- Coronavirus vaccines have given the markets hope and propulsion in recent months and now we have our first major Covid-19 mutation.
- Congress came together on a minimalistic support bill, but it won’t be enough for 8 million Americans newly in poverty or the 34 million that were already in poverty.
- Central bank policy remains accommodative, but at what point is countercyclical policy going to have to change direction again?
- The long-term war between deflationary and inflationary forces has no near term end in sight. Stick with our barbell strategy for years.
In a recent Macro Monday article I pointed out that there were “signs of weakness” in both the economy and markets.
With unemployment numbers exceeding predictions as I expected – High Wage Layoffs Will Sink Stocks Soon – and a surge in Coronavirus stifling economic activity around the globe again, that weakness is becoming clear to more market participants.
Today, I examine the short and long-term economic challenges in the context of fiscal and monetary policy in the United States. Let’s also lend understanding to why our barbell approach to investing is not a short-term idea, it’s going to be good for a long time.
With Christmas on Friday, I will not be holding an investment webinar. I will be holding a year-end Q&A session on Sunday night though.
Please submit questions for discussion on the chat board as I can’t guarantee I’ll get to anything not brought up ahead of time. I’ll be checking the chat until about an hour before the webinar starts.
The webinar will be using Zoom on Sunday night, December 27th at 7pm central time. Use room number 2627513361 and password “QA.”
From April, the stock market has looked forward to a vaccine. Every positive vaccine announcement was met with stock buying by highly liquified traders.
The smart money has been more selective.
You can see the dichotomy. Dumb money, generally small traders and retail investors, are extremely optimistic about stocks. Smart money, generally institutions and family offices, are quite pessimistic about stocks.
In the long run, the smart money is usually the better intermediate term (6 months to a few years) indicator of the direction of stocks. However, in the short term (weeks to a year) traders and retail can drive market moves to extremes.
Remember, money is made at the margins in any market or business. The traders are the marginal investors in the stock market. As they go, the stock market goes in the short run. Lately, traders using cheap money, to leverage up accounts, haven’t had a big challenge to their margin accounts.
We have discussed repeatedly in webinars how the call volume by retail accounts, driven by margin accounts, is a form of leverage on leverage. This is combined with historically high valuations. Think 1999 meets 2007, but with Fed backstopping.
When the leverage unwinds, and it always does, the correction will be fast and severe. Think about some of the bigger stock market corrections just the past decade, from the “flash crash” to year-end 2020 to this past March.
And, of course, we all expect the Federal Reserve and government to come to the rescue if things get too bad. So, the question becomes, when to buy again if you are heavy in cash.
Over the weekend, we found out about a mutation of Coronavirus Covid-19.Will that be the match that lights the fuse on a leverage unwind? Hard to know. But, that’s not the only thing out their looming.
Minimalistic Support In The Face Of Rising Poverty
Maybe our expectation that the government will do what it needs to do to support the economy is over or understated. It seems the numbers are big, but who really is getting helped and how fast does that help arrive?
We know that the vast majority of aid since March has gone to corporations. There hasn’t been much trickle down, except for stock market investors. In other words, virtually all of the fiscal and monetary support has gone to the top 10-20% of the population.
Poverty has risen from 60 year lows in 2019 by 8 million newly impoverished. That brings the number to about 42 million Americans in poverty.
The current poverty rate is now at 11.7% which was a clear impetus for Congress to finally act after months of Fed Chair Jerome Powell telling them to do so.
Congress finally acted, but stuck to mainly Republican Senate ideals. A $600 check isn’t going to change the poverty numbers much. Neither is $300 extra in unemployment benefits for 3 months. Here’s a breakdown of the current bill: What’s in the $900 billion coronavirus relief plan: Stimulus checks, unemployment aid and more
It is clear that the ONLY thing that brings the economy back long-term is more good jobs. And, that can’t happen until Coronavirus is under control. We are at least several months from that point and it could be another 18 months or longer if the virus mutates faster than we can adjust vaccines.
How Bad Is The Debt Problem?
Many of those who think about the macro economy as similar to a micro home or business economy get it wrong all the time. We do not need balanced budgets or low debt for the economy to grow and thrive. We need for debt not to be out of control and more expensive than we can afford.
That was the message from Chairman Powell last week when he said that America’s debt “isn’t that bad.”
Remember the Dick Cheney quote from the early 1980s? “Debt doesn’t matter.” I have referenced that Cheney quote many times in our Investing 2020s webinars. Why would he say that?
It’s because back then, interest rates were very high, but about to start a multidecade bull market of falling rates. And, they knew that they could suppress interest rates a long time, especially longer than they would be in office. I do wonder how surprised Dick Cheney was when it was still working 20 years later when he became Vice President.
As interest rates fell, that put a huge tailwind behind stock prices. How?
When interest rates are falling, we can keep refinancing debt to fuel economic growth without much regard to the debt, because interest payments aren’t rising (much).
Today, and tomorrow, with GDP growth somewhere in the low single digits, it will take interest rates below GDP growth to keep debt from getting out of hand.
