July 15, giving individuals more time to file their tax returns given the limitations caused by the Coronavirus emergency. The filing date would be aligned with the extended payment filing date already announced by the Internal Revenue Service. The bill also allows all individuals to postpone estimated tax payments due from the date of enactment until October 15, 2020. There is no cap on the amount of tax payments postponed, and any individual required to make estimated tax payments can take advantage of the postponement. This delay should increase the available cash flow for individuals experiencing cash shortfalls as a result of the Coronavirus.
- Special rules for use of retirement accounts: The bill waives the 10‐percent early withdrawal penalty for distributions up to $100,000 from qualified retirement accounts for Coronavirus-related purposes. Income attributable to such distributions would be subject to tax over three years, and the taxpayer may recontribute the funds to an eligible retirement plan within three years without regard to that year’s cap on contributions. A “coronavirus‐related distribution” is defined as a distribution made to an individual (1) who is diagnosed with Coronavirus, (2) whose spouse or dependent is diagnosed with Coronavirus, or (3) who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, being unable to work due to lack of child care due to Coronavirus, closing or reducing hours of a business owned or operated by the individual due to Coronavirus, or other factors as determined by the Treasury Secretary.
- Allowance of partial above the line deduction for charitable contributions: The bill encourages Americans to contribute to churches and charitable organizations in 2020 by permitting them to deduct up to $300 of cash contributions, whether they itemize their deductions or not.
- Modification of limitation on charitable contributions during 2020: The bill increases the limitations on deductions for charitable contributions by individuals who itemize, as well as corporations. For individuals, the 50‐percent of adjusted gross income limitation is suspended for 2020. For corporations, the 10‐percent limitation is increased to 25 percent of taxable income. This provision also increases the limitation on deductions for contributions of food inventory from 15 percent to 25 percent.
- Expanded unemployment insurance: The bill expands unemployment insurance (“UI”) for workers, including a $600 per week increase in benefits for up to four months and federal funding of UI benefits provided to those not usually eligible for UI, such as the self‐employed, independent contractors, and those with limited work history. The federal government is incentivizing states to repeal any “waiting week” provisions that prevent unemployed workers from getting benefits as soon as they are laid off by fully funding the first week of UI for states that suspend such waiting periods. Additionally, the federal government will fund an additional 13 weeks of unemployment benefits through December 31, 2020 after workers have run out of state unemployment benefits.
The CARES Act also provides the following relief for small business owners:
- Paycheck Protection Program for small businesses: The bill allocates $350 billion to the Paycheck Protection Program, which is meant to help small businesses (fewer than 500 employees) impacted by the pandemic and economic downturn to make payroll and cover other expenses from February 15 to June 30. Notably, small businesses may take out loans up to $10 million—limited to a formula tied to payroll costs—and can cover employees making up to $100,000 per year. Loans may be forgiven if a firm uses the loan for payroll, interest payments on mortgages, rent, and utilities and would be reduced proportionally by any reduction in employees retained compared to the prior year and a 25 percent or greater reduction in employee compensation.
- Delay of estimated tax payments for corporations: The bill allows corporations to postpone estimated tax payments due after the date of enactment until October 15, 2020. There is no cap on the amount of tax payments postponed. This delay will provide critical cash flow to help businesses maintain operations and continue paying employees during the Coronavirus emergency.
- Delay of payment of employer payroll taxes: The bill allows employers and self‐employed individuals to defer payment of the employer share of the Social Security tax they otherwise are responsible for paying to the federal government with respect to their employees. All employers are responsible for paying a 6.2‐percent Social Security tax on employee wages. The provision requires that the deferred employment tax be paid over the following two years, with half of the amount required to be paid by December 31, 2021 and the other half by December 31, 2022.
- Modifications for net operating losses: The bill relaxes the limitations on a company’s use of losses from prior years. NOLs are currently subject to a taxable income limitation, and they cannot be carried back to reduce income in a prior tax year. This provision provides that a loss from 2018, 2019, or 2020 can be carried back five years. The provision also temporarily removes the taxable income limitation to allow an NOL to fully offset income. These changes will allow companies to utilize losses and amend prior years’ returns, which will provide critical cash flow and liquidity during the Coronavirus emergency.
- Modification of limitations on losses for taxpayers other than corporations: The bill modifies the loss limitation applicable to pass‐through businesses and sole proprietors, so they can benefit from the NOL carryback rules described above and access critical cash flow to maintain operations and payroll for their employees.
- Modification of limitation on business interest: The bill temporarily increases the amount of interest expense businesses are allowed to deduct on their tax returns, by increasing the 30 percent limitation to 50 percent of the taxable income for 2019 and 2020. As businesses look to weather the storm of the current crisis, this provision will allow them to increase liquidity with a reduced cost of capital, so that they are able to continue operations and keep employees on payroll.
In addition, the CARES Act allocates $454 billion in emergency lending to businesses, states, and cities through the U.S. Treasury’s Exchange Stabilization Fund. This includes $25 billion in lending for airlines, $4 billion in lending for air cargo firms, and $17 billion in lending for firms deemed critical to U.S. national security. Firms taking loans must not engage in stock buybacks for the duration of the loan plus one year and must retain at least 90 percent of its employment level as of March 24, 2020. Loans also come with terms limiting employee compensation and severance pay for firms taking loans. Emergency lending will be overseen by a Congressional Oversight Commission and a Special Inspector General.
Another $150 billion will be allocated to a Coronavirus Relief Fund for state and city government expenditures incurred due to dealing with the coronavirus public health emergency. The fund would be allocated by population proportions, with a minimum of $1.25 billion for each state.
Fiscal Stimulus has Proven to be Effective in the Past
Studies have shown that the fiscal stimulus measures taken during past recessions have been effective at increasing economic activity and boosting long term economic growth. There are many different ways that the government can inject fiscal stimulus into the economy and the CARE Act is designed to get the most “bang for the buck”. The fiscal multiplier is calculated by determining how much of every dollar spent by the government increases private spending. The fiscal multiplier is higher when fiscal stimulus is implemented in the early stages of an economic downturn than it is during any other time. The fiscal multiplier is also higher when nominal interest rates are low because it is cheaper to finance stimulus. The Congressional Budget Office (“CBO”) did a study of all the various stimulus measures used during the 2008 financial crisis and they found the portion of the fiscal stimulus that went directly to individuals had the highest fiscal multiplier ($1.50 for every $1.00 spent). The CBO study also showed that large fiscal stimulus programs that are implemented during economic downturns in the past have helped reduce the magnitude and duration of the recession and increased long term economic growth. The study found the American Recovery and Reinvestment Act (ARRA) that was passed in 2009 increased GDP by over 3.5% in 2010 and it helped lower the unemployment rate by 1.8%. The study also found that the cost of the ARRA was offset by the increased tax revenue that was generated over the next five years.
It has been a big relief for all of us to see the market bounce back over the last few days, but there will still be some volatile days ahead because of the uncertainty related to the Coronavirus and the economy. The stock market should continue to make up lost ground as investors start to realize that the doomsday scenarios that the media has been perpetuating are not going to happen. The economic impact of the Coronavirus will be severe in March and April but we believe pent up demand and the massive fiscal stimulus programs passed by Congress will help economic activity recover quickly during the remainder of the year. We will continue to look for opportunities to make changes in your portfolio and positions that should outperform the market going forward. We are committed to helping you navigate this crisis successfully. Thank you for the trust and confidence that you have placed in all of us at PFA.