Monthly Outlook: June 2021
Everything is opening up. Do you feel it? Vaccines have been widely distributed, COVID is on the way out, masks are coming off, graduations just happened, today is June 1st, and summer vacations are starting. And I can just hear a national exhalation, “Whew, we’re ready!” Meanwhile, on Wall Street, investors have been in party mode for a year already, enjoying massive stimulus and expectations of economic recovery. While Main Street is coming alive, Wall Street seems to be stalling. Why? Well, all that stimulus has created significant inflation and maybe too-optimistic earnings expectations. What if the Federal Reserve (Fed) is forced to taper their stimulus programs? What if Congress doesn’t pass any more COVID-relief stimulus plans? What if the economy has to recover from here by itself, on its own strength? That could have a major impact on investment prices and that is the reason for the current stall that we’ll discuss, below.
The Stimulus Bubble – How We Got Here
We really have to go back to the 2008 Financial Crisis to appreciate the current stimulus bubble. In short, much of the stimulus needed to recover in 2008 never went away. The Fed lowered the discount interest rate from 5% in 2007 to 0% in 2008 and kept it there until 2014, well past the 2009 recovery. They allowed rates to barely nudge higher to 2% in 2019, before lowering rates to 0% again in 2020 for COVID relief. In addition to the stimulus from lower interest rates, the Fed bought bonds through QE1, 2, 3, and 4 as well as other stimulus programs that sound like alphabet soup. Congress also provided massive stimulus programs and deficit spending that added to the national debt. Stimulus absolutely helps a struggling economy to recover, and it’s needed from time to time. But much of it ended up propping up financial assets including stocks, bonds, and house prices.
When COVID hit in early 2020, the Federal Reserve and Congress responded with even more stimulus, understandably. Interest rates went back to 0%, and over $5 trillion of various programs including CARES Act, Families First, PPP loans, direct payments to taxpayers, etc., were enacted. The U.S. is running a massive $3 trillion annual deficit in 2021 and at least $1 trillion annual deficit is expected for the next 10 years based on the proposed budget. National debt is now $29 trillion, or 130%+ of annual GDP. None of this is meant to be political. Rather, it’s just to explain how much stimulus is “out there” and how dependent on it we are to support economic recovery, and to support current asset prices.
Inflation is a By-Product of Stimulus
We currently see massive inflation everywhere, especially if measured from the COVID shutdown levels of a year ago. Corn has risen from $3.50 to $6.50, lumber is up from $4.00 to $13.00, house prices are up 20%, and stocks are 25% higher than they were before COVID. Yet, the underlying economy is not even back to pre-COVID levels. The Federal Reserve uses the Consumer Price Index (CPI) and other indicators to track inflation. Somehow, the just-released CPI shows “only” a 4.1% annual increase in inflation. Further, the Fed tells us that inflation is only “transient” and nothing to worry about once the supply chains get back on track. They may be right, but with the economy continuing to re-open, pent up demand for travel and spending, and millions getting back to work, we may see some price pressures over the next few months. This inflation-watch and debate about whether it’s transient or persistent will keep markets volatile.
How to Invest This Summer
We’re cheering for further re-opening of the economy and the fun that comes with it. But we expect markets to be more volatile as investors grapple with deciding when the massive stimulus from both Congress and the Fed is likely to taper. We do not expect any major market decline this summer, however. Longer term, we’re watching whether overly exuberant earnings expectations get ratcheted downwards on concerns of inflation, less stimulus, and perhaps a more modest recovery. That would raise the risk of a deeper price correction this fall. For now, we’ll remain hyper-vigilant, open-minded, and patient. Enjoy summer!