Economic Outlook

By: Gaby S. Dominguez

Tuesday, the first of February, marks the start of Black History Month (BHM) for 2022. In 1976, Gerald Ford began the first tradition of designating the month of February as Black History Month [1]. Ten years later Congress passed National Black History Month into law and aimed for everyone to be “aware of this struggle for freedom and equal opportunity” [4]. Other countries, like Canada and the United Kingdom, also devote a month to celebrate Black history. This gives us an opportunity to understand Black histories and go beyond stories of racism or slavery to highlight Black achievement [4].

The origins of Black History Month arose about half a century after the Thirteenth Amendment abolished slavery [2]. The man who established the initial celebration of Black history is Carter G. Woodson, who was a Harvard-trained historian and founded the Association for the Study of Negro Life and History (ASNLH). During the month of February in 1926, Woodson sent out an official press release proclaiming the first “Negro History Week” [1]. The month was chosen because it holds the birthdays of Abraham Lincoln, the president who abolished slavery, and Frederick Douglass, a former slave, influential writer, orator, and social reformer. However, a week was not enough time to fully appreciate the history of African Americans, so it eventually transformed into a month. Barack Obama recognized Woodson’s initiative, in 2016, as one of America’s oldest organized celebrations in history. Obama inspires us to reflect on the importance of Black History Month by stating, “let us resolve to continue our march toward a day when every person knows the unalienable rights to life, liberty, and the pursuit of happiness” [1].

In addition to Carter G. Woodson, there are various other prominent figures to honor during Black History Month, such as:

• Madam C.J. Walker, the first woman in the United States to become a self-made millionaire
• George Washington Carver, who derived about 300 products from the simple peanut
• Rosa Parks, the woman who initiated the Montgomery Bus Boycott and energized the civil rights movement
• Shirley Chisholm, the first African American woman elected to the United States House of Representatives
• Robert Johnson, the first African American billionaire after the sale of his cable station, Black Entertainment Television (BET) in 2001 [3]
• Jesse E. Moorland, an esteemed minister that assisted Carter G. Woodson in founding the Association for the Study of Negro Life and History (ASNLH) [2]
• Secretary of Defense Lloyd James Austin III, a retired U.S. Army four-star general serving as the twenty-eighth U.S. Secretary of Defense, who is the first African American to serve under this title

Every year, the Association for the Study of African American Life and History, or ASAALH (originally the ASNLH) chooses a theme for Black History Month. The theme for 2021 was “The Black Family: Representation, Identity, and Diversity,” which explored the ‘diasporic’ nature of the African family [4]. The word “diaspora” refers to the dispersion of any people from their original homeland. The theme for 2022 is “Black Health and Wellness” that emphasizes the importance of Black health and wellness while appreciating the legacy of Black scholars and “other ways of knowing throughout the African Diaspora” [4].

The annual celebration of African American achievements is a significant time to recognize and reflect on the central role they have in our nation’s history. It is also an opportunity to acknowledge their activism and attainments throughout the world, not only the United States [4]. For modern Black millennials, this can be a time to reimagine what possibilities are ahead. On the other hand, the same impetus that drove Carter G. Woodson almost a century ago is more relevant than ever. Just as Gerald Ford stated in 1976, this is a time to “seize the opportunity to honor the too-often neglected accomplishments of Black Americans in every area of endeavor throughout our history” [1].

The celebration embarking on February 1, 2022, marks an opportunity for all individuals to come together and honor the accomplishments and history of African Americans. We live in one world, so there is also a need for us to unite as one. Our history reflects and shapes who we are today, but also impacts what we can do tomorrow. The best thing we can do as patriotic Americans is support the same Americans who have been by our side throughout history. ■ 

Footnotes:
[1] The Man Behind Black History Month, Sarah Pruitt February 2, 2017, https://www.history.com/news/the-man-behind-black-history-month

[2] Black History Month, History.com Editors January 19, 2022, https://www.history.com/topics/black-history/black-history-month

[3] Black History Month Facts, History.com Editors January 21, 2021, https://www.history.com/topics/black-history/black-history-facts

[4] Black History Month: What is it and why do we need it?, Alem Tedeneke January 27, 2022, https://www.weforum.org/agenda/2022/01/black-history-month-what-is-it-and-why-do-we-need-it/

Inflation, which is described as a general increase in prices and fall in the purchasing value of money, erodes purchasing power over time. It is a pressing topic at present, particularly for retirees on a fixed income.

COVID-19 has increased inflation risk. Indeed, the price index for gross domestic purchases increased 5.7 percent in the second quarter, much higher than the sub-2% rates we’ve enjoyed over the past few years. Some of the rapid rise reflects recovery from the depths of the pandemic, which drove inflation to abnormally low levels. While the movement of the index was concentrated in a few key categories such as used cars and gasoline, there have been prices rises in many industries. A key question is whether inflation will be permanent or transitory, and if transitory how long we should expect rapid inflation to continue.

