Economic Monitor: So Close, Yet Still So Far

BY: Mark Drachenberg


Sometimes, things can appear to be right in front of us, yet when we reach out to touch them, they remain just beyond our grasp. Such is the case with the economy, at present: It's opening up – Madisonians need only drive the Beltline in the morning or evening to attest to the fact that traffic has increased, a result of workers returning to their offices – but GDP has some way to go to make up all that was lost.

Employment will not be back to where it was for some time yet, and the full opening of stores and restaurants will likely take even longer. One wonders, though: Once the full “economic pie” is ready to again be tasted, will it be better than hoped for, or will a few bad ingredients ruin the flavor?

March continued where February left off, in terms of gaining ground since the January doldrums. Equity indices all moved higher during the month and were led by the Dow Jones Industrial Average, which saw a return of 6.78% during March. Value continued to gain on growth, as the NASDAQ squeaked out a gain of only 0.48%. Once again, the only negative on the board belonged to the Barclays U.S. Aggregate Bond Index, which posted a return of -1.25%, as interest rates continued to tick higher. Year-to-date, mid- and small-cap stocks lead the way at 13.47% and 18.24%, respectively. Last year’s big winner, the NASDAQ, is showing more pedestrian returns, as the index has gained 2.95% on the year. Volatility has returned, as the 10-year U.S. Treasury yield pushed above 1.60%, causing growth stocks' momentum to slow. This increase continues to stoke fears of inflation and the possibility that the Fed could alter its "easy money" policies sooner than anticipated. .

As the wait for a full economic reopening continues, there are several things to keep an eye on, including the amount of fiscal stimulus in, and coming to, the economy; taxes; and inflation, all of which could impact the markets.

The fiscal stimulus has been, quite simply, staggering: The CARES Act ($2.2 trillion), Consolidated Appropriations Act ($900 billion), and American Rescue Plan Act ($1.9 trillion) were all passed by Congress over the past 13 months. All of that is on top of what the Fed is doing with its bond buying, as well as other measures taken by federal, state, and local governments.

Savings rates have soared and credit card balances have fallen, as consumers had limited opportunities to utilize their stimulus funds. This is starting to change, as stores, restaurants, and travel opportunities become more available. Hotels are seeing an uptick in bookings, and places like Disney World are operating at or near their (limited) capacities. Even movie theatres are re-opening (though there is little new to see), and ballparks have people in the stands!

All of this affects the markets, of course – especially those areas that have been shut down for some time. This is why value stocks are gaining on growth (along with rising interest rates), and the fact that the rally is broadening is a good thing for investors. Future stimulus packages will likely include funds for infrastructure and possibly student loan relief. The former (estimates range from $2 trillion to almost $5 trillion) is particularly likely to pass, as it enjoys some bi-partisan support and will provide jobs and boost companies in the construction industries.

Unfortunately, all that stimulus is, at some point, likely to bring a hangover to the markets and the economy, unless it is paid for effectively. Taxes are likely to go up, but for whom? Corporate taxes were cut under the Trump administration, and that helped bring jobs home from overseas. That is likely to change under the Biden administration, as corporate rates are expected to increase to somewhere between 24% and 28%. Personal tax rates are a more complicated story. Rates for those earning under $400,000 likely won’t change much, but taxes on capital gains, dividends, and estates could hit home even for those in the middle class. From a market perspective, this presents a large cloud on the horizon. Taxes hurt the bottom line and would put pressure on earnings and possibly dividends, reducing overall returns to investors. Personal taxes, no matter the form, reduce disposable income and, therefore, spending. The collective impact depends on the rate of the increase and the timing. .

Inflation is another potential looming storm. When an economy is flooded with money, like the U.S.'s is now, history shows that inflation is around the corner. That can happen when wage inflation drives up prices, as employees demand more from their employers. It can also happen due to overwhelming demand, or scarcity, for products and services.

Wages are not currently rising rapidly due to employer need, unemployment numbers show. Additionally, labor costs are adjusting, as many remote employees have opted to stay remote and employers are finding ways to get by with less. The demand for goods and services will continue to increase dramatically as the economy opens up: Airfare, gas, hotels, cruises, theme parks, and more will see a significant bump, but things should settle as the initial enthusiasm fades.

The demand for cars is up, and that will drive prices up. Even rental cars are scarce in certain places, as demand outpaces the limited supply car-rental agencies have due to their inability to make new purchases. The housing market is a seller’s paradise, as too few homes are available to meet demand, and the price of lumber and other products limits demand for new construction. While the flood of cash into the economy will likely have long-term negative effects, in the short run, we there may be an initial spike of inflation that eventually settles down. Longer-term effects will erode purchasing power, and that is never a good thing for the economy. Hopefully, that's still a ways away.

Putting it all together, the economic picture is potentially very bright in the near term, but more troublesome in the long run. That creates volatility for the markets, as valuations are already somewhat extended – and if the market looks too far down the road, it may not like what it sees. There are ways to deal with it – such as the rotation into value stocks. Other potential tools in the toolbelt include short-duration bond funds and ladder CDs.

At this point, limiting one's exposure to interest-sensitive growth stocks will lessen some of the volatility. We have said, and continue to believe, that the first half of this year will see periods of heightened volatility, as news of the virus ebbs and flows, and inflation and interest rates adjust. As always, we will look for opportunities to take advantage of valuation disparities, diversify, and still provide downside protection.

We are here and available to discuss your portfolio or any other topic you'd like. Please send me an email or call us at (608) 826-3570. We look forward to speaking with you.

Related Blogs

Sign Up For Our Newsletter