Bull Market Pause. On 8/21 we questioned whether global stocks were about to “break out” and exceed pre-Covid price levels on a sustained basis. Since then, global stocks have sold off. US growth equities have led the downturn, retreating -10.52% from their August highs, as of Friday’s close.
Increased risk aversion from investors can be at least partially attributed to waning fiscal support. With a stopgap funding bill passed in the House and political attention now diverted to the passing and replacement of Justice Ginsburg, no additional stimulus measures are expected before the November 3rd presidential election. Undoubtedly supported by prior fiscal measures, retail sales now remain a key economic barometer. With consumer confidence rising through the spring then turning lower after the July 30th expiration of the PPP and Federal Pandemic Unemployment Compensation (FPUC) programs, the question to consider is whether retail sales can continue to diverge from confidence and stay at these recovery levels.
Can the Fed break the disinflationary trend? If there is one lesson central bankers have learned from the last decade (other than it’s hard to forecast inflation; chart below via @cullenroche), it is that falling unemployment and monetary easing through QE failed to stoke the flames of inflation. Right or wrong, this conclusion lies at the heart to the philosophical pivot toward allowing inflation to run “hot.” Put simply, in the past, the Fed would act preemptively to quell any signs of inflation. Now, they are determined to wait and accept a higher inflation rate north of 2%.
No disinflation in housing, as it continues to be a stellar component driving the economic recovery. House prices rose 6.5 percent from July 2019 to July 2020 according to the latest Federal Housing Finance Agency House Price Index (FHFA HPI). With 30-year mortgage rates falling to historic lows of 2.86% this month, residential construction and housing activity will likely continue higher in the months ahead.
Debt Trap. The WSJ noted this week that American households had amassed $10 trillion in total debt prior to Covid. When rates are low and incomes are rising, debt service payments don’t pose a problem. However, the economic strain caused by the downturn is pushing families to manage liquidity by seeking forbearance extensions and deferring debt payments—both of which offer only temporary relief.
Pension problems. As the impact of low rates and high stock valuations reverberate through the financial ecosystem, retirement systems with future payment responsibilities are left scrambling to fill a gaping void in their financial projections. These entities are collectively starting from a weak financial position, with only approximately 83% of promised benefits covered (chart via Mercer):
And as noted in Bloomberg this week, with the Fed’s “lower for longer” policies and a 7% return target for most plans, “pension funds will be left with no alternative but to take more risk, and buy more equities, despite the current sky-high valuations of equities, while regulators will have no choice but to let them.” It is important to note that this kind of perverse incentive structure typically sows the seeds of its own demise.