We always exist in a world of contrasts. It just appears to be the case that the extremes are wider apart than what has been in our collective experience in the last fifty years. As investors, we lament the level of interest rates available in the market. The only way to pick up yield is to go down in credit quality. At the same time, one of the hottest investments around is gold that does not even pay any dividend. Of course, gold is viewed as a sort of universal hedge. But, the preference for gold may change very quickly. Viewing other asset classes for what they are helps us to appreciate the value in municipals.
Some investors still agree that municipals provide value in this environment. All we need to do is to look at the positive weekly inflows to the mutual funds for evidence. Low rates are not exciting. We should have the exciting parts of our portfolios invested in other markets if appropriate.
The economic outlook is encountering turbulence once again. We have a long way to go until the unemployment rates descends appreciably and remains there. Most pundits believe we are looking at next year for a reasonable timeframe. But how do we persist in the meantime?
The major players on the stage are fiscal and monetary policy. Right now, the two camps in Congress are so far apart that the process of reconciliation is almost an imponderable. Last time I checked, the chasm between $3.5 Trillion and $1 Trillion is wide.
Reducing the Covid-19 additional unemployment assistance of $600 to $200 per week will have an impact. In common terms, the former is enough to pay the rent or close to it in a fair number of locations while the latter might be enough for two trips to the grocery store. Pegging UI to 70% of pre-pandemic compensation appears to be most unwieldy and would expose state governments to making many calculations that they may be ill equipped to do.
The lack of direct aid to state and local governments is very unsettling. I appreciate the fact that the Republican proposal to dedicate a $105 billion to education is significant but it does come with strings attached. Opening schools should really be in the domain of a local decision. We all appreciate the stakes. We want parents and guardians to be able to go back to work. There may be some compromises to come in this regard. Unfortunately, facilities cannot be reconfigured so quickly to allow for social distancing. Cooling temperatures will also be a factor going into the Fall.
As I have stated before, I do not see it as a problem to carve out the use of federal aid to pay pensions if that is the price of receiving the aid. A new additional restrain of not refilling rainy day funds or fund balances appears to me to be a bit stringent. Estimating revenues and expenses in this scenario is more informed art than science. There needs to be a bit of a buffer to ward against the unanticipated. Are governments just supposed to run at breakeven. That prospect also appears to be a bit perilous to me. Most governments look to maintain an RDF or fund balance of about 5% to 10%. One month’s expenses would be ideal but is not always possible depending on the context and the disposition of the electorate. Need I mention that such a balance may be liquidated very rapidly in a downdraft.
It has also been mentioned on numerous occasions that not all the funds that have been provided in earlier phases have been spent. More flexibility in that regard would certainly be welcome but it still does not counter the consideration of a sharp decline in the revenue base for too long.
The other choices to balance budgets will be to raise taxes; resort to some combination of furloughs, early retirements, and layoffs; and to incur more debt.
Out of the four factors that are considered in a GO rating, the debt level is often the weakest variable in the outcome. Given the prevailing circumstances and where rates are currently, there will be some more tolerance of rising debt levels. However, there will be some upper bounds on this consideration.
Downsizing the labor force is always a serious consideration that will influence service delivery. Some services are mandated by law and are difficult to trim in an efficient manner. Other services that are not mandated by law but are subject to management discretion will often bear the brunt of the cuts.
Raising taxes in a downdraft should be a last resort since it is usually not the best remedy. Acting on taxes is also sensitive to the political cycle that is in the forefront this year in most locales.
I have stated in prior articles that at least $250 billion should be provided to states and localities. The $1 trillion mark will be most difficult if not attainable in this environment given the relative stances of the parties.
We have precious few days to wrestle some compromise among all the interests. Good luck to us all. We will not have too much financial feedback before the decision needs to be made given most audits will become available in the September to January timeframe. Most budgets that have been approved starting July 1 had many assumptions about the level of federal aid that was estimated to be received. At a minimum, we look forward to the many mid-year adjustments that will be necessary if some reasonable level of state and federal assistance is not forthcoming.
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