Rollout, Recovery & Remnants

The Monthly Five Author Avator

Katie Nixon, CFA, CPWA®, CIMA®

Chief Investment Officer, Northern Trust Wealth Management

January 15, 2021

Your Questions Answered

As the world anxiously awaits a turn toward recovery and normalcy, investors wonder what economic remnants the pandemic will leave in its wake. Will stimulus bridges be long enough for those hit hardest by economic fallout? At what point does deficit spending become a crisis in and of itself? Once unleashed, will pent-up demand lead to soaring inflation? Below, we address questions on this next market landscape as well as the vaccine distribution phase upon which it rests.

1

What are your expectations for a new COVID-19 relief package under the Biden administration?

President Elect Biden has released details of the heavily anticipated next COVID-19 relief package, and the proposal includes broad-based support for the economy. Importantly, it includes financial relief for households through direct payments — completing the “down payment” of $600 from the last package — and extended and expanded support to the unemployed. It is critical to recognize that the pain on the employment front continues to deepen, with weekly jobless claims data pointing to steep job losses at a pace we have not seen since the Global Financial Crisis. The data tells a familiar story: As COVID-19 cases surge across the globe, those “face-to-face” workers concentrated in the leisure and hospitality industries are the most impacted. Whether by mandate or choice, consumers are staying home. As we see a direct correlation between mobility and COVID-19 cases — that is, the more mobility rises, the more cases rise — we expect to see continued reticence on the part of the consumer until we have broad vaccine rollout. Consumers will just stay home. Given that premise, additional stimulus and support to households will be needed to fortify and lengthen the bridge to recovery.

The stimulus package proposed also includes support to state and local governments, support for vaccine rollouts and a doubling of the federal minimum wage, to $15/hour. While it is unlikely that Republicans will agree to this package as designed, we do expect a package in the $1T area. The focus will likely be on support to households, which will have the most immediate and positive impact on the economy, and can be implemented quickly.

2

I am reading about a possible “taper tantrum” again. Why?

Fed Chair Powell took pains to walk back recent remarks from other FOMC members that seemed to indicate the time to reassess the Fed’s QE program may be nearer than investors thought. As some policymakers expressed confidence in the 2H 2021 economic recovery, investors began to reprice Fed policy and, consequently, drove longer-term interest rates higher — primarily as a function of higher inflation expectations. On Thursday, Chair Powell revisited the theme of his comments from 2020 about “not thinking about thinking about” raising interest rates, commenting that there would be a time to raise, but it is “no time soon.” While he tried to tamper down taper concerns, the market chose to focus on his recovery reflection, which he characterized as coming “sooner than feared” — and rates on the 10-year Treasury, which had been falling, recouped ground, to end over 1.10%. We continue to believe that rates will be “lower for longer” and that the Fed’s balance sheet will be “larger for longer.” Importantly, the new Fed framework of average inflation targeting allows inflation to run higher than the target for some time — a condition that the Fed would, frankly, welcome, and be reluctant to quash.

3

At what point does all the deficit spending from stimulus packages negatively impact interest rates, the U.S. dollar and inflation?

To channel Chair Powell, we would say “that day is not today.” We have been concerned about the growing debt and deficit spending not only in the U.S., but globally, for quite some time. The pandemic has led to an explosion in global debt as governments struggle to support economies during an extremely difficult period. Much of the debt that has been raised has been aimed at income replacement policies, not long-term productivity-enhancing projects. This indicates that the pick-up in debt will not be accompanied by an increase in global growth. Importantly, however, much of the debt has ultimately found its way onto central bank balance sheets — clearly, friendly hands. We do worry longer term about the implications of this ballooning debt and the heavy reliance on low interest rates to maintain debt sustainability. Ultimately, the growing debt load supports our “stuckflation” thesis, whereby we expect long-term inflation to undershoot expectations.

In terms of the dollar, while we are amid a period of dollar weakness today given a long stretch of dollar dominance, we don’t expect significant weakening of the greenback. Like most financial assets, the value of the dollar is relative. While the U.S. has built up considerable debt during COVID-19, we are, unfortunately, in good global company.

4

How would higher-than-expected inflation impact my investment portfolio? Should I make any changes to my allocation to prepare for this risk?

The inflation outlook is perhaps the most important component of any forecast today. While we have maintained our longer-term view that inflation will remain suppressed by the combination of high debt, challenging demographics and continued tech innovation, we acknowledge that this thesis will very likely get tested later this year as economies re-open in earnest — with upside surprises possible given the fiscal stimulus that is anticipated. We do anticipate a surge in pent-up demand as consumers get out and spend, with the fuel for this surge being the elevated savings rate — which could, by some estimates, represent nearly $1.7 T in “excess savings.” This demand surge may meet some supply challenges as companies struggle to resume operations, and we do anticipate that this may drive a temporary inflation overshoot. The Fed agrees and has been explicit that policy would not react/overreact to a short-term bounce in prices.

We believe that, over a short time frame, businesses will be able to rebalance supply and demand, bringing capacity onstream and tempering inflation. That said, we are watching carefully. If inflation does overshoot, and if investors begin to believe that this is the beginning of a real reflationary cycle, we would expect interest rates to rise, perhaps in a disorderly manner. That would provide a headwind to risk asset markets. The question would be: How will the Fed react to this tightening of financial conditions? We believe that the Fed would likely take action to control interest rates. So while we don’t anticipate sustained inflation, there are ways for investors to imbed inflation protection into their portfolios “just in case” and, in the meantime, also position their portfolios to benefit from the 2H 2021 economic rebound. We recommend natural resource public equities.

5

Given the slower-than-anticipated vaccine rollout, how have your expectations for economic growth and stock market performance changed?

We are watching closely the vaccine rollout, and it is indisputable that the early experience has been underwhelming. We are seeing a stronger logistical backbone after these early fits and starts, however, and we anticipate that the pace of vaccinations will accelerate — not only the pace of distribution of the current Moderna and Pfizer vaccines, but also that additional vaccines will become available. The Johnson & Johnson vaccine, which requires only one dose, will be incredibly helpful in accelerating vaccinations. Under the best of circumstances, however, we believe it will take months to have a critical mass of citizens vaccinated. Importantly, the prioritization of our most vulnerable in the vaccine queue means that we will see declining hospitalizations and deaths even during this vaccination period, which may allow for staggered re-openings of economies.

We continue to anticipate a 2H recovery in the global economy, and investors are clearly pricing that into equity markets today. The risk here is one of timing, and the recovery may be later in the 2H than we had anticipated prior to the COVID-19 waves and vaccine issues. For investors, we believe the market will be patient. Interestingly, and as we sit in front of 4Q earnings season, we are anticipating that companies will beat Wall Street estimates, which will lend more confidence to the earnings picture for 2021.

Disclosures

This document is a general communication being provided for informational and educational purposes only and is not meant to be taken as investment advice or a recommendation for any specific investment product or strategy. The information contained herein does not take your financial situation, investment objective or risk tolerance into consideration. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. Any examples are hypothetical and for illustration purposes only. All investments involve risk and can lose value, the market value and income from investments may fluctuate in amounts greater than the market. All information discussed herein is current only as of the date of publication and is subject to change at any time without notice. Forecasts may not be realized due to a multitude of factors, including but not limited to, changes in economic conditions, corporate profitability, geopolitical conditions or inflation. This material has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed. Northern Trust and its affiliates may have positions in, and may effect transactions in, the markets, contracts and related investments described herein, which positions and transactions may be in addition to, or different from, those taken in connection with the investments described herein.

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