COVID-19 impacted both supply and demand for goods and services, and the recovery produces effects on both sides. First, workers have been slow to return to jobs and departed some sectors in search of better opportunities. Companies have offered higher wages to lure workers, in some cases unemployment benefits provide an incentive for workers to delay their return to work and health impacts of the pandemic have made some workers completely unavailable.

Pandemic induced production disruptions have caused supply chain bottlenecks. Finally, unprecedented levels of government spending ($5.4 Trillion), expanded credit ($4.0 Trillion) and pent up consumer demand amplify the impact of supply shortages.

Various factors will mitigate these inflationary effects going forward. Unemployment benefits and many stimulus measures taper off beginning this September which should incent workers to return to work. Supply chain bottlenecks will resolve as prices rise, although the speed of adjustment will vary by market. For instance, the construction lumber market has adjusted quickly while the market for microchips used in many consumer goods may take much longer.

Finally, while the Federal Reserve has signaled it will begin to curtail the growth of its balance sheet, i.e., taper its purchases of government bonds, in late 2021 or early 2022 they’ve also signaled that they may let inflation run above its stated 2% target for a period of time. This seems to signal a very gradual and measured pace with respect to normalizing interest rates.
However, the consensus of policy makers is to support recovery and drive down unemployment even if it means a brief period of higher inflation. The path of least resistance and the lesser of two evils is to keep rates too low for too long versus the alternative of raising interest rates too quickly. The risk of “too low for too long” is even loftier valuations and the growing presence of bubble-like conditions.
How long will this myriad of inflationary conditions persist? It is too soon to tell, but it might be a year or more before inflation cools off. Investors should be expecting more volatility as the debate over whether inflation is permanent or transitory continues. We expect that markets will be forward looking with respect to inflation and inflation expectations.
If it is evident that more rapid inflation is permanent, investment strategies that have proved effective over the last twenty years will undoubtedly have to be revised. In short, this would involve a favoring of hard assets e.g., commodities, real estate and gold, over financial assets. For now, we are vigilantly monitoring signs that inflation may be here to stay and are crafting contingency plans to reposition portfolios as needed. Stay tuned for more! ■

The economy continues to fire on all cylinders as COVID-19 vaccinations continue and restrictions on many businesses continue to ease, albeit in fits and starts, given the rise of the new Delta variant. According to the Bureau of Economic Advisors[1], real GDP grew at annual rate of 6.1% in Q1 2021 and posted an initial estimate for Q2 2021 of 6.5%. The Atlanta Fed website www.gdpnow.com is currently forecasting Q3 2021 real GDP growth of 6.1%. If these forecasts hold true as expected the four quarter average for GDP growth will be nearly 5.7%. That’s impressive growth!

Moreover, after falling 22% in 2020, corporate earnings are forecast to increase by 56% in 2021, according to FactSet[2]. The rebound in the economy, corporate profits and accommodative monetary policy by the Federal Reserve has help contribute to  the ~ 18% increase in the S&P 500 this year.  That’s more good news! 

What might be considered bad news is the surge in prices i.e., inflation for things like housing, building materials, and the more volatile food and energy prices. As we discuss below, the current surge in prices could very well prove to be transitory as suggested by Fed Chair Jerome Powell during his recent semi-annual congressional testimony[3]. As we will discuss in our upcoming article, Is Inflation Here to Stay?, this is a key variable that bears watching!

Are we Overvalued, Overextended and Overdue for a Correction?

The fly in the ointment, however, is the rather lofty valuations for stocks, growing speculation among individual investors, technical divergences in the broader market as small cap stocks lag behind FANG and other mega-cap stocks and a rather protracted period of time without the typical 5%-10% intra-year correction.

Regarding valuations, and according to JP Morgan’s Guide to the Markets[4], the S&P 500 trades at 21 times forward earnings, well-above the long-range average of 16.5, which not only exceeds valuation levels seen in 2007, but is also approaching 1999-2000 valuation levels. Undoubtedly, investors will remember the significant declines that followed the bursting of the Tech Bubble in 2000 and the Great Recession in 2007-2008.

