Economic Outlook | Spring 2021
Last year unemployment was 14.8% and the economy contracted by an annual record of 31.4%. What a difference a year makes. This year GDP growth is 6.4% in the first quarter, unemployment is now 6%, and corporate earnings are stronger than even the optimists projected. U.S. output is nearly what it was in the fourth quarter of 2019, even with payrolls being 5% smaller, and employee compensation is 2.9% higher! On the earnings front, Amazon’s profits, have tripled to $8.1 billion in the first quarter of 2021. With the economy opening up and vaccines rolling out, the good times appear to be here for some time. The stock market certainly seems to think so. The S&P 500 is up 12.11 % so far this year as of 5/03/2021.
More help on the way, but is it needed?
There is plenty of stimulus out there (the M2 money supply increased $4 Trillion, or 26% last year, the greatest increase since 1943*) and there may be more on the way. President Biden has proposed spending bills totaling $6 Trillion in Federal spending over the next decade.* Although this will likely get paired down in Congress, this additional spending will increase economic activity, leading to even greater earnings. Also, household income increased 21% just last month and consumers already have fat wallets from the lockdown. Low mortgage rates and a strong desire to spend, as the earnings from Amazon shows, will also likely continue to propel this economy through 2021.
Downside to more stimulus:
Our national debt has reached all-time highs in absolute terms and is currently at the highest level since 1945, when measured as a percentage of GDP. Just two decades ago, a debt to GDP ratio of 70% was thought dangerous. Our government added so much debt after the 2009 crisis that our sovereign credit rating was downgraded by Standard and Poors on August 5, 2011. Now our debt to GDP ratio is 102% and rising^. Economists now believe, especially those who espouse the Modern Monetary Theory, that although our debt is very high, our deficit is serviceable given the current interest rate environment.
What could go wrong?
Ironically, if the economy responds well to the future stimulus, inflation expectations should increase. This expectation will lead to bondholders requiring a higher interest rate on their investments. Higher interest rates mean a greater cost to our Government to service the debt. Although the debt may be serviceable at current interest rates, at higher interest rates that may not be the case.
How do we payoff this debt?
There are only two ways to pay off debt. You either increase revenue (taxes) or decrease spending. The Biden administration has proposed raising taxes to offset the amount of debt that the Government will need to fund the stimulus plan. Higher taxes, of course, lead to a slowdown in economic activity.
A slower economy brings in less tax revenue to the government than one that is growing. There are no pain free solutions. Most likely the Federal Reserve Bank will buy U.S. Treasuries to force interest rates down and keep the servicing of our debt manageable, at least in the near term. This increase in the money supply, of course, is inflationary. Monetizing the debt is not without risks either.
How can I hedge?
Traditionally, investors who feared inflation bought gold. However, because gold tends to decline when interest rates go up, this can be a losing proposition. How about TIPS? In theory, inflation protected US treasuries seem to be just the ticket. Investors certainly seem to think so. US funds investing in TIPS has seen 25 consecutive weeks of inflows and nearly $18 billion into the market as of April 7.** However, the yield on these babies is currently negative for all maturities, except the 30 year. Unless inflation really takes off, you will likely lose money. Bitcoin? At this time Bitcoin is more a speculative commodity than a means of currency. Additionally, Bitcoin needs to be stored on a computer somewhere, and of course it is not insured by the FDIC or SIPC.
Lastly, because government cannot trace bitcoin (and therefore cannot tax transactions using this instrument) there is regulatory risk down the road.
Where does that leave us?
A diversified, well balanced portfolio always makes sense to us. Perhaps more so now, than ever.
• WSJ.com/articles/the-money-boom-is-already here
^ Congressional Budget Office
**Barron’s April 19, 2021 TIPS...
• WSJ April 30, 2021 “Biden plan...”