The US Economy seems ready to explode in activity with so much pent-up demand to travel, eat out and basically socialize. Towns and communities are returning back to form. Freeways are crowded. This Summer is expected to bring increased spending and economic activity not seen since the 1980s.
The Market knows it, and has gone a long way to price it forward. The Fed sees it, but isn’t convinced that it’s sustainable. The White House wants to keep throwing money at it, in order to upgrade the nation’s infrastructure as well as sprinkle funds broadly in other areas. It’s all inflationary, which has caused a push-pull event for the Market. It might not have been evident by looking loosely at the Dow and S&P, which have continued to hit fresh, all-time highs. Below the surface of the Stock Market has been a rapid rotation of strength as well as substantial corrections within the fastest growing momentum stocks.
The economic recovery hit a seeming snag in April. Or did it? It was reported today that only 266K jobs were created last month, well below the 1 Million expected. The April hiring boom was a bust. March was revised lower too and the unemployment rate rose to 6.1%. This was quite a surprise. The yield on the 10-Year Treasury Bond immediately fell, as did the Dow, while the Tech-heavy NASDAQ soared. They reversed direction a bit midday, and all 3 ended the day higher. There was a lot to study and extract. That’s always the case.
The thinking is that the Fed is going to remain quite supportive for longer, something the Market had been starting to question. The Fed has not waivered one bit from its commitment of support, but the Market was calling its bluff, thinking a taper was coming sooner. It makes no logical sense for the Fed to keep rates near zero and continue pumping more money into the system when the Stock Market is at all-time highs and the US Economy is about to grow at the fastest rate in 4 decades. Not after this report. The issue is temporary versus sustainability, as it pertains to inflationary pressures and economic growth. Look around you; There’s inflation everywhere. The current bullish sentiment has been reflected in expectations of a rapid economic rebound from the pandemic, as well as promises by the Fed to keep rates near zero through 2023 (not to mention the $120 Billion per month in asset purchases). There’s no reason to believe that has changed.
There was some economic contradiction in this Job Report, resulting in a lot of head-scratching as to why. The reopening of America continues to gain momentum. Businesses keep opening further as the vaccinations expand. Job openings are growing as employers look to fill roles to meet demand. Of course, many workers are still concerned about the pandemic. There was an estimated 1.6 Million workers that want a job but didn’t actively look last month because they were still concerned about contracting the virus. There’s also the issue of childcare and schools not being completely back and open, limiting participation in the labor market. That’s certainly a real issue, which won’t be fully addressed until back to school in the Fall at the earliest. There’s also this: Questions are growing as to whether the major stimulus package passed through Congress earlier in the year disincentivized work. In many cases, Americans are getting paid the same or more to stay home. A study done by the Economist suggests that 40% of Americans are making more money collecting unemployment than they did at work, pre-Covid. That’s a significant issue. They might not be working, but they’re definitely spending. Strong retail sales reflect it.
US GDP grew an annualized 6.4% in Q1. It’s officially the fastest-growing US Economy since the Reagan era. It came from low levels in the pandemic. But the recovery is real. Many on the Street believe 8%, even 10% growth is doable for 2021. Consumer spending exploded by 41% on durable goods like appliances and other long-lasting purchases. Personal incomes grew 21% in March. The $1400 stimulus checks had a lot to do with that. How about this stat; 34% of personal income in 2020 came from the government, in response to the pandemic. These extra benefits expire in September. The Covid Relief package was paid for completely with borrowed money. The plans for additional spending are based on higher taxes, in the form of higher rates on Corporate America, top earners and capital gains. It’s coming with a great deal of resistance, from many circles within both political parties.
President Biden said again this week that he’s open to negotiations on the Corporate tax hike. His initial proposal raises it from 21% to 28%. We’ve been saying somewhere in the 25% range was likely, and it’s looking even more likely now. The President plans to meet with Republican leaders next week to discuss how to pay for the White House proposals. It’s still very early days on this. Democrats themselves aren’t in complete agreement. The way we see it, which is validated by our Washington sources, the Biden Infrastructure plan is just an opening offer. That’s the case with all tax proposals, especially capital gains. Politics are definitely at play. The President is trying to appeal to the Left before negotiating with the Right as Moderate. These are standard Washington games. Any deal most likely lands in the $2 Trillion range, focused on traditional infrastructure. Politicians keep politicking.
There’s also the issue of debt. There’s a mountain of it; To the tune of $28 Trillion. Even with the rapid economic growth, the United States owes more than it brings in. Debt to GDP is expected to be 108% in 2021. That would approach, if not exceed, the WWII peak. That was the previous high in recorded history. The thing is, America was born in debt. It’s had a tight relationship from the get-go. Coming off the Revolutionary War and independence from England, President George Washington tasked Alexander Hamilton to solve the young nation’s debt problem. The country owed roughly $80 Million, mostly to cover the costs of the war. The problem was, it brought in less than $5 Million, in the form of taxes. Solving this problem was not easy. Hamilton was given 110 days. There was no guaranteed success. Young America had a major aversion to taxes. That was no secret. Hamilton proposed a national bank, Jefferson and Madison opposed it, Washington approved it, and the rest is history.
The cost of World War II was substantial, in every way. Whatever it took was the attitude. Everyone bought in. The cost of not doing enough wasn’t an option. It led to tremendous prosperity. The US emerged as a Super Power in a relatively strong economic position compared with the rest of the world. Conversely, today the US is not at the start of global economic dominance. In fact, without substantial investment and innovative approaches, the United States is at risk of being left behind China in the Digital Age. There are so many fixed costs in place that did not exist before. There is much more entitlement spending obligations today versus 8 decades ago. America has tough choices in front of it. If a change is not made, and fast, this trend has the United States Federal debt doubling GDP by 2050. There is simply no precedent for such high levels of sustained borrowing in American history.
Come August, the debt ceiling will be reinstated, which will prevent the Federal government from issuing new debt without Congressional compromise. The Treasury Department can use “extraordinary measures” to prioritize debt payments to avoid default for several months, but lawmakers must eventually agree to increase or suspend the debt ceiling or risk default. Since Democrats have been bypassing Republicans to pass legislation using budget reconciliation, Republicans have signaled they intend to use the debt ceiling as a negotiating tool to push for spending cuts.
For now, the Market seems content with the current course. The Fed is going to have its hands full with a booming Economy, inflationary pressures and a Stock Market at all-time highs. The Market still doesn’t seem to believe the Fed. The disappointing April job number perhaps bought some more time. How much is unknowable now. The Fed has made it clear it won’t change course until there is evidence of actual and sustainable economic strength and inflation. That means months, perhaps many, many months, of accelerating growth and higher prices before the central bank acts. The Fed is not merely looking at estimates nor big growth rates from depressed pandemic levels. With limited options, a mountain of debt and precious resources needed, the Fed is metaphorically sitting atop Bunker Hill in Boston. The Battle Cry of Bunker Hill was “Don’t fire until you see the whites of their eyes.” Those were words of warning to the soldiers, to preserve their gunpowder until proof the enemy was upon them and their muskets could do the most damage, without moving too soon. The Fed wants to see the whites of the eyes of recovery before it lets go. Letting go should be celebrated. That will be the sign that the US Economy is heading on course toward stronger footing with economic expansion sustainably ahead, and the economic and financial challenges of Covid behind.
Have a nice weekend. We’ll be back, dark and early on Monday.
Happy Mother’s Day to all of you Superstar Moms!
Mike
