If you could answer the following question, my job would be much easier.
Are we in (1) an extended bull market that still has not ended and is now in the final stages of a melt-up, (2) the beginning of a new bull market after experiencing the shortest bear market in history (government shutdown induced), or (3) a world of Federal Reserve stimulus so large it masks a large depression highlighted by a dissatisfied and unemployed cancel-culture.
If you sense we are in scenario 1 (an extended upturn about to correct) you may be pleased to know that your portfolio is balanced in the go-go technology stocks, defensives, infrastructure stimulus holdings, pandemic rebound holdings, gold and cash. In scenario 1, as the melt-up wanes or corrects as the pandemic ends, those companies that at one time were significantly discounted, will advance. Moreover, 2020, post-election, both parties want additional fiscal stimulus in the form of infrastructure spending. So, your fiscal-stimulus holdings should advance even as technology go-go stocks correct for overbought reasons. Meanwhile, interest rates remain low due to the Federal Reserve Board’s intervention, which should mute the degree of a sudden correction.
If you sense we are in scenario 2, (the beginning of a protracted upward cycle) you are part pragmatist and part optimist, for this scenario has as much of a probability of developing as any. The adage “don’t fight the fed” is historically true. Given the trillions of dollars the federal government has and will unleash since the pandemic began, both by way of fiscal and monetary policy, the new bull market scenario suggests that most asset classes should reflate. Both parties want it. Both need it to reduce unemployment and put the nation back on a stability track. Yet, in an election year, the rebound is all about reflation.
Reflation takes time. We went through the reflation transition in the years following 9/11/2001 and the Great Recession of 2009. On those two occasions the early measurement of strategic success using monetary policy was pricing power. Today that measurement is reflation. So, both fiscal and monetary stimuli are being used today to reflate asset prices back to pre-pandemic levels. Thereafter, these economic policies will be used to extend reflation into real inflation.
Initially, the benefits of reflation only accrue to those who enjoy an ownership (or equity) position. Fixed-income investments may see a short-term premium on their bonds, otherwise they do not participate in reflation.
To illustrate, monetary policy lowers rates, making housing more affordable, though it also reflates home values. The home buyer and seller benefit in the exchange of ownership. The mortgage holder, however, works on a very thin margin of profit while inflation is low.
Fiscal stimulus is the other piston that drives reflation. Fiscal stimulus tends to lower the value of the dollar. This reflates gold prices. As the post-pandemic economy emerges, cyclical stocks should reflate. It appears investors expect clear signs of cyclicality which may not fully emerge until more fiscal stimulus is unleashed, perhaps after the presidential election in November, or 2021. But that’s just 4-6 months from now. As such, the pricing of building materials stocks appears to have troughed, leading to the expectation of further improvements to come. To add to the expectation of relative outperformance, the more protracted the pandemic, the more you can expect to see congressional action to advance infrastructure spending.
Of course, none of this happens in a vacuum. The pandemic must end some way, either through a vaccine, testing and tracking or population immunity. Void of biological solutions we may find a high percentage of the population exposed to COVID-19 by the Spring of 2021.
Scenario 2 accommodates still further upside in technology companies as 5G technology spending produces a dramatic improvement in the speed and efficiency by which we live our daily lives, through education, advanced 3-D printing, emergency healthcare options, law enforcement monitoring and tracking efficiencies, energy usage solutions, management efficiencies, improvement in human resources and quality control, and through scientific breakthroughs combining speed with artificial intelligence. These are just a few of the reasons to be excited about the post-pandemic, 5G decade that is now ensuing even as COVID-19 grips a larger percentage of the American populous.
If you perceive we are entering scenario number 3, (a lengthy depression of cutbacks and unemployment) your logic is underpinned by the sense that growing U.S. debt levels weaken economic growth and inflation, creating a long-lived economic tangle. If so, you can expect a declining dollar, tax increases, low inflation and continued false readings as to the true inflation rate, as measured by the consumer price index (CPI). Increased taxes have a direct impact on reducing debt levels, though your standard of living also tends to decline. The other way governments pay off debt is through deflating the currency and inflating the money supply, thereby disrupting the strategy of savers.
