Spring 2021 Market & Economic Commentary
Economic crises often call for massive fiscal action. The New Deal and the enormous amount of government deficit spending that resulted was made in response to the economic doldrums following the Great Depression. Debt-to-GDP nearly doubled in the 30s, climbing from less than 20% of GDP to 40%. The cold war defense and stimulus spending in the 80s drove Debt-to-GDP up from 25% to 50% of GDP. The financial crisis and resultant bailouts (to banks, automakers, and states) a little more than a decade ago saw increases of another 30% of GDP, taking our Debt-to-GDP ratio up over 100% of GDP for the first time since WWII.
In 1982, unemployment eclipsed 10%. Thirteen years ago, infrastructure spending and extended unemployment were put into place to combat nearly 10% unemployment. The Great Depression saw unemployment rise to exceed 20%. Mass amounts of deficit spending were needed to get Americans working again. In the 24 months after the onset of COVID-19, U.S. debt is expected to expand by nearly 40% of GDP…and counting. However, there is one key difference today. Most of that spending is being initiated after the majority of the problem has subsided. Unemployment is down to nearly 6% and most of those still affected are in service industry jobs that are being forestalled due to health policies, not fundamental economic conditions. Yet the Federal government is sending out $1,400 stimulus checks to most Americans, employed and idle, for the third time in a bit over a year. A massive infrastructure bill is on its way, and the Biden Administration is just getting started. Talks of generational tax hikes in income, capital gains, and elimination of 1031 exchange tax deferment for commercial real estate will join trillions in stimulus spending to redefine the term ‘shock and awe.’
Of the 40% increase in U.S. debt, the second half has been proposed in just the first 100 days of the new administration. As Joe Biden took office, unemployment had already fallen to 6.3%, a rate not achieved until 16 months into the SECOND Obama term, over five years after the onset of the financial crisis. Today’s deficit spending is unprecedented, occurring at already record debt levels…and it’s likely just getting started.
How the Markets Fared
Similar to the Biden Administration’s plans to keep the economic pedal to the metal, the Federal Reserve continued its stance that it would likely leave monetary rates unchanged in a “patiently accommodative monetary policy” for the foreseeable future. Comments out of the Fed indicated that they were far less interested in inflation than they were getting back to full employment. Despite unemployment falling from a peak of nearly 15% just a year ago to 6.3% in February (now 6.1%), Chairman Powell remarked after the February FOMC meeting that:
“Fully realizing the benefits of a strong labor market will take continued support from both near-term policy and longer-run investments so that all those seeking jobs have the skills and opportunities that will enable them to contribute to, and share in, the benefits of prosperity.”
These comments are quite uncharacteristic from a Fed Governor, going beyond focusing on mere employment by hinting at further government stimulus to shape the quality of jobs and workers’ skills to fill them down the road. Debt markets have responded to the Fed’s dovish stance by selling high-quality bonds, especially those at the longer end of the yield curve. The yield on the bellwether 10-year Treasury nearly doubled, rising over three-quarters of a percent from 0.90% at the end of 2020 to over 1.6% at the close of Q1. This led to large losses in long-term bond values and declines of a few percentage points in most high-quality bond funds. Only high-yield bonds were able to escape declines during the quarter.
The prospects of a continued open spigot of stimulus for the U.S. economy, however, bolstered investor’s appetites for equities to start the year. As economically sensitive stocks would benefit both from fiscal support and renewed economic activity as COVID-vaccinations roll out, value indices continued the rally that they began in November. Much of this demand came as investors trimmed their tech-heavy and stay-at-home trade growth stocks to rotate into cyclicals. The disparity of returns was most pronounced in small cap U.S. stocks, where value outpaced growth by over 16%. As the dollar rallied during the quarter, returns in international stocks were not as robust when measured in U.S. dollar-terms. As expected, inflationary concerns caused commodity prices to rise in Q1. That would have normally led to gains in resource-sensitive Latin American equities. Unfortunately, a strong dollar and continued domestic challenges with COVID led to those markets bucking the upward trend, posting modest declines for the quarter.
