Author: Mike Cagney | October 30, 2020
There has been a lot of hand wringing around the next stimulus bill. The market has been trading up and down around the comments of Congresswoman Pelosi and Secretary Mnuchin. But does it really matter?
I tried to find a picture of them together but couldn’t. I know they aren’t the same person...but odd, right?
There is a line of thought that with a 7.9% unemployment rate, lower labor force participation and the expiration of the supplemental unemployment program in July, the US economy is in trouble. However, the data doesn’t look that way.
Income and Savings Are Elevated Year Over Year (Source: BLS)
The above chart shows disposable personal income (after taxes) and personal savings from January 2019 to September 2020. As I discussed in my previous blog Opens a new window., the supplemental unemployment programs actually boosted income for the average wage earner. That explains the spike in income and savings. But the program ended in July, so why has income stayed high?
Wages are Flat and Social Benefit Payments are Elevated Year Over Year (source: BLS)
The above chart shows that worker compensation is actually slightly higher in September 2020 than September 2019 ($11,513B vs. $11,460B). After spiking in Q2, government social benefits are at modestly elevated levels in September 2020, consistent with our 7.9% unemployment rate (vs. 3.6% in September 2019).
This data is inconsistent. Total compensation is higher in September year over year. However, we know the unemployment rate is higher (7.9% vs. 3.6%) and labor participation is lower (61.4% vs. 63.2%). The BLS says wages rose about 3% from last September, but the math doesn’t hold up. For compensation to be at the September levels, wage inflation would have to be at around 7.7% year over year (you can DM me for the math). Either the government has some numbers wrong, or my friends from the Austrian school are finally getting their due. More on inflation in “What Could Go Wrong” below.
As it relates to excess savings, part of the challenge for consumers has been limited options to spend their unexpected 2020 income windfall. Our friends at Citi have a great graph showing that goods consumption is significantly elevated from trend, while services have yet to fully rebound. This is expected given the various states of shutdowns across the country and individual decisions to shelter in place.
I bought a truck during lockdown (really) - what did you buy? (source: Citi research)
The net of this situation is that even with government programs ending mid-year, income has held up, households are spending and they are doing so without dipping into their recently acquired savings. This is a generalization, of course, as this is in aggregate and some households have done better and others worse during Covid. But if you take the numbers as is, the expansionary PMI numbers and the 7.9% unemployment rate (which was last at this level in December 2012), it doesn’t look like waiting until Q1/Q2 for a stimulus deal is going to sink the economy.
As it relates to a stimulus deal, we expect one passes in the first half of 2021. But there are risks, specifically related to what the Senate and Executive Branch look like next year. These risks are exacerbated if the country goes back into lockdown, as Europe has now done.
Negative Interest Rates
In speaking of the possibility of another nationwide Covid-driven lockdown, one has to question what tools are left in the Fed’s arsenal. We’ve seen Europe and Japan push rates negative. In the past, most market participants have felt this could never happen in the US, but with the 10-year stubbornly under 1.00%, it’s a real possibility.
Negative rates have some obvious benefits, but also some unintended negative consequences. Homeowners have already benefited from an unprecedented drop in mortgage rates. The monthly benefit of going from 4.5% to 2.75% on a $500,000 mortgage is around $500 ($2,041 versus $2,533). But what if the mortgage rate went to -1.00%? Well, you are paying $1,190 a month, and significantly improving your monthly cash flow.
Many doubt that mortgage rates in the US can ever go negative, but there is growing consensus high grade corporate borrowing rates can (as they have in parts of Europe). What if I’m the Treasurer of a company that can issue debt at negative rates? Why not simply issue as much debt as I can, store the cash in a vault, and pay less than I borrowed back at maturity? So long as the storage cost of the cash is less than the negative payments, the return on equity - because you don’t need any equity - is infinite. I’m pretty sure such action in lieu of things like capital expenditures is not the intent of a negative rate policy, but it could be the result.
My Next Startup - The Negative Rate Vault!
What Could Go Wrong
While I like to joke about negative rates, what we at Figure Investment Advisors are most concerned about is whether the wage inflation we discussed above is real. The Federal Reserve has been able to run - or more often threaten to run - an unlimited printing press of money. This works when rates (and money demand) stay low. If inflation were to rise - nominal rates would put the Fed in an untenable position (not to mention kill the unprecedented home equity being tapped through cash out refinancing). This - plus the election outcome - are two things we are watching very closely.
In our World Equity strategy we are constructive, but at 95% allocation with heavy emphasis in US tech and some China and US bank equity exposure. We’re also holding the Japanese Yen above market weight as a downside hedge with limited negative carry. With Europe going back to lockdowns we are staying out of the region, and are underweight Japan for valuation reasons.
For more macro investing insights, visit: https://www.figure.com/asset-management Opens a new window..
The content of this post is for informational purposes only, and should not be construed to provide tax, legal or investment advice, nor does it constitute an offer to sell, a solicitation of an offer to buy, or a recommendation for any security, portfolio of securities, or investment strategy. The author of this post may, directly or indirectly, have or may acquire a position or other interest in stocks or sectors that are mentioned in this post, or may take positions that are different from the views expressed in this post.