The Outlook with the Dems in Control?
By Mitchell Anthony
January 18, 2021
The Democrats have taken control of the Senate and hold it along with the house and the presidency. While a Biden victory was expected by many, control of the Senate by the Dems was unexpected by most investors and market strategists. Democrats have a history of taxing and spending that has frightened investors concerned about the fragile state of the US economy!
The Outlook for the Economy and Markets Under New Political Leadership
What is the economic outlook and financial market outlook with this sort of political backdrop? With the financial markets broadly at all-time historical highs it would seem that investors believe that the environment will remain stable and friendly to both the economy and the financial markets. Risk assets are highly valued despite the obvious fear of higher taxes and spending. These valuations are a product of expectations for inflation, central bank policy, and economic growth. All in the ideal zone currently. Investors have grown uncomfortable that this nirvana environment may not continue.
Expectations for the political environment ahead have investors concerned that the status quo might be under attack. However it seems that the primary objective voiced thus far by leaders of both parties remains focused heavily upon leading this nation out of the pandemic that has gripped the world and our economy for the last year. The cost of backstopping the US economy from the perils of this pandemic has been tremendous and undoubtedly has put the agendas of Republican and Democrats on the sidelines until the US economy is on a path of sustainable growth again. As a result we do not expect obstacles to be put in front of the goal of bringing about a recovery of the US economy. As the globe struggles to get consumption and demand up there is not much risk of inflation in the world. Consumers are just not chasing goods and services in a manner to produce inflation. Discretionary earnings are being saved and not spent and as a result monetary policy is driving up assets prices. Central banks around the globe have never been more committed to a cause than they are to seeing the global economy through this pandemic. Central banks will be there buying up whatever debt needs to be issued by governments for the stimulus required. As a result interest rates will remain zero for several years. What is unknown however is the outlook for growth and whether it will be negative, modest, or moderate. It would seem that modest would be the best probability bet.
Risk Assets will Remain Highly Valued
Given this backdrop of low-inflation, accommodative central bank policy, and modest growth it is clear that risk assets will remain highly valued because of these fundamentals. Equities, real estate, and fixed income are all at historical high valuations. They will undoubtedly remain there until there is exuberance in our economy again that produces inflation and a higher interest rate environment that could drain money from these highly valued assets. Of the three asset classes I believe equities offer the best value given the outlook for earnings of secular growth names as well as the outlook for earnings for cyclicals tied to entertainment and leisure. With an abundance of stimulus already in the US economy as well as high expectations for more, consumer confidence will undoubtedly rise from current depressed levels as Vaccine distribution is carried out. This combined with expectations for accelerations in corporate earnings will undoubtedly push equities higher.
We expect strength in domestic equities as well as Asian emerging markets. The FAANG which has been under some selling pressure for the last five months will likely gather strength again as fourth-quarter earnings are reported over the next two weeks for these corporate American superstars. It is reasonable that all five companies will beat expectations.
There is another emerging group of American stars involved in new emerging industries that I have labeled the SIFI (Sexy, Innovative, Fragmented Industries) that have been leading their more mature counterparts in the market this past year, but not without risk as these SIFI’s will consolidate and there will be collateral damage to the ones that are out-innovated. The SIFI would include industries with high and rising expectations like digital payment, electrics, biofuels, cybersecurity, Gyms from anywhere, virus killers, digital productivity, and personal protection equipment. Companies that look interesting would include PTON, CRM, SQ, PYPL, MRNA, CRWD, NIO, and Zoom. Some of these names may be experiencing a perfect storm with positive effects, while others may have found the storm to have offered an opportunity to sustain and better position themselves with demand that was pulled forward.
The Chinese markets also look attractive because of their rising presence in e-commerce and digital devices. We have already begun to invest in these areas through exchange traded funds.
Interest rates have pushed higher over the last several months as economic recovery has been anticipated and the Fed has laid low and surprisingly allowed long term rates to rise 50 basis points or more. The big unknown is how fast this economy will get back on its feet and as a result the interest-rate environment may be a bit volatile in the year ahead. The 10 year treasury could well fall to near zero over the next few months as the virus continues to grip the world. Conversely the 10 year treasury could stay over 1% until the Fed begins the next round of quantitative easing. Either way the upside in treasuries is not too appealing as the total return looks modest at best unless you are an extreme pessimist about recovery.
