The coming economic boom will be just a mirage
10 Mar 2021
One of the primary rules of investing is don’t get carried away by the madness of crowds. Still, markets are signaling that many investors are ignoring that rule.
Asset prices suggest that many believe most everyone will be vaccinated against by mid-year, or at least herd immunity will be achieved by then. So homebound-weary consumers will burst forth and spend the 11.4% jump in personal income they received from the December federal stimulus bill, to say nothing of their chunk of the US$1.9 trillion relief and stimulus package.
Despite the recent wobble in technology-related stocks that depend on ultra-low interest rates to discount future earnings into high current valuations, stocks have mostly soared in response, especially those sensitive to changes in the economy. The jump in long-term Treasury note and bond yields is in anticipation of rapid economic growth, credit demand and much faster inflation that the Federal Reserve will be slow to confront.
Forecasts of 6% to 8% growth in real gross domestic product this year are common, but where will it come from? Not from plant and equipment outlays, which remain subdued by business uncertainty and excess capacity. Real capital spending has risen at only a 1.6% annual rate since 2007. Housing has been strong, but residential construction is just 3.7% of GDP. Besides, rising mortgage rates are curbing mortgage purchase applications, which fell 19.4% in February, according to the Mortgage Bankers Association.
The foreign sector remains a drag on the economy. Former President Donald Trump’s trade war with China netted little, as that country continues to fall short of its promises to buy more American exports. President Joe Biden is less confrontational than Trump when it comes to trade. Also, further restrictions on imports from China will only speed up the exodus of low-cost manufacturing to cheaper locales that are, thus far, out of the trade war line of fire. Vietnam is one example, and its exports have leaped almost 60% in the last three years. So, even if imports from China are drastically restricted, goods entering the US from Asia as a whole will continue and keep the foreign sector a net negative for the American economy, as well as depressing US manufacturing jobs.
So the economy’s fate is in the hands of consumers who account for 69% of GDP, and they may continue to not spend government stimulus money freely, but instead, save most of it for rainy days. According to the Federal Reserve Bank of New York, consumers saved 71% of the government money they received a year ago, while spending 18% on essentials, just 8% on non-essentials and 3% for donations. The layoffs due to the pandemic were a shock to many households that were financially unprepared. Fed surveys found 16% of millennials and 12% of Americans overall wouldn’t be able to come up with US$400 for an emergency.
That exercise was repeated with the year-end stimulus money. That US$900 billion included US$600 for those with incomes below US$75,000. Even though lower- and middle-income Americans typically save little, they did so again. Some 82% of the increase in after-tax income was saved, pushing the household saving rate from 13.4% in December to 20.5% in January.
Americans are using their savings to build assets and reduce debt, a long-term trend that was already well underway. Back in the 1960s and 1970s, household debt averaged 60% of after-tax income. That debt includes home mortgages, auto and credit card loans, as well as student loans. But starting in the early 1980s, free-spending and big-borrowing consumers pushed that ratio to 134% in 2007. The rate began to fall with the financial crisis and has nosedived recently. Nevertheless, at a recent 92% in last year’s third quarter, it’s still a long way from the 60% norm, and I’m a believer in reversions of long-term trends.
This pattern implies that most of the pending stimulus bill money also will be saved and used to further reduce debt and build contingency assets. Any discretionary spending will no doubt be concentrated on services like restaurant meals and travel, as cooped-up consumers leave home. Stay-at-home households have already loaded up on goods ranging from exercise equipment to cooking gear to vehicles used to avoid close proximity on public transportation. As I noted in January, unlike goods, services are consumed when purchased, so there’s no inventory to rebuild. Also, people may eat out more frequently but probably not every night.
Inflation fears are unwarranted, as long as protectionism doesn’t prevent the global supply of most products from exceeding worldwide demand. Asian nations are big producers but have subdued consumers, so the resulting saving glut insures worldwide excess supply and low inflation for goods and services, if not outright deflation. Slow economic growth also widens the supply-demand imbalance. Furthermore, low rates of inflation are self-feeding and induces consumers to resist price increases.
Monetary and fiscal stimulus, however, has spawned rampant asset inflation. As a result, with stocks in the stratosphere and rampant speculations like GameStop, IPOs, SPACs and electric vehicles, there’s no room for economic disappointments later this year. Even a twitch by the Fed in response, might touch off an agonizing reappraisal.