Those in Washington have adopted a risky mindset regarding our fiscal policy. It now appears to be okay for our government to spend as much as they desire, even if the government’s revenue (federal taxes) may not be enough to pay for those expenses. This is still the case even after the proposed tax hikes by President Biden.
Note that this post is not a partisan debate (both President Trump and President Biden have significant budget deficits under their tenures), but rather a critique of Washington’s overall lack of fiscal accountability.
As such, I wanted to talk about the impact these government programs are having on the markets and the economy and the concerns I have for our future.
Stocks Up – Bonds Down
Massive government spending since the COVID pandemic began last year has had a very positive impact on risk assets. 2020 was undoubtedly a great year to be a stock investor. 2021 is shaping up to be another fantastic year for the equity markets, but not so much for bonds.
Stocks are clearly the biggest beneficiary of a rebounding economy and loose fiscal and monetary policies. Cheap cost of capital + large government spending + a strong economic rebound = higher stock prices.
However, the concern for higher inflation levels is dragging on bond prices, especially longer-dated Treasury bonds. If you recall, as rates rise, bond prices fall, and vice versa. Inflation signs are everywhere. In fact, Costco is seeing accelerating prices across a range of products, including shipping containers, aluminum foil, and a 20% spike in meat prices over the past month. The big question today is whether or not this inflation is transitory.
Market Tailwinds
Leading Indicators continue to show a robust economic rebound from the March 2020 lows. Yes, COVID had significant and damaging effects on businesses and families. However, the rebound is unprecedented and rapid. As stated earlier before, I expect this rebound to be swift as the 2020 recession was one caused by government-forced lockdowns and not one caused by excess capital in our economy. As such, we do not have to work through that excess capital to resume a fully functioning economy.
Vaccination efforts are clearly having a positive effect. 51.5% of all U.S. adults are fully vaccinated, and 62.6% have at least one dose. I don’t need to tell you this, but if we can keep positive infection rates to a minimum, businesses will thrive.
The Federal Reserve is continuing to adopt a highly accommodative policy. Economics 101 – if the cost of capital is cheap, it will act as a boost to the economy. The Fed has stated that it intends to keep its target rate at abnormally low levels, despite the evidence of a significantly strong economic rebound and inflation concerns.
President Biden and Congress is pushing forward for more stimulus spending, despite a strong economic recovery, including a $6T spending plan. Is it needed? I don’t believe it is, yet others have differing opinions. My concern is not so much about the benefits a spending plan like this will yield, it is the enormous cost.
Concerns
As with anything else, the universal law of cause and effect states that everything happens for a reason, good or bad. The U.S. deficit spending levels and the mounting debt it leaves behind worry me more than anything else. During President Trump’s tenure, the U.S. increased its debt load by a staggering $7.8T. President Biden is already upping the ante, bringing our Debt-to-GDP ratio to historic highs, higher than what was achieved during WWII.
Of course, this will take years, if not decades, to play out. Though, I feel it necessary to at least discuss this topic. Our government has begun a historic attempt at implementing a form of MMT, Modern Monetary Theory. If you are not familiar with this concept, it is the idea that “a government does not rely on taxes or borrowing for spending since they can print as much as they need and are the monopoly issuers of the currency. Since the U.S. budget isn’t like a regular household’s, under the MMT mindset, their policies should not be shaped by fears of rising national debt.” (Investopedia)
One pesky concern with this theory is that inflation is likely to be a side effect of this policy. MMT advocates don’t talk too much about this too much, though it is almost a guaranteed outcome.
Higher inflation levels can certainly help with the rising debt levels in this country ($6T today will not be worth the same 15 years from now if we see any level of inflation). But our government is essentially betting that they can stay on top of inflation and not let it run rampant like it did in the late 1970s and early 1980s. We shall see.
The good news is that stocks/equities are your best hedge against inflation. There is no other asset class agile enough to adapt to an ever-changing economic landscape. If you think about it, a company’s incentive is to make a profit. You literally have a company full of people doing everything they can do so. There is no other asset class that can say the same. Stocks, again, for the win.
Caveat
However, this concern may be all for naught. ‘Stimulus’ spending may cease very soon and we may begin to finally implement a more balanced budget. If this is the case, then annual inflation levels will be more manageable or tepid (2% as it has been for the past decade).
If anything has been proven time and time again, it is that forecasting economic events years into the future is nearly impossible. I wouldn’t be surprised to learn that these concerns are overplayed.
Either way, this highlights the importance of staying invested and diversified. The global economy is extremely complex and taking one side versus another is more akin to gambling than investing. It is okay to make calculated bets, though be sure that bet is one based on data and not one based on emotion. Your money should be working for you, just be sure that it is working wisely!
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