The speed with which the U.S. economy has recovered after the Covid-19 shock has surprised most observers. According to Morgan Stanley estimates, the U.S. will reach pre-crisis output levels by the end of the current quarter. They further expect the economy to outpace the path that it was projected to follow before the recession hit – which would be the first time since the 1990s that the GDP rose above its pre-recession projected path in post-recession reality. Morgan Stanley’s chief U.S. economist Ellen Zentner, is forecasting growth of 7.3%Y in 2021 and 4.7%Y in 2022, almost 2 percentage points above consensus this year and 1 percentage point next year. That is quite a wide margin and of course we look to find reasons for such a gap.
That brings us to the monetary and fiscal policies that our fearless leaders in Washington have embarked upon. The fiscal policies from Congress have totaled staggering sums of trillions of dollars that have now outpaced the income lost during the recession. As the economy reopens, the labor market is poised for a rebound which implies consumption growth in 2021 supported by wage income and transfer payments. Considering this, many economists are predicting consumption demands to stretch supply in coming months and spur inflation. The Federal Reserve has set its arbitrary 2% inflation target (which we have repeatedly declared erroneous) and even implied that they may tolerate inflation running hotter than 2% as sort of a make-up for weaker inflation numbers due to the virus scare.
Of course, as always, we question the Fed’s capacity to manage inflation to any modicum of precision should the genie pop out of the bottle. The U.S. debt numbers are skyrocketing on most every measuring scale (save personal credit card debt which is good news.) Should longer term interest rates continue higher we will have a problem on our hands. Asset prices as defined primarily by bonds and stocks are at very high numbers. The S&P 500 is trading at 22 times forward earnings, which is in the 99th percentile since 1976, according to Goldman Sachs, suggesting that the valuations could be a threat particularly in a rising-rate environment. However, comparing the S&P 500 dividend yield with the 10-year yield shows valuations only in a midrange – around the 42nd percentile. So maybe stocks are not so crazy high unless interest rates continue higher. Two weeks ago, when we wrote about this the 10-year Treasury yield had just pierced the 1.5% mark for the first time in more than a year. We mentioned then that a mutual fund manager we know had set the danger mark for stock prices at 3% on the 10-year Treasury yield. At the time of this writing that yield is 1.62% - still a long way from 3%. We are keeping this on our radar, though as north of 2% would start to concern us. There is simply too much debt out there to sustain significantly higher service payments without significantly higher inflation.
But back to concerns about said inflation…The U.S. Bureau of Labor Statistics put out February inflation statistics last week. Some commentators complained about the gorilla math (BLS literally made some of the numbers up this month) the government uses including “hedonic adjustments” which are subjective calculations of higher utility. For example, your car may cost a lot more, but it has better gadgets and more functionality, so it is worth more. Right now, the rate of inflation is still shockingly low. Certain things, housing for example, have rocketed higher but the progress of technology has at least been a factor in keeping inflation at by in a number of different industries and consumer verticals. That is good news for at least the near term. At the end of the day, the “statistics” may say one thing, but most people recognize that there will only be so many times that the government can hand out $1.9 trillion dollars of “stimulus” and expect the value of those dollars to maintain their purchasing power. Wherever the breaking point is, our intuition is that our spendthrift crew in D.C. will eventually find that point. There is no perfect indicator of when/where the value of paper money will start breaking down. The chart of the growth of our “monetary base” is just one general indicator - it has launched higher and is now some 5 X of what it was before the last recession:
So, the amount of money in our system is obviously rocketing higher. We also believe there is a psychological component to managing confidence in a fiat currency – a component in which we believe our leadership is failing. In the meantime, if you listened to us late last year when we mentioned crypto-currencies https://andorracapital.com/u-s-dollar-weakness/ it is not yet time to sell them – and as we frequently write in this post, don’t sell your gold.
Regards and good investing,