Bond investors and savers may find low rates analgesic to an otherwise volatile stock market. However, these negative total returns (after tax, consumer price inflation and currency deflation) leave the heirs of fixed-income investors little in comparison to the estate’s current value.
In addition, if you believe scenario 3 is most likely, you can expect to see more corporate bankruptcies, dividend cuts, and struggles to advance profit margins, as corporate unit volumes, neutered pricing power, tax hikes and altered spending patterns of the middle class more than overtake advances in technology.
Scenario 3 becomes still more palpable if the federal government’s need to take on debt and raise taxes to pay for current fiscal stimulus plans includes the appeasement of voters who demand promised free childcare, a guaranteed living wage for the unemployed, reparations for the disenfranchised, subsidized or free college and more.
While any number of hybrid possibilities exist, on the short term, most likely if you have two years or longer to invest, scenario 2 should begin to emerge as the most likely outcome. In such an eventuality the rewards flow to the investors (and their heirs) who maintain a diversified equity or ownership strategy. Hence, staying away from asset classes that do not participate in the reflation trade is key. Another way of saying this is that you must remain in an equity position to participate in the reflation of asset classes the Federal Reserve Board seeks to engineer. Why? Depressions cost more.
So, a fixed-income investment strategy appears to be outside of those strategies that produce growth and outside of a strategy that allows pension funds and retirees a positive return. Asset classes that do not participate in the reflation trade include bonds, savings accounts or fixed-rate annuities. Therefore, investment classes than do not participate in the Fed’s reflation strategy, using fiscal and monetary stimulus, are the new enemy.
The writing and opinions put forward here are mine. Sometimes I write about fundamental or technical data or observations affecting the markets which are unique, novel or important to understanding the securities markets. Other times I write about what I call “big umbrella” aspects of the larger economy. All of the elements upon which I focus are meant to produce understanding. Most of my comments relate to where we may find ourselves on the economic cycle, an imaginary economic setting that explains the youth or maturity of market cycles.
Market cycles are important for explaining, monitoring and managing asset allocation. Where we are in a cycle determines the relative superior intelligence of one asset allocation as compared to another. It also accounts for relative risk/reward ratio thinking. This includes diversification, overweighting and underweighting of industry groups, the reasons behind short and long-term accumulation or distribution patterns and the observed actions of the larger investment community. The capacity to understand the cyclicality of industry groups which go in and out of favor is an important factor in assessing problems and solutions. In neuro-economics this is called salience. It can be difficult to surmise, especially during this pandemic, the degree to which I use a caring confidence on your behalf to act or pass on portions of your asset allocation that facilitate a balanced strategy toward income, growth and tax benefits. In many ways, that is the reason I write. I’ve always said I do my best work with people who trust me. Yet this trust cannot take place without communication. You entrust me with the monitoring and management of your holdings, and I take every action seriously and with a multiplicity of fundamental and technical clues. In a world of chaos, you are paying me to remain humble, be circumspect, monitor, manage and take no greater a risk than that which is in your best interest. This includes positional proportion. Therefore, as usual, thank you again for your continued faith in all we do daily to manage your accounts. In the immediacy of the pandemic downside lurch, we have witnessed a remarkable rebound. When I say I or we obviously I mean not only Robert and myself but the larger staff of compliance and accounting personnel with whom we speak every day for support. They are located a computer nano-second away in Bolton, Massachusetts.
Vaughn Woods, CFP, MBA
Vaughn Woods Financial Group, Inc.
2226 Avenida De la Playa
La Jolla, CA 92037
Investors should be aware that there are risks inherent in all investments such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter may not reflect the views of Bolton Global Capital or Bolton Global Asset Management. The information provided is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0xxx