The US Economy will struggle as vaccine distribution begins with lots of unknowns but undoubtedly will be accompanied by rising consumer confidence. Containment of Covid 19 remains challenging as the 2nd wave accelerates across America. US hospitals are close to capacity in most states. The US Infection rate is at an all time high, and unfortunately the Death rate in US continues to make new daily highs. The respect from the US population for the virus is highly divided with a lot of disparity among states and cities across America. Vaccine distribution is underway with a sketchy time frame for distribution. Thus far we have been doing 1 million shots/day, however logistics are impacting distribution. Elderly and health care providers have already been vaccinated, and the next in line are 65 & older and Essential business employees. There are also worries about new strains of virus that are occurring but seemingly are addressable with the current Vaccine.
The US Economy is recovering in volatile manner, after a smaller second round of planned fiscal stimulus passed and is now under implementation, with $600 checks and an unemployment boost of $300/week. There is another round stimulus coming, with another $1400 of helicopter money, as well as a boost to $400/week in unemployment for longer.
Other economic data to note: Consumer Confidence has fallen back to March lows, Personal Income remains high at 19.5 Trillion but is falling back to trend. Unemployment remains high at 6.7% down from 7.9%. Corporate profits are back to pre-Covid highs. Retail sales are steady and at all-time highs. (pg. 4, figs. 1-4) Some areas of the economy are still dead – business travel, cruises, Broadway and live entertainment. Weak areas that are rebounding a bit would include energy, commercial real estate, hotels, and airlines. Manufacturing is rebound nicely with autos, durable goods, appliances, and consumer electronics seeing strong demand. Tech and e-commerce are obviously enjoying an ideal environment.
Financial Markets Made New Highs With Stay At Home Leadership
US Equities have led all asset classes for the last quarter and Year. The Leadership broadened in Q4 to include Domestic Value, Emerging Markets, and Small Caps. For the Quarter the SP500 advanced 12.1%, the Russell 2000 gained 31.3%, MACM Dynamic Growth gained 9.7%, and MACM Diversified Equity gained 11.2%. For the Year the SP500 advanced 18.4%, Russell 2000 20.03%, MACM Dynamic Growth 31.1%, and MACM Diversified Equity gained 42.9%. Foreign Equities lagged badly as they lack share of big cap tech and are not players in e-commerce. For the quarter Gold gained a mere .33%, REITs gained a respectable 6.9%, Fixed income was flat to down, while Distressed debt gained with HYG up 5.7%. Value stocks caught up a bit in Q4 with large Cap value IWD advancing 16.3%, compared to Large Cap Growth IWF gaining 11.4%. However for the last year IWD gained a mere 2.7%, versus IWF advancing 38.3%.
Economic Outlook
I believe current trends will continue with some modest change. I believe tech demand will continue, travel and entertainment demand will return as the vaccine is distributed and found to be effective. At the same time home construction and home remodel will lead the industrial sector as the interest rate environment remains ultra-friendly. It would seem that Protectionism may well be in decline with the Dems in control creating a better environment for Chinese exporters. There are some new trends that are on the horizon. Mild improvement in business travel, demand for energy will improve with better global growth, pent up demand is building in entertainment & leisure, and there will be increased demand for healthcare as Dems seek to expand Healthcare affordability. Consumption of products from sexy innovative fragmented industries will accelerate further as the storm plays out for these opportunistic companies.
Financial Market Outlook
Risk assets will remain highly valued with no competition from risk-free assets on the horizon. Prices will move higher has monetary policy inflates markets further. Inflation of goods and services will remain bottled up. Demand for goods and services will improve but on a slow to moderate pace that will not be inflationary. Fed policy will remain accommodative – rates near zero to continue. Domestic Equities and emerging market equities will lead, fixed income will likely be flat, gold lower, and REITS higher. This is not a time to be on the sidelines as the trillions of dollars that the central banks are printing will undoubtedly flow into stocks and other risk assets pushing them much much higher. We remain optimistic.
We remain optimistic.