It’s been a while since we’ve released a fundamentals update, so we thought we’d roll up our sleeves and dig into the numbers in this quarter’s KnowRisk report. The better we understand the exact mechanisms involved, the better we will understand short-term economic development.
As we all know, COVID19 and the subsequent government / health closures have had a major negative impact on the economy. In economic terms, factory closures lead to a decline in the supply of many products, while at the same time demand patterns have changed, such as the closure of much of the travel and restaurant industries. . The net effect ended with a decrease in US GDP of $ 500 billion or 2.3% for the year, which would have been considerably less without government intervention. As a benchmark, GDP growth was -2.75% in 2008. To avoid the risk of triggering a negative feedback cycle, the government took three major steps: Congress funded $ 5,335 billion in trade revenue and personal (including the recent US bailout), the Federal Reserve government funded $ 2.7 trillion in purchases of government and corporate bonds, and the Fed cut interest rates from 1.5% to zero.
So where are we now?
These actions were successful in the following areas: stock prices generally rebounded and continued to rise, companies raised a large number of debt while debt levels fell (due to the surge stock prices above debt levels), and US households have managed to store $ 1,600. billion in savings (source: Bloomberg and shown at the top of the congressional spending bar on the graph). Some government interventions are still in place. For example, the Fed continues to buy an additional $ 120 billion in treasury bills and mortgages per month. The latest round of stimulus is still underway in the economy. Finally, segments of the economy remain constrained both by the government and by a slow return in demand.
Normalization will have predictable effects on the future economy. With the assumption of some degree of mean reversion, we can uncover clues about the future. Continuous vaccinations and natural immunities lead to continued economic normalization. As government payments cease and businesses increase their capacity, unemployment will continue to decline. The US bailout will continue to impact spending, and Americans will spend some of their surplus savings. These three factors all work in harmony to increase the “demand” side of the equation. Keep in mind that the size of consumer savings is currently 3 times the GDP gap of last year. On the ‘supply’ side, as we hope the worst COVID shutdowns are over, we fear shutdowns due to shortages are on the rise. We are seeing this currently with the shutdown of auto factories due to missing computer chips, which are expected to last at least a year. With rising demand and uncertain supply, the potential for price increases, also known as inflation, is high.
The recovery was also very uneven. Oxford Economics estimates that the top two income quintiles in the United States have all of the $ 1.6 trillion in additional savings. In terms of sectors of the economy, the US real estate index “FTSE NAREIT” has just returned to levels from February 2020 to April 2021, while the NASDAQ Tech index has gained more than 80% over the same period. The price of wood has increased even more dramatically. Government bonds, one of the most stable asset classes, lost -4% for the year ending March 31, 2021, as long-term debt fell -16% for the year. same period. Worryingly, margin debt has increased significantly, which may be indicative of speculation in the market. Low interest rates contribute to speculation, as uncertain future payments are worth more in the present than they would be with higher interest rates.
The movement in bond duration was particularly dramatic in the first quarter, causing almost all of the loss. Although the Fed again promised a longer cut, the market decided to disagree by betting on a faster rate hike. With rates this low, we remember several KnowRisk reports we wrote in 2012 when rates were at this level, including one with the appropriate title “No Return Risk”. It is available on our website (www.equitas-capital.com/research) and deserves a proofreading. The Federal Reserve has at least two separate tools to manage this. Their next step will be to end their purchases on the open market. When Ben Bernanke, then chairman of the Federal Reserve, mentioned the end of these purchases in 2013 after the financial crisis, interest rates rose briefly. After that, the Fed can also cool the economy (and presumably inflation) by raising interest rates. However, we must remember that they have been promising not to do this for some time. Regardless of whether rate hikes happen sooner or later, the change will hurt long-dated bonds and stocks that anticipate future payments, while shorter-dated bonds and companies that earn more today with growth. slower will appear more attractive. According to Jamie Dimon, CEO of JPMorgan
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