The risk of economic surprises in 2021 increases. The good news in 2021 is that COVID-19 vaccines are rolling out quickly. This increases the prospect of the economy opening up soon. Meanwhile, the Democrats won the last two Senate races in the 2020 election cycle, so the chances of more aggressive budget spending to prop up the economy increase.
There’s an old Wall Street saying for the stock market that goes something like this: “Bad (economic) news is good news (for the market)”. We saw this dynamic game in spades in 2020. That gave us everything from a pandemic to dysfunctional elections to the murder of hornets. Despite these concerns, the S&P 500 closed at an all-time high on December 31stst!
While we’d all want to hear some good news in 2021, that begs an interesting question for investors as we head into 2021: Will stronger economic data boost the stock market even further? Or are we at risk that “good business news is bad news” for the market?
Do consumers have some catching up to do?
Finally, in late 2020, Congress passed a stimulus package that included another round of checks to be sent to consumers. While they were half the size ($ 600) last spring, many people were getting that money by the end of the year.
When consumers received their $ 1,200 checks last April, many people used that money to pay off debts. Total outstanding credit card debt is $ 100 billion lower than it was before the pandemic. This corresponds to about 1/3 of the total economic money spent. The remainder was used to cover the cost of living for those who lost their jobs or to work on home projects for those fortunate enough to keep working.
Since then, the economy has stabilized, making up about half of its losses in the spring. When new checks for USD 600 arrived in bank accounts in the last week of December, we noticed a quote from TGI Friday’s CEO Ray Blanchette:
“We’re actually doing much, much better in the last few days,” Blanchette said in an interview. He said the company noticed the surge “once those stimulus checks are made – talk about pent-up demand.”
Later in the article, Mr. Blanchette noted that TGI Friday sales increased 20% for the week after the stimulus payments were received. Talk about pent-up demand!
A chart we saw recently illustrates this pent-up demand well. This shows that the growth in consumer spending in the past year has lagged well below the “spending potential”.
With the introduction of COVID-19 vaccines, there is a “risk” that the economy will open faster than currently expected. In this case, there could be an increase in consumer spending. All because of how many people want to get back to normal.
How will the Senate’s democratic scrutiny affect the economy?
Two Senate seats remained undecided after the November elections, which resulted in a runoff election in the first week of 2021. What is at stake is: which party would control the Senate?
With President-elect Biden in office and Democrats taking control of the House, those races were big. Would Congress split, which would lead to more stalemate? Or would the Democrats take control and open the prospect of more spending?
With the Democrats winning both seats in Georgia, we have a party that controls the White House and Congress. Historically, this means that big laws are being passed. Here the Democrats have promised to send out another round of stimulus checks, this time $ 2,000 each.
To put the potential impact of these controls in perspective, the median family income in the United States is around $ 70,000, or $ 5,800 per month. When this new round of stimuli is over, a couple with two young children would receive $ 8,000. Which is a lot more than you would normally do in a month!
With the long nine months of everyone trapped in their homes, it wouldn’t surprise us if consumer spending spikes when this new round of incentives passes. The combination of people emerging from hibernation and having a handful of “free” money would likely lead to a surge in economic optimism.
Will good news be bad news for the market in 2021?
One of the toughest things about investing is that the stock market is not so much in the news of * today * as it is in the news it expects in the next 6 to 12 months. Last April we saw the severity of the economic damage becoming apparent. Several commentators said, “Why on earth is the stock market rising – the economy is just down 33%?!?!”
It’s a perfect example of why making buy / sell decisions based on the news you hear today is rarely a good idea. The exchange discounted this news weeks ago.
What drove the stock market to new highs in 2020 despite the economic turmoil? Answer: It was the promise and delivery of an exceptionally simple monetary policy from the Federal Reserve.
As I mentioned before In previous newsletters, the stock market is very sensitive to where Federal Reserve policy is going, not where it has been.
In recent years there have been two examples of the stock market correcting itself despite better economic times. In late 2015 and 2016, when the Federal Reserve was preparing to tighten monetary policy for the first time in years. Then the stock market suffered two 15% declines in 12 months.
At the end of 2018, the stock market fell over 20% as investors feared the economy could overheat. Tax rates for businesses and consumers alike were lowered, and the Fed accelerated short-term rate hikes.
Wayne Gretzky is famous for saying, “Go where the puck will be, not where it’s been.” With that in mind, let’s imagine what mid-2021 could look like if COVID vaccines are aggressively introduced. Small businesses are allowed to reopen. Restaurants, live music events, and travel reopen for the first time in almost a year. Do you think consumers will itch to get out and enjoy these things? What if they have an extra $ 2,000 in their pockets for each family member? Heck yeah, we might see a feeding frenzy in the summer!
When will the Federal Reserve tighten?
When the economy gets “hot” in the summer, we need to think ahead what the Fed might think. They made it clear last year that they expect interest rates to stay very low for several years. However, when the economy grows, so does the prospect of higher inflation.
Anyone who has done a home project in the past nine months knows that building materials and labor costs have increased. And for a good reason; If we are trapped at home, we may as well improve on what we have to see every day! Higher demand for something almost always leads to higher inflation.
It was clear to the Federal Reserve that they wanted to see higher inflation. Because of this, we expect them to keep short-term interest rates low over the course of 2021. But in all honesty, they are trying to get into a Goldilocks situation where inflation is rising, but not too much.
We believe the Fed is overestimating its ability to optimize the economy with so much precision. As we learned in the 1970s and early 80s, inflation cannot simply be turned on and off. Given the massive potential pent-up spending stimulus in the economy, we can envision a scenario where the economy will boom so much in mid-2021 that investors are concerned about Fed tightening. And when that happens, history suggests that the stock market may have trouble as this new “risk” is priced into the market.
Separation of the real economy from the stock market
I think the Fed and many investors too often see economic health through the lens of what the stock market is doing. However, we cannot ignore the fact that the top 10% of all earners in the US own 87% of the stock market wealth. There is a significant percentage of society who don’t care what stocks do because they don’t own stocks. Her aim is to find work every month and to make ends meet.
While the Fed has made no contribution to promoting wealth inequality, it has said that Goldilocks unemployment – the point where the labor market is so tight that it drives wage inflation – is lower than previously thought.
This leads to one of two possible scenarios:
First, the Fed is skipping the punch bowl longer in order to bring the unemployment rate to a very low level. This is great for workers, of course, but it also increases the prospect of inflation.
Alternatively, at the first sign of an overheating economy and a short circuit in employment growth, the Fed could revert to its old playbook of tightening monetary policy – either explicitly or implicitly.
Regardless of which of these scenarios takes place, we see an increased risk that a “good news is bad news” scenario will unfold for the market in 2021. As always, we don’t make portfolio decisions based on our assessment of where the market is going to go. However, we believe it is important to “know where the puck is going” so that we can look for potential investment opportunities in the future.