Stocks took a breather this week, pulling back slightly from record levels as concerns over elevated prices, higher Treasury yields, and a weak jobs report imbued a risk-off tone for investors. Corporate earnings season is wrapping up, and the results have been surprisingly stronger, with guidance for the rest of the year mostly exceeding our expectations. At the same time, COVID cases are plummeting and the vaccination campaign is seeing real progress, with over 17% of Americans having received at least one dose so far. It is estimated an additional 20% of the US population carries COVID-fighting antibodies from prior infections, meaning herd immunity may not be on the horizon. Bond investors have taken notice as well, with yields surging on the prospect of higher economic growth and possibly an uptick in inflation.
The policy action seen from both the US Treasury and the Federal Reserve over the last year, as well as what is still ahead in coming months, has led many in Washington and on Wall Street to vigorously debate the effectiveness and long-term results of this unprecedented amount of support and stimulus. While everyone loves “free” money, concerns over the potential for high inflation in years ahead as well as an untenable debt burden is causing angst for many economists and investors. The argument around inflation rests on the notion that too many dollars in consumers’ hands will chase too few goods, and lead to an increase in prices on heavy demand for services when the economy reopens. Add to that money printing at the Federal Reserve and other central banks around the world to the tune of $7.5 trillion in 2020, and growth in the money supply in the US alone has increased by nearly 25% last year. In regards to the ballooning US debt pile, while the numbers seem staggering, they must be considered in the context of debt servicing. Public debt is set to increase to 135% of GDP, more than twice what it was in the 1990s, but the borrowing costs are half of what they were at that time, making the debt pile manageable in our view. With the size of the COVID shock and loss of output that will take years to recover, we believe that additional support is still necessary to keep millions of jobless Americans from remaining permanently displaced and impoverished. As for fears of inflation, while we do expect a meaningful rise in short term inflation, which has already shown up in robust retail sales figures and producer price indices, there is reason to think these effects will be transitory in nature, as longer-term trends will continue to keep price rises in check. Digitization, demographics, and productivity growth, much of which has been revealed from the COVID-induced crisis, are powerful headwinds to inflationary pressure, and we believe will ultimately dominate over any near-term stresses. These themes have weighed on price pressures for the last decade, and are likely here to stay for the foreseeable future. We believe the Fed will also remain comfortable with inflation running higher over the short run, as supply chains are re-established and demand comes back in a big way.
Given the likelihood of a strong rebound throughout this year, but near-term signals of complacency and a lack of risk aversion, we are maintaining neutral positioning at this time to balance potential volatility ahead with the longer-term upward trajectory for risk assets. We are waiting for a pullback in equity markets to provide a window of opportunity for rebalancing portfolios, and think a retracement is likely in the coming weeks. As always, we continue to remain extremely focused on monitoring unfolding market dynamics and reacting only when appropriate. Please feel free to call our office with any questions you may have.