I want my
I want my MMT
I want my
I want my MMT
Now look at them yo-yo’s, that’s the way you do it
You change your policy to MMT
They ain’t workin’, that’s the way you do it
Money for nothin’ and your checks for free
As a variation on the Dire Straits song, “Money for Nothing,” we feel the above serves as today's policy theme song. Amazingly, it was only a few years ago we started hearing about the strange new tenets of Modern Monetary Theory (MMT), which many felt were just a pipe dream and not something that would materialize anytime soon. But all it took was a health crisis and “BOOM!”, we are living MMT right here and now.
Core Principles: The central idea of MMT is that governments with a fiat currency system under their control can and should print (or create with a few keystrokes in today's digital age) as much money as they need to spend because they cannot go broke or be insolvent unless a political decision to do so is taken.
Some say such spending would be fiscally irresponsible as the debt would balloon and inflation would skyrocket. But according to MMT, large government debt isn't the precursor to collapse we have been led to believe it is, countries like the U.S. can sustain much greater deficits without cause for concern, and a small deficit or surplus can be extremely harmful and cause a recession since deficit spending is what builds people's savings.
MMT theorists explain that debt is simply money the government put into the economy and didn't tax back. They also argue that comparing a government's budgets to that of an average household is a mistake. (Source: Investopedia)
Recovery on Steroids
This monetary experiment we are currently living in has been one of the primary reasons for the dramatic turnaround of events. A year ago, the COVID-19 crisis was beginning to pick up steam and optimism measured on many facets plummeted. In stark contrast to last year, we have a strongly recovering economy and, at least in the U.S., we have COVID-19 infections under control as vaccinations in our country are rising rapidly. In fact, according to JP Morgan estimates, they believe the U.S. reached 50% immunity last month as they also consider those who have been infected by COVID-19 and survived. Based on the rapidly rising vaccinations, it is conceivable that the U.S. may reach herd immunity as early as the end of this month.
Not only has the COVID-19 immunity in the country risen dramatically, so too has the overall economic recovery which, on several fronts, has surpassed pre-COVID activity levels. This is in no small part due to the unprecedented stimulus (the word “unprecedented” just doesn’t seem to quite fit anymore) from monetary and fiscal authorities in response to what some are now referring to the “Great Covid Crisis (GCC).” Consider the astounding apples-to-apples comparison of the response to the GCC relative to the “Great Financial Crisis” (GFC) of 2007-2009.
In the GFC, the cumulative hit to the economy ended up being roughly half the size of our annual economic output as measured by gross domestic product (GDP). The total budget deficit spending amounted to roughly 20% of GDP, recouping less than half of the economic hit. Under the GCC of 2020, the cumulative hit to the economy was under 15% of GDP and the total deficit spending amounted to roughly 25% of GDP. The stimulative response in the GFC was less than half of the overall economic damage, while the response to the GCC of 2020 has been double the magnitude of the economic hit and that doesn’t even consider potential infrastructure spending!
The massive response by the U.S. to the GCC has sped up the recovery compared to past downturns. For example, the GFC took a sledgehammer to consumer’s net worth which took five years for households to recoup what was lost and in terms of income, took nearly two and a half years for personal income wage and salary disbursements to recoup their prior levels. With the government performing helicopter drops of money and the Fed pumping trillions into financial markets, it took only six months for household net worth to eclipse its pre-Covid levels while it took 11 months for personal income to be recouped.
Spending Surge Underway
The U.S. consumer is now equipped with record savings and has been confined to spending mostly on goods versus services. For example, personal consumption on goods has not only eclipsed its prior highs but is now 12% higher in just one year. That feat took six times longer after the GFC. In contrast to durable goods spending, the prior peak for spending on services has still not been recouped with large swaths of the economy still undergoing lockdowns. As vaccinations surge, we are starting to see more and more of the country open and with it will likely be a surge of spending by consumers on services that were previously denied. There is a significant gap between household incomes and spending levels in both the U.S. and Eurozone that reveals plenty of pent-up demand to be unleashed in the coming months.
The U.S consumer is not the only one overflowing with cash and likely to engage in a spending surge, so too is corporate America. The combined cash level of S&P 500 companies is approaching nearly $2.7 trillion, nearly 50% higher than the 2018 peak that occurred after the Trump tax breaks. Due to the uncertainty of last year’s crisis, many companies held onto their cash to see them through it and now that we are nearly through the crisis we are likely to see corporate buybacks, dividend hikes, and acquisitions begin to pick up which will add further support to the stock market.
China's Credit Impulse
There will be plenty of support for the economy coming from the excess savings that have been accumulated over the last year, but we are also likely to continue benefiting from the stimulative efforts by the growth engine of the world: China. China continues to represent each year more of the marginal global economic growth. As such, China played a major role in digging the world out of the GFC through its explosive stimulus as well as its spikes in stimulus that helped get the world out of the 2011-2012 and 2014-2016 economic downturns. Similarly, when China begins to remove stimulus, it sows the seeds for the next global slowdown.
This process can be seen below when looking at Bloomberg’s Chinese Credit Impulse Index (black line) which measures China’s financial stimulus growth and leads the JP Morgan Global Purchasing Managers Index (red line below), which tracks global manufacturing. Peaks and troughs in China’s Credit Impulse lead peaks and troughs in global manufacturing with over a year’s lead time and argues for the cyclical recovery that began last year carrying into the middle of 2022.
