Market Outlook, 2nd Quarter 2021
April 7, 2021 | Sage Capone
Key Points for Retirement Planning with Hawaii Investors
- Fiscal Stimulus: The stimulus efforts are much larger than what was used to counteract the global financial crisis of 2008-2009.
- Interest Rates: The large stimulus plans are pushing up inflation expectations and in turn bond yields.
- Tech stocks: After a swift and strong recovery in 2020, tech stocks have been lagging in early 2021.
The U.S. fiscal response to the pandemic has been very aggressive. The $1.9 Trillion coronavirus relief package announced in March, makes it an estimated $5.2 Trillion in U.S. fiscal response to the COVID-19 pandemic. U.S. fiscal spending in absolute and relative terms has been larger than most other countries. Fiscal spending is intended to support the economy while it recovers from the loss of GDP (the broad gauge of the economic activity).
According to economics Professor Christina Rommer, fiscal spending during the Great Depression was relatively minor for the magnitude of the massive drop in economic activity. One program did work well, Veteran’s Bonuses. In the 1920s, veteran’s of World War I, were promised a bonus to be paid in 1945. Given the hard conditions of the depression, Veteran’s lobbied to get the bonus paid early.
In 1936, Congress approved the bonus payment, at an average of $547 (about $10,000 in today’s dollars) per veteran which amounted to about 2% of GDP at the time. As expected, those bonuses, similar to stimulus payments helped economic activity in 1936 and into 1937, before a harsh recession developed in 1938. The 1938 recession is seen by many economic policymakers as a policy err that favored the reduction of the federal budget deficit, rather than supporting economic activity.
Policymakers today are well aware of the risk of fiscal policy contraction given today’s unique circumstances. The policymakers are not going to make that mistake today. The mood is that any policy err will err on the side of overstimulating the economy. To put this in perspective, consider that the fiscal spending to counteract the Global Financial Crisis was larger relative to the size of the economy than the fiscal spending during the Great Depression. The chart below shows just how strong the fiscal spending today has been compared to the Global Financial Crisis. The pandemic recession had only one-fourth of the loss in cumulative GDP of the Global Financial Crisis, but has received more than four times the fiscal spending to support economic activity! [See Figure 1]
Figure 1: Fiscal Response
Professor Christina Romer has had a distinguished economic career since graduating from M.I.T. with a Ph.D in economics in 1985. She has authored many research papers on a variety of economic topics. She is very influential in the field of economics and economic policy making. The topic that has largely influenced her policy recommendations is her research into the Great Depression.
She strongly believes that the reason deflation (declining prices) and declining economic activity took hold during the Great Depression was because of consumer expectations. Consumers came to believe that prices would keep declining. For example, if a consumer liked a piece of furniture at a store, they would wait a few months and the price would be lower. This caused low sales, which made businesses hesitate to invest and employ for the future. Which in turn, made employment unpredictable, further dampening consumer expectations.
Romer believes that when used, policy action should be strong enough to change expectations, not just to maintain conditions. If the stimulus efforts are too small it will not be enough to get the economy through to full recovery and consumer expectations will not adjust accordingly. It seems that the stimulus efforts have now been large enough to change expectations. While the stock market recovered during the last year, interest rates remained at crisis low levels through 2020. However, since the start of this year, interest rates have risen sharply reflecting an expectation of faster economic growth and higher inflation. The 10-year treasury yield was 0.93% to start the year and jumped to 1.74% by mid-March. [See Figure 2].
Figure 2: Interest Rates
As a reminder, bond prices decline when interest rates rise. So while this increase in interest rates may be optimistic for economic growth, it is short-term negative for bond prices. Bonds are a major asset class and play an important role in diversified portfolios. As bond yields rise, forward returns for bonds rise as well because interest income increases. As bond yields stabilize, the interest continues to accrue helping to offset declines in bond prices.
After a swift and strong recovery from the market lows in 2020, technology stocks have been lagging in 2021. The rise in economic expectations has shifted the market expectations from favoring tech stocks or growth stocks to favoring economically sensitive stocks or value stocks. The market has shifted from favoring growth to value stocks. These rotations occur rather abruptly and given growth’s large outperformance last year, in the first quarter, value showed its best quarterly relative performance in 20 years. [See Figure 3]
Figure 3: Growth vs Value Stocks
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