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Fourth Quarter Outlook

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Vaccine Rollout Key to First Half Growth – Potential New One Dose Vaccine

The speed of reaching broad-based vaccinations will likely determine how fast the economy snaps back. Post-vaccine activity will initially depend importantly on economic momentum pre-vaccine. Funding for the states in the last COVID package plus additional funding in the new Biden package should accelerate the current disappointing vaccine rollout. Additionally, a new single dose vaccine coming off trials in the next month or so will provide a further shot in the arm for the rollouts with its simpler logistical requirements.

Third COVID Rescue Package Size and Speed Depends on Bi-Partisan Support

Near-term, President Biden will propose a $1.9 trillion relief package (nearly 10% of GDP) covering a broad spectrum of programs. The proposed rescue package will extend supplemental unemployment coverage to the end of September, increase individual checks from $600 to $2000, broaden funding to state and local governments by $350 billion, and accelerate vaccine rollouts and testing. How fast the Congressional legislative process works depends on whether faster regular order (which requires 60 votes) in the Senate or more complex budget reconciliation process applies.

In addition, the delays could result from the Senate impeachment trial. After the Obama Administration took office in 2009 following the Great Financial Crisis, President Obama signed a stimulus package on February 17—one month after taking office. At that time, Democrats controlled the Senate with 60 votes—not the case today. The Biden proposals total fifty percent larger than the Obama stimulus— inflation adjusted. With the current Senate makeup, regular order will require bi-partisan support to achieve 60 votes needed for passage. With their complexity, these proposals might be broken up into separate legislation so that some could be fast-tracked with bi-partisan support.

Many Consumers Will Save Their COVID Checks – Savings Initially Could Help Power the Snapback

Many consumers will save a large proportion of their $2,000 checks. High levels of savings, reflect, among other factors, both limited availability of and health concerns using consumer services such as restaurants, travel, and leisure activities (see Figure 1). Record consumer savings and vaccinations will likely contribute to an economic snapback sometime in the second half as consumer services open up. With increased savings, Robinhood’s merry men (80% are men) will likely use some part of their savings to pursue increased option and stock trading. Above normal option trading levels increases volatility which becomes noticeable during market downturns.

Household Balance Sheets Show Strong Financial Condition

Early lockdowns and continuing limited services led consumers either to spend on goodies or save—and save they did. Households both increased their personal savings rate and improved their balance sheets (see Figure 2). With vaccines distributed by mid-year, the resulting strong consumer balance sheets should particularly benefit a broad group of consumer service sectors that nearly disappeared early in the pandemic.

The Fed Out of Ammo – Fiscal Policies Step-Up Under the New Administration

As both a Keynesian and former Fed Chair, Treasury Secretary-designate Janet Yellen understands the need for increased fiscal spending to offset the limits monetary policies currently face. Therefore, the Biden administration will likely look to longer-term fiscal spending programs over the coming decade to meet these specific post-COVID-19 needs. Such fiscal stimulus could include, among others, new infrastructure and green energy spending programs. These and other programs will lead to major increases in
capital spending by private industry.

Economics of Renewable Energy Generation More Than Regulations Speed the Shift

After quickly reinstating stricter environmental regulations, the Biden administration will likely propose bringing renewable electric generation up to an estimated 80% of power generation by 2035. That would compare to 17% today. Many observers predict that realistically such goals will more likely be reached at a later date — 2050. At the same time, the economics of alternative energy generation, as much as new legislation and regulations, will accelerate this shift. Figure 3 shows a sharp decline in total renewable energy costs compared to traditional sources. Currently, states control the mandate for alternative energy development. Speeding uniform change on a national basis will require Congress to enact Federal clean electric standards. With divergent state interests, Congress, so far, has failed to approve such Federal standards.

Long-Term Inflation Increase Likely Responds to Both Lower Labor Market Slack and Recovery of Service Sector

Recently, 10-year yields increased from 0.93% on January 4th to fractionally over 1.1% currently. Rising long-term interest rates reflect concerns that inflationary pressures will respond to increased fiscal spending and the economic snapback. In our view, the economic snapback will quickly bring stronger pricing as consumers find more ways to spend their accumulated savings-–particularly for consumer services. Long-term inflation will likely respond to how fast labor market slack falls resulting in increased wages. Reducing that slack will depend on how fast depressed consumer service employment recovers (see Figure 4).

Investment Conclusions

2021 Equity Market Performance Dependent on EPS Growth Not Multiple Expansion

Successful fourth quarter vaccine trials gave investors sufficient confidence to look for an economic snapback beginning in the second half of 2021. Their confidence led to fourth quarter 2020 equity markets growth far outperforming the growth of corporate earnings per share (see Figure 5). However hopeful, vaccine trials will not prove sufficient to judge the potential second-half economic snapback. Instead judging the speed of vaccine rollouts will likely prove critical to the timing and which sectors will benefit from the snapback. That snapback will prove key to
producing sufficient earnings growth to reduce dependence on multiple expansion for equity market performance. This will become even more important with potentially rising interest rates.

Fixed Income – Shorter-Duration

The cyclical snapback will likely lead to rising interest rates in reaction to possible signs of gradually increasing inflation. Having federalized fixed income markets, the Fed may still hold off attempting to moderate the yield curve’s upward tilt unless unexpected pressures result. Nonetheless, with that outlook, investors should stick with shorter-duration fixed income investments. This will avoid the price risk longer duration debt faces from rising interest rates.

Pandemic Disruption – Democratic Control – Opportunity for Active Managers

The disruptive nature of the pandemic will force many business sectors and companies to reposition themselves o meet this change. Adding a rollout of new fiscal programs from democratic-controlled Washington creates opportunities for active managers to differentiate their investment selection skills. These forces may lead investors to selectively consider making greater use of actively managed funds.

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