The Chinese Credit Impulse Index also tends to lead peaks and troughs in the US Dollar (USD). When the global economy slows, capital flows into the US dollar as a safe haven and, conversely, capital flows out of the US dollar when the global economy is expanding. On top of the rapidly eroding balance sheet of the U.S. government, which tends to lead the USD and points to a bearish trend, the Chinese Credit Impulse also argues for a weak USD well into 2022 and is why we remain bearish on the USD and bullish on commodities.
Global Vaccination Rates
Shorter term however, over the next several weeks and months, we believe the USD is unlikely to fall significantly further and may even continue to rally. This is because, while the US and Europe began their recoveries around the same time last year, the US is pushing well ahead of its developed peers due to a faster vaccination schedule, which is allowing more and more of our country to reopen as we approach herd immunity (estimated around a 75% vaccination rate). According to Bloomberg’s vaccine tracker, the current pace of immunization will see 75% of the US population vaccinated within three months. Here are the estimates to reach 75% of the population vaccinated for other countries at their current vaccination rates:
- France = 10 months
- Germany = 8 months
- India = 16 months
- Italy = 11 months
- Japan = 7.3 years
- Mexico = 16 months
- Portugal = 12 months
- Spain = 8 months
Looking at the data above, it is clear to see that the US is well ahead most of the world and may see a faster economic recovery. This accelerated pace compared to other nations is likely to entice global capital flows into the dollar and keep it bid higher in the short-term. However, it is our belief that the slow vaccination schedule of the rest of the world will only delay but not prevent their own reopening surge of economic activity giving us an attractive entry point to further increase our exposure to cyclicals, commodities, and foreign stocks and bonds, which are likely to remain under pressure while the USD remains strong. Again, we believe this strength is likely to prove temporary and, as such, we will be using this as an opportunity to buy a dip in our favored areas.
More specifically, we are interested in increasing our exposure to the energy and financial sector as both are economically sensitive and stand to benefit from the economic recovery. Oil prices are rising while US crude oil production remains nearly 17% off of last year’s highs and the total rig count in the U.S. is 62% lower than last year’s peak. With the slow supply response from U.S. producers, oil inventories have fallen 8% from last year’s highs. Our belief is that demand for energy will recover faster than supply and lead to further declines in oil inventories which will put upward pressure on oil prices and energy stock prices.
The financial sector is under a vastly different operating environment from a few years back as the yield curve (difference between long-term lending rates of banks and their short-term funding rates) is at a 4-year high. The increase in long-term interest rates is likely to encourage banks to accelerate lending as their profit margins have been improving. A further catalyst that is likely to lift the banking sector is being cleared by the Federal Reserve to resume dividend increases at the end of June, ending pandemic-era restrictions that have weighed on banks. The restriction on stock buybacks will also be lifted for banks that clear the next round of stress tests.
As Good As It Gets?
Given the above, we are not in any rush to gain exposure yet to either the energy or financial sector as we feel the market is in much need of a breather and a recent study we conducted argues as much. We went back 30 years of history for the S&P 500 and looked at periods in which 95% or more of the index’s members were above their long-term moving average (as measured by the 200-day moving average), and found only three clusters in which this occurred, early 2004, late 2009, and April of this year. With the benefit of hindsight, we know that 2004 and late 2009 occurred within one year of a bear market bottom and the beginning of multi-year bull markets. The signal we received this month comes one year after the fastest bear market in U.S. history that we experienced due to the COVID crisis.
For clients that would like to see the details of that study they can watch our recent weekly investment video. The study suggests that we are likely to see weak returns for the market in the coming weeks, though longer-term returns out three months to one year show a higher probabilities of positive returns compared to normal time periods. We believe this study is likely to bear out and why we expect the market to cool off and provide us an attractive opportunity to put new capital to work.
Risks to the Outlook
The biggest risk we see in the coming months is a US economy that overheats, driving long-term interest rates higher after an already extreme move, and bringing forward the Fed’s discussion on when they will begin to slow their accommodative stance, particularly if inflation begins to heat up. There is a raging debate on whether the inflation spike we are about to get—due to year-over-year 2020 comparisons—will prove transitory, as the Fed believes, or will remain elevated and put pressure on them to ease up on the monetary throttle. If inflation does heat up and remain sticky, the exposure we plan to build in energy, commodities, and financials should serve as a hedge as they often perform well during rising inflationary periods.
There is also the risk that the increase in COVID cases in the rest of the world dampens global growth this year which would hurt cyclical sectors of the market. To address this risk, we maintain our neutral to slightly overweight exposure to the technology sector which has some of the strongest and persistent growth rates of the 11 sectors within the S&P 500.
Even if we have a setback due to rising global COVID infections, we believe that we are still early in the economic recovery and a COVID-related setback would only delay but not derail the global recovery and is why our longer-term outlook remains bullish at this time.
We hope our clients and their families remain healthy and strong and look forward to our economy reopening again so we can begin to return to our normal lives. If you have any questions regarding our portfolio strategy, please do not hesitate to reach out to your wealth manager.
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Advisory services offered through Financial Sense® Advisors, Inc., a registered investment adviser. Securities offered through Financial Sense® Securities, Inc., Member FINRA/SIPC. DBA Financial Sense® Wealth Management.
Copyright © 2021 Chris Puplava