We all remember the game musical chairs. A certain number of chairs are set out, the music plays, people move around the chairs until the music stops, and then everyone sits down. The catch is that each round, a chair is removed and if you don’t get one of the remaining chairs, you’re out of the game. The market is starting to feel a bit like musical chairs – high flying tech and stay-at-home names are starting to falter.
- Shopify – Ran up over 400% and now down 30% from its highs.
- Peloton – Ran up over 700%, now down over 50% from its highs.
- Zoom Media – Ran up over 600% and is now down over 40% from its highs.
- Twitter – Ran up over 300% and is now down over 30% from its highs.
And these are just the first players to exit the game.
Valuations are still sky-high on Amazon, Tesla, Google, Facebook, Apple, and many more tech names. Most have doubled or more since the COVID-outbreak. No one doubts how prolific the businesses of these corporate behemoths are, but are their lofty stock prices, especially compared to longer-term norms, sustainable? Apple historically traded at around 14 times earnings. Today it trades at nearly double that rate, which would be one thing if it were growing faster, but estimates suggest that Apple’s earnings will grow at less than 5% from 2021 to 2022. One can see why a rotation from growth stocks to more cyclical names is underway. The question remains, are we in the beginning stages, or will a rising economic tide lift all ships?
Stock prices are not the only assets setting new records. The National Realtor Association reported that existing-home sales for March saw median prices set a new record, rising 17.2% to $329,100, with all regions surging. Limited supply continues to be the key driver.
Despite sales slowing 3.7%, lack of inventory puts supply of homes for sale at just 2.1 months, where 6 months is considered to be equilibrium. This has homeowners feeling good and home-seekers feeling frustrated.
It’s a Beautiful Day in the Laborhood
Though the labor markets have recovered over 80% of jobs that were lost due to COVID-19, most of the recovery has occurred in middle to high-paying jobs. In fact, most of those jobs have fully returned…and then some. Presently, the U.S. has over 8 million unfilled job openings, an all-time high. This is starting to create another source of frustration. Many employers are reporting that there is actually a labor shortage. As one will note in the included chart from the BLS, when unemployment is measured vs. available jobs, it appears that the labor market is getting tight. Once the retail and hospitality industries come fully back online, we will likely see a fully employed labor force. That is unless extended and enhanced unemployment benefits are disincentivizing a certain portion of available workers from returning to the workforce, which many claim is already happening.
The April ISM Manufacturing Index pulled back a bit to 60.7% from 64.7% in March, still indicating robust expansion. The services side of the ISM survey (“the Non-Manufacturing” Report on Business) decreased modestly from March’s record 63.7% to 62.7% in April. Both reports showed meaningful increases in prices as well as cost of goods from the manufacturing report. Again, here we signs of a heating economy with concerns over upward price pressure.
The whole world is debating the topic of inflation. Inflation itself is not necessarily a bad thing. Measured inflation helps home prices. Modest inflation can diminish the future effects of present-day debt. Runaway inflation is a whole other monster. (Think the U.S. in the early 80s at best and Zimbabwe and Venezuela at worst.) The April Consumer Price Index (CPI) soared 0.8% month-over-month. Since April 2020 was meaningfully impacted by the COVID-19 shutdown, Breifing.com suggested we look just at the last six months, where “total CPI is running at an annualized pace of 5.0% while core CPI is running at 3.0%.” These levels are far above the Fed’s stated long-term target of 2%, so there is no doubt that inflation is amongst us. With our Federal debt expected to eclipse $30 trillion in the next two years (135%-140% of GDP), that may not be such a bad thing. If one adds in future entitlement obligations like Social Security, inflation starts to look like a powerful tool. Is that why the Fed and the current administration have their feet so firmly on the gas, despite an economy that appears to be recovering just fine due to the lessening effects of COVID? Whether they are being calculated or careless, continued massive stimulation of the economy at this point seems to be a game of high stakes economic ‘chicken.’ Will we pull up in time to avoid a wreck? Or will we have too much momentum to stop? Time will tell; but the faster we go, the more blurred all of our PIERspectives will become.