By far the most common question I get asked these days is “what is next?”. Many times, it starts like this: “Chris, I know you don’t have a crystal ball, but…..” Actually, I do have a crystal ball! Chris Lee gave me one years ago. It’s on a shelf in my office. Unfortunately, it doesn’t tell me what is going to happen next. It does not flash red at the top of the market telling me to get out before a market correction. Just as important, it does not have bells and whistles going off at the bottom of the market letting me know to be fully invested. Maybe I should check the return policy since it may be defective!
Luckily for you, at New England Capital, we prefer proper planning over prognostication. When I hear all the predictions coming from “experts” this time of year I’m reminded of economist, John Kenneth Galbraith’s quote: “The only function of economic forecasting is to make astrology look respectable”. For clues as to what might be ahead, let’s look at how we got to where we are today.
The COVID 19 pandemic has affected everyone in so many ways. I’d like to review the economic impact on a macro level and look at what the US government spent to combat the pandemic’s brutal force. While the CARES Act is the most recognized Covid-19 relief package, there have been four laws passed to date, not including President Trump's executive actions:
- Coronavirus Preparedness and Response Supplemental Appropriations Act (March 6, 2020)
- Families First Coronavirus Response Act (March 18, 2020)
- Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) (March 27, 2020)
- Paycheck Protection Program and Health Care Enhancement Act (April 24, 2020)
The total cost is about $2.6 trillion in stimulus spending and another $900 billion in tax relief. This $3.5 trillion is equivalent to 8.5 weeks of Gross Domestic Product (GDP) in the United States. This means if we produced no goods and services for 8.5 weeks, the stimulus packages would have fully replaced all our goods and services. Of course, the US still was producing goods and services throughout the pandemic. For the three months of April, May and June, GDP declined by a third. Since then, the economy has recovered, but not to pre-pandemic levels. According to my math, this means the four COVID spending laws replaced over 26 weeks of economic activity. This is one big reason why the stock market rose during one of the worst economic declines in our country’s history!
Another reason for the market valuation going higher is the Federal Reserve’s lowering of interest rates to basically zero and pledging to keep them low for the foreseeable future. Lower rates tend to stimulate the economy by allowing people and businesses to borrow money at lower costs for purchases such as houses, cars, buildings, and other goods.
My two friends, TINA and FOMO, have worked to push stock prices higher. TINA stands for There Is No Alternative, and FOMO is Fear Of Missing Out. With interest rates so low for so long, money in bank accounts are not earning enough to meet life’s goals. A 1% annual return on a 10-year Treasury Bond, a one-year CD rate of less than a half a percent, or .05% on a bank saving account will not be enough of a return to get your kid to college or for you to achieve your retirement goals. And if you are already retired and in the distribution phase of life, those rates will not allow you to keep up with taxes and inflation without going into principal to maintain your lifestyle. The low-rate environment now, and really since the Great Recession, has forced savers to become investors by moving some bank assets into the stock market.
FOMO has caused more speculation by making traders out of some investors. BITCOIN and investment firms like Robinhood are luring people to take on more risks and trade more frequently (the return of Day Trading) than they would have in “normal times”. A record number of Initial Public Offerings (IPOs) and Special Purpose Acquisition Companies (SPACs) also contribute to the more speculative feel in the market. I caution people not to let these developments sidetrack them from their financial plan or abandon proper asset allocation and sound diversification. Please, stay the course in 2021 and don’t try to overload your portfolio with whatever was red hot last year. That has typically been a formula for underperformance.
Finally, because the stock market as a leading economic indicator, it is always looking ahead. The progress made against this virus by the development (and the start of distribution) of several vaccines must be viewed as a strong economic light at the end of this long dark tunnel we have been living in for the last year. Of course, this development would not go unnoticed by the stock market!
Looking ahead, one of first items on President Biden’s agenda is a new round of stimulus with a price tag about $1.9 Trillion. The proposed package includes direct checks to most Americans, as well as more money for state and local governments for testing and vaccine distribution. Other items in the package include a $400 per week unemployment insurance supplement, raising the minimum wage to $15 per hour, expanded paid leave and an increase to the child tax credit.
Before you think that this is the first time the Federal Government has gone into debt, a history lesson is in order. In 1790, our first United States Treasury Secretary, Alexander Hamilton asked President George Washington that the Federal Government assume the debts held by the States for the cost they incurred from the Revolutionary War. The very young United States of America went into debt to the tune of $25,000,000.
Currently the United States can raise the debt ceiling and has the ability to borrow this money by selling bonds. This stimulus money will provide short term help for those in need and could boost stock market returns in the short term. But the private sector and private economic activity must replace Government stimulus money in order to keep these higher stock valuations. This money which has added to our national debt will eventually need to be paid back. For example, if I borrow on my credit card, I could spend a wild night buying everyone drinks at the bar (stay with me; this is a post COVID example). But after waking up the next day with the mother of all hangovers, I’d need to figure out how to pay the bar bill. I would need to work harder and longer to earn more and reduce my expenses to pay this bill. That is what the US will need to do some day. This much is clear, even looking at a defective crystal ball.
Thank you for your time and attention. We at NEC look forward to speaking with you and answering all your planning and investment questions.