Some Winners, Many Losers
Good Times?
Are these good times or bad times? Depends on whom you ask. Wages are up 23% since just before COVID. Yet, this hasn’t kept pace with inflation in rent, gas, and food prices. Meanwhile, the stock market and home values are up over 60%. Hence, there are two different economies coexisting. Homeowners and investors want to party like it's 1999. Everyone else feels like it's shakedown 1979.
Quantum Economics
Governments want – and need – higher asset prices. Rising stock markets and real estate prices help keep the economy growing, employment full, and tax collections high. The risk is that the easy monetary and fiscal policies employed to support asset prices can ultimately lead to consumer price inflation, thus hurting those without assets. It is a tough balance that policymakers aspire to sustain. We believe they will lose balance from time to time. When that happens, we believe they will choose to do what they have done in the past: step in and reinflate asset prices. We need to get used to Quantum Economics, where our economy can be in two places at the same time.
Approximately 45% of the consumption in our economy is driven by the wealthiest 20% (those who own assets like homes and stocks).* If you’re “wealthy” (meaning you own your home and stocks), you’re way ahead. If you had a $1M stock portfolio just before COVID, it is now worth ~$1.7M. If your home was worth $500K before COVID, it’s now worth ~$750K. Combined, you’d be over a million dollars richer than just four years ago. Do you think that would make you more inclined to take a vacation? Or buy a new car? Maybe a new home? If you’re the average consumer, you’re not getting ahead. If you’re less than average (meaning in the bottom 50% of wage gains), you’re losing ground. For those without assets, there is no wealth effect tailwind, just higher costs.
Wealth effects matter. The Fed and the Treasury are well aware of this - especially of the fact that it works both ways. Any large and sustained drop in asset price will hurt consumption and thus the economy. Another worry is that lower asset prices can hurt tax collections (due to lower capital gains taxes). California felt this acutely when state income tax collections fell 25% following 2022, when stock markets fell and venture capital IPO’s dried up.
A fitting analogy is quantum mechanics, the theory that a subatomic particle can occupy two locations at once. We believe today’s economy is in two very different places at the same time.
Inflection Point
Fed Chairman Jerome Powell was in Nashville last week for his first public speech since the Fed’s big pivot last month when it cut interest rates by half of one percent. That was the first time in over four years the Fed has cut rates. This marks an inflection point. We believe that global liquidity is poised to expand materially. Powell now believes the economy is robust, and barring any change in the data, the Fed likely cuts interest rates another half of one percent by year end. The yield curve implies further cuts in the year ahead. We believe other central banks across the globe will follow. Indeed, Switzerland, the UK, Canada, Sweden, and New Zealand already have. Even more remarkably, China announced a large stimulus plan two weeks ago encouraging domestic consumption and even stock buybacks (wow).This marks a significant inflection point in global liquidity, from contraction to expansion. It is a positive for markets and asset prices globally. Based on our observations above, we believe this is early stages. Is this good public policy? Will there ultimately be unintended consequences? That’s a discussion for another day.
What to do?
Simple: avoid what governments seek to deflate (cash). Own what they seek to inflate (assets). As long as liquidity continues growing, it is likely good for asset prices (stocks, real estate, commodities, gold, etc.). We’re available to address any questions you may have, as always.
Yours in the Field,
Frank Byrd, CFA Steve Korn, CFA
*According to Ellen Zentner, Morgan Stanley’s Chief economist.
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