Let us be grateful 2020 is finally behind us. No one saw the pandemic coming. We can at least enter 2021 with renewed hope for a better year. Two vaccines are currently being distributed, with a third due in early January. My 92 year-old father has had his first shot. Prospects for a better 2021 have been a significant driver for recent record market performance.
Many areas of the economy continued to perform through the crisis, which was reflected in consistently better results than forecast. As vaccinations are increasingly rolled out and more people carry immunity, the worst hit economic sectors will begin to recover, sooner or later. We are optimistic that this will provide the next leg up for investors.
Expectations for 2021
In many ways, society has been permanently changed by the forced protocols of 2020. Work-from-home practices will be a larger part of the work ethic. Our firm has successfully used videoconferencing to expand communication with clients, providing more frequent and personal meetings. It has also relieved all of us from wasted road time. Many will have been exposed to expanding telemedicine services. It remains to be seen how the retail sector will emerge, but the process of consolidation was severe for many firms, and familiar names have disappeared forever. And food delivery became the norm for many.
Our expectations are the economy will continue to rebound, and that is in line with most financial industry forecasts. Interest rates should remain low, which is bullish for housing and automobile purchases. Large SUV’s are being sold with up to 7-year loans, at prices more than double the cost of my first home!
One surprise in the past year is the US personal savings rate has gone up to exceed all highs for the past 60 years. This was of course helped by mandatory stay-at-home orders, and fear. The elevated savings should provide additional fuel for the economy as we loosen up in 2021.
Finally, adding to expectations for markets is the anticipation of an unending spending spigot from Washington DC. However, this gives us great angst for the longer term, as federal deficits explode to all-time highs never seen in the history of the republic. Unfortunately, one of the lingering effects of the virus is that we may be morphing our economy into a state of Zombie life over the longer term, similar to Japan for the past 30 years.
The Bugaboo – Unrestrained Spending
Forgive me for being the Bugaboo – it’s part of my job. Few investment strategists and other so-called experts, especially those on mainstream news channels, are willing to discuss the implications of unrestrained spending and debt. But it cannot be ignored in the context of the current trend, and future implications. We have received many questions from clients about this.
A familiar term found in the financial press is the emergence of the “Zombie Company” referring to highly leveraged firms which make little money, but survive by rolling cheap debt. They are like a Zombie, neither dead or alive. To their lenders, they are better off making just enough to service their loans.
The US Federal government is running deficits exceeding post World War II records in order to support a damaged economy. The pandemic accelerated a process where political expediency is overwhelming the longer-term economic health of the nation. If this continues, the US and the rest of the world face dire choices as the dollar faces a major devaluation – it has been falling for the past year. We are creating digital dollars by the Trillions. Before computers, this was called money printing. Today it is called quantitative easing, on steroids.
An expanding field of opinion called Modern Monetary Theory is promoted by some to deflect concern about expanding deficits. These experts go to great lengths to create the rationale to support it.
The only rationale that explains it is a global lack of political will to really do something responsible about the imbalance. And herein lies the danger – much of the budget is composed of entitlements – the will to control those does not exist. They kick the can down the road, but someday the road will end.
Raising taxes in a fragile economy is also risky. When you want the economic engine to grow, taxing it only slows it. While you may raise some taxes, the amount of taxes you would have to raise to balance the books is catastrophic. There are not enough billionaires.
If inflation rises, and interest rates on the debt follow, the debt compounds itself.
I won’t go further in the weeds on this. However, all of this leads to further devaluation of the dollar, which has been occurring for over a year. Everyone’s standard of living will fall.
The government and the Federal Reserve are backing themselves into an increasingly tight corner. Zombieconomy 2025?
Investment Strategy Implications
But wait, there’s more. Tesla now trades at a market value exceeding that of the 8 other largest car companies in the world combined, while selling a tiny fraction of cars by comparison. Almost all markets are selling at valuations well beyond the excesses 1929, 2001, and 2008. At some point, these valuations will correct.
Our asset allocation will be increasingly shifted on building inflation resistance into overall strategy. This will include real assets, commodities, and Treasury inflation-protected bonds, and a shift from gogo growth sectors toward value-based investments.
Let’s all get our shot(s), and work for a better tomorrow.