Terms like “stimulus” and “tapering” are often thrown around in the financial press. Understanding what they mean is helpful, because the past year in the market has been dominated by stimulus and the next couple of years may well be dominated by tapering.
Or not, if Fed Chair Jerome Powell never switches the money printer off. Only time will tell.
In response to the pandemic, global central banks have pumped money into their economies. This monetary policy (another important term) can be executed via measures like lower interest rates, buying bonds in the market or making payments directly to consumers.
Collectively, this is called stimulus. The process of slowing this down is known as tapering.
The US has become the land of the free, the brave and the highly stimulated. It’s like the market has been drinking six Red Bulls a day and washing each one down with a Monster. In the briefest yet deepest recession on record, a once-in-a-lifetime pandemic was met with once-in-a-lifetime stimulus.
In the process, debt has increased to unprecedented levels. The US is no stranger to debt, with the Congress-approved US national debt ceiling having been raised well over 100 times since it was introduced in 2017.
Even against that backdrop, the current situation is extraordinary.
If Democrats and Republicans cannot reach a compromise in Congress, then the US will run out of steam in October. The debt ceiling of $28.5 trillion (a number none of us can fathom) will be reached.
Of course, the politicians are behaving exactly how one would expect. Democrats are arguing that the debt came in before Biden’s time and Republicans are arguing that Biden’s social benefits have accelerated the problem.
Undeterred, Powell made it clear at the Jackson Hole Symposium on Friday that his goal remains maximum employment. With an unemployment rate of 5.4% being “much too high” in his view, a dovish stance by the Fed is likely to continue.
This means that monetary policy will not be materially tightened yet.
The Fed must balance inflation against the goal of maximum employment. The central bank firmly believes that inflation is transitory, driven by supply-side shocks in durable goods rather than broad-based inflationary pressures. For example, Powell noted that used car prices appear to have stabilised, which he sees as a sign that inflation is stabilising.
Wages are also being carefully monitored. Powell claims that wage growth is in line with the longer-term inflation objective of 2%.
As another indication of his comfort with current levels of inflation, Powell reminded everyone that we have come from an extended period of low inflation. His view is that the forces behind this (like technology) haven’t gone anywhere, which supports an overall belief that inflation is transitory.
In an effort to give a balanced view, Powell acknowledged that the 1970s saw periods of high inflation because core inflation kept running even after energy and food inflation subsided. That is the risk faced by the Fed in the pursuit of maximum employment.
With that in mind, the Fed will begin reducing asset purchases later this year, although there is no confirmation of exactly when. Rates aren’t set to increase until maximum employment is achieved.
With inflation running at 5.4% and central bank interest rates in the US at between 0% and 0.25%, portfolio strategies are critical.
According to Wells Fargo research, growth stocks tend to outperform value stocks in periods of inflation. Although emerging markets have historically performed well in these periods, most South Africans are over-exposed to our market through property and other investments, which means that global diversification is logical in equity portfolios.
Relative Rand strength offers a particularly useful opportunity to introduce that diversification or improve it. Although valuation multiples in markets like the US are high by historic standards, equities perform well during periods of inflation and many of these companies are generating exceptional profits which may justify these valuations. Nobody knows exactly how this will play out in the short term but long term investors can’t afford to “wait and see”. While valuations in global markets seem stretched, they could easily go higher on the back of positive sentiment on US inflation or the global Covid pandemic coming under control. One thing is very clear to us, ZAR risk is something you want to limit as much as possible.
The benefit of an active strategy is clear in these complicated conditions. With access to our Unicorn and Altos Funds, which continue to deliver excellent results for our clients over some of the most difficult markets in recent history, you have an opportunity to enjoy resilient growth with prudent diversification.