It is mind blowing to think that we are right around the one year mark before Covid 19 changed our world as we know it. While 12 months seems like a lifetime ago, it is worth putting some perspective on how things are different, how some things are the same, and just generally get a grip on what is going on.
This is especially true with the heights the market has hit in early 2021, taking account of some of the good things going on in the economy, and also paying mind to some of the warning signs that may be flashing.
In this commentary we ask some of the questions we have been hearing from clients and hearing in financial media.
Topics within include:
- Are we in a strong economy?
- Interest rates: what are we looking at and where are they headed?
- Inflation: The impact on investing
- National Debt
- Is the market too expensive?
- What are we doing in accounts looking into the next few months?
We hope you enjoy, and if you have any questions, we hope you reach out and ask!
What’s going on with the Economy?
Despite the major decline in economic activity, GDP is expected to regain its pre-pandemic level by March 2021. Pretty impressive that we have recovered in just 1 year, but without the major fiscal and monetary help we have seen and continue to see, it is unlikely we would be where we are right now.
But this also explains a lot. Monetary policy is like a shotgun, and fiscal policy is meant to be more like a sniper rifle. But with much of the fiscal stimulus being pointed directly to consumers through federal checks and unemployment benefits, fiscal policy looked like a shotgun as well, hitting all parts of the economy.
And this is essentially why we see the difference in performance between new technology companies and older more classic economy companies. New technology companies benefitted from both the changes in the way we live our lives and from the stimulus fired into the economy. Classic economy companies needed that stimulus to survive, and many business models remain permanently impaired with some of the long-lasting changes we are likely to see (work from home, shopping online, digital solutions).
So, with that, we think the shotgun is still firing with the recent passing of the 1.9 trillion stimulus bill, and the benefactors will be everyone, but better to stick with the companies that don’t need it to survive (like technology companies) than the companies that do!
Interest Rates; How high will they go, and what does it mean for stocks?
Below is a text message chain we intercepted from a CNBC talking head and a professional trader: (note, this is a parody)
CNBC Talking Head: OMG, did you hear about that crazy spike in interest rates!!!!! Just take a look at a 1 year chart!!!
Professional Trader: Wait, but how does the rate compare to the last 25 years?
CNBC Talking Head: Oh!!! So it is still at historic lows. I guess we might be making a big deal out of nothing…….
Professional Trader: Probably. It also looks like it is bumping up against a long-term resistance level around 1.5%.
CNBC Talking Head: But if I can’t complain about interest rates, how will I help CNBC sell advertising slots?
Professional Trader: I don’t know, maybe talk about Gamestop……
CNBC Talking Head: Great idea! Thanks for that…..TTYL, XOXO
The resurgence of Inflation; How concerned should we be?
I can’t help but chuckle when I hear concern about inflation….we hear it at least every other year when oil or some commodity spikes. Everyone starts thinking about 1980, or back in the post war era, and how inflation was a major problem. I certainly understand that, and we study and talk about those times in economics day in and day out. But inflation has been incredibly low in the last 25 years, and while we have a spike here and there, it has remained on an average under 2% since the turn of the century.
The Fed made it abundantly clear that they are not concerned about inflation for the foreseeable future, and additionally, said if it runs above its target of 2%, it would not consider that an issue because it is making up for all the below target inflation we have experienced.
To keep it short and simple: The Fed isn’t worried about inflation, and it will take a lot of inflation to change their mind.
But what about all the debt and money printing?!?!
Let’s run a quick hypothetical scenario on our friend Mr. US Economy, and let’s imagine that our national debt level is a mortgage on a house. Instead of using actual GDP numbers, we will make up some numbers.
- US Economy makes $200,000 per year; he is in a low growth but steady job, and his salary only goes up 2% a year for the prospective future (like GDP).
- US Economy owns a nice home with an all-interest mortgage of $270,000. His current interest rate on that mortgage is around 1%, and his loan term is 6 years, so he pays ~$2,000 per year for his mortgage (we are in low interest rate environment).
- US Economy has about 17.5% of his income to spend on his mortgage and other obligations, otherwise he would have to take on more debt to pay for his lifestyle.
- US Economy does not mind taking on more debt to maintain his current lifestyle, but he realizes at some point he needs to find financial discipline or get a new, higher paying job!
Mr. US Economy sounds like a normal situation, right? Well, as silly as this sounds, that is a pretty good picture of what the actual U.S. Economy looks like; just change $200,000 in income to about $20 Trillion in GDP, change the mortgage to the national debt of $27 trillion, the interest rate and loan term is the effective maturity of outstanding US debt and the average yield on that debt, and 17.5% is the tax receipts that the U.S. government collects. IN SUMMARY: When we look at the U.S. Economy like a neighbor down the street, it hopefully becomes a bit clearer. As long as his job is good, he can keep rolling his debt, the interest rates are low, and he maintains some responsibility around his spending, he is in fine shape.
30 years of U.S. Debt to GDP (macrotrends.net)
So, while there is a lot of doom and gloom about all the borrowing Mr. US Economy is doing, and how much money he is spending on his credit card, his bills remain paid and his situation is fine. The important thing is that he spend money on productive things like education, home improvements, and useful tools; we just need to make sure he does not waste it on booze and gambling!
OK, so the Economy is on good footing, Inflation seems contained, Interest Rates will likely remain below historic norms, and the debt level is manageable…….BUT certainly valuations are stretched, right?!
The answer is simply “Yes, yes they are.” But it is rare valuation itself causes are market downturn, and sentiment and bullish trends are incredibly strong. The issue is, when valuations are stretched, volatility picks up and declines are more dramatic.
So, expect strong markets with higher volatility, more drastic corrections, but an overall positive slope. It is going to be challenging because of all the uncertainty and the fact that we are pushed up against extremes in all directions, but with a good plan, smart observations, and a clear discipline on how to take advantage of anomalies, we think this is a great time to invest and look forward to the future!
Stay calm and trade on!
Jordan Kaufman, CFA, CFP®
CIO, Green Ridge Wealth Planning