It's Not Over Till The High-BMI Lady Sings, or Market Narratives For 2021's Second Half
Market Narratives continue to dominate market behavior as we progress through 2021. If you are not familiar with the application of narratives to market analysis, I suggest you do a quick internet search of Nobel prize-winner Robert Shiller and his writings on the topic. In 2017, Shiller published a paper called Narrative Economics which was an effort to introduce concepts from sociology, anthropology, and epidemiology to economics. In particular, he explained how narratives and ideas could affect markets and economies. Narratives spread like a virus. They may be quietly present in the population causing no trouble, then at times spread wildly affecting markets both to the upside and downside. This is a psychological phenomenon that may only be slightly related to changes to underlying economic fundamentals.
In recent years, the Market Narrative has been dominated by the Covid-19 pandemic and the government response to the disease outbreak. In particular, we have seen very heavy-handed monetary stimulus from the Federal Reserve. Interest rates were cut to zero and quantitative easing was restarted as the Fed stepped in to buy $120 billion of Treasury and mortgage bonds each month. Similarly, Congress produced its own heavy-handed stimulus in three large buckets: the $2.2 trillion Cares Act, the $900 billion Appropriations Act of 2021, and the $1.9 trillion American Rescue Plan Act of 2021. Additionally, regulators created moratoriums on evictions, mortgage, rent and student loan payments.
The results are plain for all to see. Unlike past recessions, where people lost their jobs and spending fell, consumer spending skyrocketed as their personal cash flow situation improved dramatically from lower housing costs and supplemental unemployment insurance. The National Bureau of Economic Research recently announced that the Pandemic Recession of 2020 was a two-month affair, making it the shortest recession in recorded history. Recent readings of high inflation and widespread supply shortages are evidence that consumers are flush with cash and eager to spend.
This background is important because the Narrative is changing. The Federal Reserve is under political pressure to do something about high inflation by either halting quantitative easing or raising rates. Congress is struggling to pass a new spending bill that is a shadow of the $5 trillion already spent. Many of the debt and rent forbearance policies are winding down as supplemental unemployment insurance gradually expires. It is deeply ironic that the Fed may be forced to modify its stimulus policies just as fiscal stimulus expires. This may be an accidental simultaneous contraction of monetary and fiscal policy.
Incidentally, little-discussed tax policy changes are also imminent. So far, the proposals are modest, but some concepts addressing long-term capital gains taxation may be problematic for investors. Tax increases are typically a drag on economic and corporate earnings growth.
There is some evidence the markets are getting ready for these scenarios. Long term US Treasury bond yields have fallen dramatically since peaking in the first quarter. Tesla, bitcoin, and lumber have significantly declined after being the focus of speculators in 2020 and 2021. Housing starts have unexpectedly declined in June after a frenzy of buying activity in the housing market. The stock market continues to sail higher with the stock prices of the largest companies: Facebook, Microsoft, Amazon, Google and Apple. For international stocks and small caps, the story is ok, but performance is weaker.
The Market Narrative will focus on changes to Fed monetary and Congressional fiscal policy. It will not wait for these changes to show up in company earnings numbers or gross domestic product. So, keep an eye on headlines involving the Fed, Congressional spending and tax policy proposals as we move into the second half of 2021.
Robert Lloyd, CFA®
Chief Investment Officer
Lloyds Intrepid Wealth Management
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