Strategy Update
While we acknowledge that valuations are “stretched” at present, we remind our readers that, in and of themselves, lofty valuations don’t create bear markets. They can, however, be the burning embers that start a forest fire. Hence, we believe that investors should be vigilant when managing short term volatility over the typically erratic summer months and not be surprised if we see a correction in the broader market over the coming few months. In our view, and assuming that recent inflationary pressures are transitory as we will discuss further in a future article, we view a 5% -10% \”correction\” in the stock market as a buying opportunity.
Having said that, we see a continuation of historically low interest rates coupled with the prospects for stronger economic growth and higher earnings over the next several quarters as bullish for stock prices overall. Moreover, with the 10-year Treasury bond yielding approximately 1.25% it’s reasonable to assume that long-term investors still prefer quality blue chip companies with dividends that exceed 1.25% as a reasonable alternative to bonds. The “TINA” phenomenon (There Is No Alternative) is alive well for the time being. For now, and as we have been for quite some time, we are inclined to allow our equity allocation to drift 3%-5% above our stated neutral targets. ■

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[1] 2^nd Quarter 2021 GDP Estimate, Bureau of Economic Analysis July 29, 2021, https://www.bea.gov/news/2021/gross-domestic-product-second-quarter-2021-advance-estimate-and-annual-update
[2] Stocks Keep Moving Higher Even As Earnings Estimates Continue to Fall April 28, 2020, https://www.forbes.com/sites/chuckjones/2020/04/28/stocks-keep-moving-higher-even-as-earnings-estimates-continue-to-fall/?sh=57a1b1af5598
[3] Semiannual Monetary Policy Report to Congress July 14, 2021, https://www.federalreserve.gov/newsevents/testimony/powell20210714a.htm
[4] Market Insights – Guide to the Markets July 31, 2021, https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/

Americans have watched in disbelief during the past year as financial markets lost value in one of the largest and fastest recessions in history, followed immediately by one of the largest and swiftest recoveries in history. The signals seem lined up to push equity prices higher, though many historic indicators such as P/E ratios are flashing red and hint that markets may have become a bit overheated. What are the fundamental and historic forces that are pushing these trends and what strategy can reap the gains and avoid the dangers?

One complication is that there are causes on both sides of this recession — demand and supply. There are also responses on both sides, thus sorting out the full effect is a bit tricky but not impossible. The Bureau of Economic Analysis (BEA) reported that the U.S. economy contracted at an annualized rate of -5.0% in Q1 and -31.4% in Q2 of 2020. In magnitude, that is over a third of the nation’s output. We saw the effects as most activities that we associate with our normal lives came to a rapid halt.

The response was equally swift. In a series of rapid reactions during 2020, the federal government implemented six stimulus bills totaling $5.3 trillion or 25.5% of GDP. The Federal Reserve implemented credit measures of $4.0 trillion. Not all of that spending and credit has flowed into the real economy, and not all of it will. But the flood of spending and credit into the economy to restore demand has already had an effect. The BEA reported that growth in Q3 was 33.4% and Q4 was 4.3%, and 2020 closed with a net real GDP loss of 3.5%. Our economy grows by about 2.0% in real (adjusted for inflation) terms during a “normal” year, so that leaves us about 5.5% down. That’s consistent with unemployment of 6% so there is room to absorb those historic levels of stimulus.

Stock prices have responded accordingly, with equity markets recovering from their historic 32% peak to trough drop to close 2020 ahead by 16%. Through the 1st quarter of 2021, stocks are up 5.8%. Stock prices are forward-looking, so this would be consistent with continued recovery in 2021. Jay Powell, Chair of the Federal Reserve, has reported that he expects recovery to continue and that the “output gap” — the difference between what the economy is actually producing and what it is capable of producing — should be closed by the end of 2021 or early 2022 absent any further disruptions.

The easy part is to say recovery will continue and that equities will rise. The difficulty lies in looking over the horizon to assess the damage the pandemic has done to supply, the productive capacity of the economy. The risk is that that lavish stimulus will cause demand to exceed supply, the economy will overheat and cause inflation and rising interest rates. There is enough idle capacity at present to absorb stimulus in the short term. Also, companies learned valuable lessons during the pandemic that will result in productivity improvements and lowered costs. For example, improvements in online operations have allowed many companies to reduce office footprints and lower operating costs.

But perhaps the most telling trend has been the reduction in the nation’s labor force that has resulted from the pandemic. In December 2019, the participation rate was 63.3% and rising. Presently, it is 61.5% and falling slightly. Businesses are already reporting spot shortages of labor, especially in skilled manufacturing specialties. Clearly, the risks for inflation and interest rates lie to the upside in the medium to long term and bear monitoring. It is not a forgone conclusion that supply and demand imbalances can’t or won’t be resolved to keep inflation in check. For decades, investors have fretted over the prospects for above-average inflation only to watch inflation remain under the Fed’s two percent target all but for very brief periods of time.

So — as the old saying goes, “…make hay while the sun shines…” and seize the upside. It’s clear that the stimulus is having the intended effect of restoring economic growth both directly in the form of lower interest rates, notably lower mortgage rates and indirectly in the form of higher stock prices and the so-called “wealth effect”. At the same time, we stay vigilant for signs of inflation and higher interest rates.

Let’s not forget that each day more Americans get vaccinated and that each day, we get closer to herd immunity and a life we knew pre-COVID. Collectively, these factors suggest that stock prices in general can indeed go higher in 2021. ■