By Mitchell Anthony
September 1, 2020
The Feds New Posture
Chairman Powell spoke at the Jackson Hole Economic Pow Wow last week about the Fed’s role in controlling inflation and made it clear to investors and financial markets that the Fed is prepared to let inflation rise over the intermediate term in order to achieve a full and complete economic recovery. The Fed believes inflation has been down and out for too long and in fact now recognizes that it acted in error in 2017 by raising rates aggressively when inflation began to ebb higher. The Fed’s actions slowed the economy then and now Covid 19 has slowed the economy even further causing historically low levels of inflation that the Fed is unhappy with currently. The Fed believes higher levels of inflation are consistent with a strong economy. The Fed believes that the last few years of ultra-low inflation must be accounted for when assessing inflation that is on the horizon. The Fed has been to vigilant in fighting inflation and so have other central banks around the world and as a result the globe has been mirrored in a period of ultra-slow growth with deflation in some areas. Just how serious is the Fed about letting inflation rise and to what extent will the Fed let inflation rise? This statement is a bit unusual from the central bank chairman we have grown to know. Comments about letting inflation rise would normally spark a rally in gold and other inflation hedges, however gold did not react significantly to the Fed statements nor did other commodity assets. Investors are becoming astute at reading the Fed and this time recognized that the Fed is not acting in a reckless manner and really just see him more aware of the need to allow this economy to progress. Stocks however did react and have pushed higher with comfort of a continuation of the current accommodative rate environment.
Financial Assets will Remain Highly Valued
This statement has significant meaning for the financial markets and assets in general. It provides further support to the position MACM has had for a long time which is that the globe is going through a very long period where financial assets are highly valued resulting from accommodative central bank policy and ultra-slow growth. Slow-growing economies just don’t produce inflation and that’s what we have had for many years. As a result stock prices have Quadrupled since 2009, real estate prices have doubled in most areas of the country, and bond prices have risen considerably as well. This statement by the Fed provides more reason to believe that assets will push to even higher valuations.
The real message from Powell’s statement is that the Fed does not plan to raise interest rates any time in the next several year’s even if inflation starts to build. As a result interest rates will stay near zero and Equity assets will remain the investment of choice for investors.
What Does The Fed Statement Mean To Gold And The Dollar?
As we are all aware gold is generally driven by expectations for inflation. Gold had significant moves after higher levels of inflation were seen in past economic cycles. This happened in the early 80s after we experienced double-digit inflation in the 70s, and again in 2005 after we experienced over 5% inflation in the 2000 to 2007 expansion. Then we had a further move in gold from 2009-2011 based entirely on EXPECTATIONS for inflation that came as a result of the extreme expansion of the feds balance sheet during the 2008 financial crisis. Gold has now in 2020 had a similar significant move without any inflation yet on the horizon. Is this move in gold likely to continue? We realize that Gold is bought for reasons other than for hedging inflation. Lots of investors think gold is a great hedge against economic disaster and purchase it when they are fearful of an economic collapse. Some of these doomsayers believe that gold will be the only form of currency that will have any value after a severe economic collapse. As a result these investors buy gold as a hedge against economic failure. Other investors buy gold as a hedge against a collapse in the dollar. These investors believe that the Federal Reserve action of printing trillions of dollars of new currency over the last few decades will ultimately destroy the value of the dollar and as a result think gold will be some sort of hedge against this collapse. The dollar has declined against a basket of other currencies approximately 7% so far this year as the Fed has printed approximate $3 trillion of new currency to purchase treasuries sold by the US government used to fund the fight against Covid 19.
The rally in gold paused over the last few weeks as Congress and the Senate struggle to reach terms for a second round of funding for Covid 19 relief. The Fed was ready to print another 2 to 3 trillion of dollars to enable the treasury to finance this record amount of stimulus. Now it is unclear whether we will have a second round of stimulus or if we do whether it will be as significant as the first round. As a result the rally in gold has paused as investors see evidence that the globe is absorbing the 3 trillion of new currency printed for the first stimulus package without further damage to the dollar or the creation of any significant inflation. This years move in gold from $1500 an ounce to almost $2000 an ounce has been entirely on the come that our economy will produce inflation ultimately over the next year or two. For this to occur Congress will have to act considerably more aggressive to reflate this economy than it has thus far. We already have an environment that will keep inflationary expectations high until it is clear how reckless Congress might get with spending. There are two views to consider: If the global economy recovers much faster than anticipated from this Covid 19 threat then the outlook for gold is poor and it may well have seen its highest levels of price for many years. However if the virus hangs around for several years and Congress is forced to continue to borrow and spend and stimulate than the dollar will weaken further and inflationary expectations will rise further, producing further upside in gold. Past gold rushes always seem to become euphoric and pricing gets out of control. This could well happen again. Given the difficulty in forecasting the virus it becomes very difficult to build a thesis for holding a significant position in gold. We currently have a 6% position in gold in our Dynamic portfolios. We believe our outlook justifies the position.
The Outlook for Equities?
The outlook for stocks and bonds is much easier given the Fed posture of accommodation. This position of the Fed is unchanged and has supported our significant overweight in stocks for the last several years. We don’t believe the new statements by the Fed really change our position that the Fed will be there for an extended period with accommodation. It would be easy to misinterpret the Fed statements as reckless and a position that might allow inflation to get out of control and terminate this long period of slow growth with the classic bust of the economic cycle because of euphoria. We believe the message to draw from the Fed’s statement is that the Fed will not act too early this time and shut down an ebbing economic expansion but will certainly act to curtail inflation before the economy becomes exuberant or out-of-control. AS A RESULT WE BELIEVE STOCK PRICES WILL REMAIN HIGHLY VALUED FOR AN EXTENDED PERIOD OF TIME. The best growth will be seen in secular growth names that have the wind at their back from the current theme of “do everything from home” utilizing every piece of technology available. As the economy gradually recovers from the Covid 19 obstacle the leadership from cyclical areas of our economy and markets will become more meaningful. Without secular growth names in your portfolio an investor would have lagged the markets performance significantly this year. However MACM’s significant overweight in secular growth names has produced over 1600 basis points of alpha for our clients this year. We currently have a modest position in cyclical names that we will be adding to opportunistically over the next 3 to 6 months as the economy gets through the Covid 19 environment.
We remain optimistic.