The financial markets are floating in a “sea of liquidity” these days, enjoying the calming effects of low interest rates, low inflation, mobility returning to the economy, COVID vaccinations, and corporate earnings rocking analyst forecasts. Furthermore, GDP forecasts for the US this year are in the +6% to +7% range. Fed Chairman Jay Powell has signaled the Federal Open Market Committee’s intentions to keep interest rates low and bond purchases (US treasuries and mortgage-backed securities) at the rate of approximately $120 billion per month. The U.S. Congress is also lending a hand with continued stimulus spending which may eclipse the $3.1 trillion federal budget deficit in 2020.
This macro-economic back drop paints a favorable picture for owning equities primarily in the U.S. but with European equities also poised for solid growth in 2021. The U.S. 10-year treasury has settled in around a 1.60% yield thus providing further support to equity valuations. Home values and housing starts are booming with analysts forecasting a persistent shortage of inventory. Industrial production and retail sales are also quite robust.
From a valuation perspective, equity P/E (price to earnings) ratios for the S&P 500 are high from an historical measure, but with interest rates at current levels some economists are predicting a year end S&P 500 target of 4,500 (versus current levels around 4,193 or another 7.5% of upside).
So why not relax and load up on equities and increase portfolio risk to maximize upside return capture? Well, Larry Summers, the former Treasury Secretary under President Clinton and Director of President Obama’s National Economic Council, characterized current U.S. fiscal policy as “the least responsible fiscal macro-economic policy we have had for the last 40 years” (see Andrew Davis, March 20, 2021 article in Bloomberg). Other economists have agreed and suggested current policies are the least responsible in the history of the United States!
And there you have it. We are enjoying unprecedented growth and continued innovation in our economy, but the ingredients are in place for downside risk from a surprise surge in inflation likely to trigger market dislocation and repricing in equities.
Most economists do not expect this valuation adjustment to occur until the end of 2022 or in 2023. However, markets are usually not so patient. Furthermore, we are already seeing signs that core inflation will jump soon from 1.7% to 2.5% and likely settle in around 3% in 2021 well above the Fed’s stated target of 2%.
Have you tried looking for a new car or buying furniture lately? How is your home renovation project coming along? Supply disruptions are popping up routinely, and inflation occurs when demand outstrips supply.
If we factor into the mix anticipated tax increases over the coming months, market shocks should be considered probable though perhaps not likely – think rogue waves on the calm seas of liquidity mentioned earlier. While not likely, they can occur with unpleasant consequences.
And what should one make of the rise of crypto currencies and the blockchain which have become almost a daily headline in our economic news?
Well, blockchain, crypto-currencies, NFTs, and DeFi have arrived and are gaining in scale and, therefore, highly likely to influence markets, economies, and finance going forward. Against this backdrop, Cassia Capital Partners will be reporting on the glossary of terms and all things crypto in our Trending section of this newsletter going forward.
In many ways, the rise of crypto and block chain is about the evolution of the future of money. It encompasses both the concept of “digital gold” and “digital cash.” It is a reminder that almost 4.2 billion people in the world are cut off from banking systems and living under authoritarian regimes with many experiencing inflation in their currencies of 200% to 300%. However, it is also about innovation in custody and payment platforms which can produce efficiencies and drive value in financial services.
Where else can you find a $2 trillion dollar asset class which interests the titans of Wall Street as well as dictators and crime bosses around the world?
The direct listing of Coinbase (COIN) in the public markets was a watershed moment in this space and will give Gary Gensler at the SEC a lot to consider when it comes to Bitcoin (BTC) and entities like Coinbase.
Stay tuned, but please know that Cassia Capital Partners is monitoring this space, and we believe our diversified and risk-based, multi-asset class approach to portfolio construction is a proven disciplined process for navigating the dislocation of innovation and meeting financial goals and objectives.