Can that be accomplished? Maybe. So long as big bond investors are willing to accept a negative real return to stimulate economic growth.
Of course, Jamie Dimon recently had this to say:
“I would not be a buyer of Treasuries… I think Treasuries at these rates, I wouldn’t touch them with a 10-foot pole.”
That smacks of the bond vigilantes. And, that sentiment is becoming more pervasive. We already know that much of the rest of the world, China in particular, are buying fewer Treasuries and even reducing holdings.
With rising debt, there is a lot of pressure to keep interest rates low a long time.
Here’s a longer term look:
With interest rates near zero and debt to GDP rising, I have said for several years now that helicopter money is inevitable to deal with debt and unfunded liabilities. Of course, we it could be that America Is On The Road To MMT.
And it’s not just the debt that matters. GDP is not as robust as the post WWII young America rebuilding the world era. The world has aged and without a coordinated global decision to rebuild the developed parts and build the underdeveloped parts, GDP will continue to slowly fall.
I have talked about aging demographics and The Fourth Turning for two decades. The concepts are finally getting some attention. These are central to my “Slow Growth Forever Global Economy” thesis that I wrote about years ago. That is, an aging population, in a world that has largely been built, will necessarily see slow growth absent offsets from policy.
So, there’s a lot of pressure to keep interest rates low a long time.
Coronavirus flipped the calendar forward by years most likely on the helicopter money I expect when debt issues come to a head. I had expected it around 2030. A recent paper suggested debt issues come to a head about 2026. That now seems about right to me.
Low Interest Rates And Stock Valuations
Here’s where we stand on stock valuations:
Powell also talked about equity valuations:
“If you look at P/Es they’re historically high, but in a world where the risk-free rate is going to be low for a sustained period, the equity premium, which is really the reward you get for taking equity risk, would be what you’d look at…”
Powell is saying that with valuations at the highest in history. What does that mean? There’s a lot of pressure to keep interest rates low a long time.
This isn’t just in American though. Japan, Europe and China, which happens to be their order for average age, are as bad or worst then America over the next generation. Is it a wonder why the Japanese government and pension are the largest owner of Japanese equities now?
Now, wrap your mind around the task that capital intensive companies have now that interest rates can’t go any lower and governments are soaking up demand from the bond market. Already we have the Federal Reserve owning some corporate debt. Is that efficient.
Ask Japan, where the government owns more of Japan’s capital markets than anyone else, how are things in their capital markets over the long haul?
Expect More Stock Market Bifurcation
One of the highlights of the stock market in 2021 was how far ahead technology, information, consumer and materials stocks stocks got.
There has been some rotation lately to give energy and other sectors a boost, but the trends should be clear longer term. How exactly the sectors shape up over the rest of the 2020s is imprecise, but I think we can accurately say that information tech will do well and energy will struggle.
Our investment barbell recognizes the secular trends and the countercyclical policy of the central banks and government.
As investor, we need to respect these things:
- The broad economy will NEVER grow as fast as it did in the 1950s and 1960s ever again (excluding post some catastrophe we would like to avoid), due to demographics, prior development, debt and technology which taken together are deflationary.
- Government and central bank policy will always try to expand economic growth, which is inflationary.
- Cyclicality is less pronounced as secular trends disrupt the economy in a massive paradigm shift to a even more technology driven sustainable economy.
- Technology will be among the leaders FOREVER.
- Healthcare will have winners and losers, but on net, with aging and climate change impacting health, more winners.
- Consumer discretionary will always yield winners, but will also have some infamous flameouts, however, on net, we are a consumer world, though, so a winning sector.
- Industry that used technology well will crush industry that does not use technology well.
- Materials for the electrification of the economy will require new and expanded supplies and certain materials will, i.e. gold, will do well because of inflationary policy.
- Real estate will be driven by the old mantra, “location, location, location.” Most money is made in redevelopment, not rents – something that “real” real estate investors already know.
- Low interest rates mean financials will be in muddle through mode for a long time.
- Energy is in massive transition with many past winners becoming losers and new winners emerging.
- Utilities, like energy are in massive transition, meaning many past winners becoming losers and new winners emerging.
- Consumer staples will only grow as fast as the economy with many companies suffering from debt that puts them in the zombie category.
At a minimum, I think we should expect a normal stock market correction. Roughly half the value from the prior cycle low to the cycle high. The recent S&P 500 (SPY) (VOO) low was 220.15 and a high of 378.46. If that was the final high, then we’d expect about an 80 point correction to a SPY around 300, maybe a little more or a little less. Are things normal?
If margin unwinds are severe, there could be another level lower than normal. How far down is that? As far as the Fed lets it get before it turns on the fire hose again.
In any scenario, the short answer to investing for the next decade is to stick to the barbell. It’s just a matter of at what prices to be a buyer. Accepting the barbell means you have to accept that we are near the end of a credit cycle, or at least a long-term flattening out, and that that disruption in the next decade will be faster and of greater magnitude than what it was in the past four decades.