Highlights:
· The Fed, Treasury and White House all seem to have a common goal of maintaining or implementing policies that result in full employment and wage growth.
· There have been some recent hiccups on both the vaccination and Covid prevention fronts, but the worst of the pandemic seems to be in the rear view mirror and a return to normal life is hopefully imminent.
· Higher taxes to deal with the debt being issued to confront the pandemic seem inevitable, but this is a cycle economies have been through before.
Commentary:
“We feel like we’re at a place where the economy’s about to start growing much more quickly and job creation coming in much more quickly…I’d say that we and a lot of private-sector forecasters see strong growth and strong job creation starting right now. So really, the outlook has brightened substantially.”
-Federal Reserve Chair Jerome Powell
The global economy continued to recover in the first quarter of the year, led by record U.S. retail sales, strong global trade, robust job creation and a jump in inflation. Ultra-easy monetary policies and unprecedented stimulus are now being complemented by a broad vaccine distribution campaign to get consumers out of their homes and spending money. Armed with a year’s worth of pent-up demand, and many with stimulus money to boot, consumers are looking to make up for lost time (and spending).
As vaccination rates and economic activity rise along with the temperature outside, many of us are feeling more optimistic than we have in over a year. Nevertheless, we are not out of the woods yet. As of the writing of this report, there is a spike in Covid-19 cases due to the aftermath of spring break, states lifting mandates (by all accounts) prematurely, new variants of the virus, and concerns about blood clots arising from the Johnson & Johnson and AstraZeneca vaccines jeopardizing inoculation campaigns around the world. We are still months away from reaching so-called herd immunity, and even then, most medical experts agree that coronaviruses are here to stay for the foreseeable future, much like the seasonal flu. Hopefully, continued development of vaccines should make future coronaviruses more of a normal year-to-year virus and not a deadly pandemic. Further, governmental units throughout the U.S as well as throughout the world should be able to perform a post-mortem on their responses to the virus over the past year and develop improvements to mitigate the toll such pandemics take on the health care system and the economy.
The new Biden administration delivered two massive stimulus programs for the economy in its first quarter in the White House. The first was $1.9 trillion in additional fiscal stimulus passed in March. The second is a proposed infrastructure plan valued at over $2 trillion that is gaining broad democratic support.
On the stimulus front, approximately half of the additional stimulus was in the form of direct cash payments, including a third round of direct payments to lower and middle income taxpayers. While it won’t be clear for some time how much of this stimulus money will find its way into the economy, strong retail sales would seem to indicate these payments have been a significant tailwind for consumer spending. The other half of the stimulus was aid to state and local governments for schools and coronavirus testing and vaccination.
The proposed infrastructure package is still in the early stages, but the preliminary prognosis is that President Biden has a good chance of getting the majority of what he wants. This is because the majority in Congress is generally in favor of a package that is intended to bring high paying, sustainable jobs, new roads, bridges, broadband, water pipes and green energy projects across the country. The downside to the proposed plan is that it seems almost a certainty that the administration will seek higher taxes on corporations, higher earners and large estates to pay for the infrastructure package.
The massive price tag of this stimulus bill reflects the fact that President Biden does not want to repeat the mistake of the stimulus bill former President Barack Obama signed shortly after taking office in 2009. In hindsight, many economists now believe that bill was too small to prevent a sluggish recovery. Obama was hardly alone in being too optimistic about the economy. A recurring theme of the 21st century to date has been policymakers believing the economy was stronger than it actually was, and doing too little to stimulate growth out of fear that an overheated economy might spark inflation. Thus, Biden is erring on the side of aggressiveness in an attempt to return the economy to full employment and spur strong wage growth. He believes the benefit of full employment justifies the risk of inflation and the Fed having to raise interest rates. Or as Heather Boushey, a member of Biden’s Council of Economic Advisers, said, “The cost of inaction far outweighs the costs of perhaps doing a little bit too much.”
Despite rising inflation, Fed Chairman Powell continues to reiterate to the market that there will be no near-term interest rate increases, and he plans to let inflation run beyond the Fed’s 2% target even when the economy surpasses traditional measures of full employment and price stability. This is music to the ears of new Treasury secretary Janet Yellen who is relying on interest rates remaining low for the foreseeable future to enable more affordable short-term borrowing to help the economy, even without concrete plans to pay it back.
The level of debt being incurred in an attempt to mitigate the economic fallout from the pandemic is unprecedented with perhaps the exception of world wars. It also would not be a surprise if it were expanded further in the near future. It is the opinion of most economists that this expenditure is necessary, however, the ending level of debt will still need to be dealt with eventually. We believe that the longer-term impact will be an impediment to economic growth. Nevertheless, given that most developed economies have engaged in such borrowings, we see the risk more as muted growth rather than inflation. This is because all debt will eventually need to be addressed and that usually is in the form of higher taxes. Those higher taxes will impede consumer spending and/or corporate capital spending.
This is a cycle that has been seen before in many economies over many years. After the taxes are increased and the fiscal condition improves, the focus is likely to come back to growth. This can take several years and we concede is an oversimplification as there are always a number of external conditions that arise during these periods. But, this general cycle has applied to capitalistic economies across the globe for many years, and we do not believe there is any efficient way to hide from or time one’s way around it. Such efforts are likely to prove to be costly, value-losing propositions. Instead, the investment policy we suggest embraces the risk in a prudent and balanced fashion. There will be volatility along the way, but the policy allows you the time to ride out these inevitable periods and achieve a return to compensate you for the risks assumed.
In the meantime, we are currently in the midst of a cycle in which equities have already priced in the fact that the economy is likely to grow for the next several years. This is at once both a source of risk (from a valuation perspective) and encouraging (from a growth perspective). The equity market recovery seen over the last year has been a relatively smooth ride up to this point, but as with all cycles, it is a matter of when, not if, volatility returns. We will leave you with an anecdote by Morgan Housel, author of the highly recommended book The Psychology of Money, which we think addresses why equity returns and volatility go hand in hand:
“If returns came at predictable times there would be no risk, because you could just show up, collect the prize, and go home. If there’s no risk, investors will bid up the price of an asset until there’s no reward, because free money on the sidewalk is always picked up. Then, once there’s no reward, the people who show up to collect their predictable prize realize they’ve been stiffed, so they get mad and storm off and the asset price falls. Which is to say: If markets weren’t volatile, prices would rise until volatility is triggered. Which is why there’s volatility, and always will be. As certain as death and taxes.”
Urban Financial Advisory Corporation – April 2021