Gill Capital Partners Mid-August 2021 Update
Summer is quickly winding down, kids are heading back to school, and many employers attempting to bring employees back to the office in some fashion. Everybody is holding their breath and hoping that COVID-19 does not derail the best laid plans. However, the virus resurgence, combined with unsettling geo-political highlights, is threatening the reopening everyone envisioned. There is a lot to talk about, including the infrastructure bill, a slowing economy due to the Delta variant and inflation, and talk of the Federal Reserve beginning their bond purchase tapering. We will get into these issues and provide our views on them, but first, some return to office humor…
Infrastructure Bill
After months (years, really) of negotiations, the United States has finally put together a bipartisan infrastructure bill, and it is significant. The senate recently passed the bill in a 69-30 vote. The bill has a $1 trillion price tag, with $550 billion in new spending, and now needs to pass the House to become law. Below is a brief summary of major provisions in the bill.
Transportation Projects – The bill would spend $110 billion in new funds for roads, bridges, public transit, rail, ports, airports, and related projects.
High-speed internet – The bill would spend $65 billion with the goals of providing broadband internet to all Americans and reducing the cost of high-speed internet.
Electric vehicles – The bill would put $7.5 billion into a national network of electric vehicle chargers. It would also put $7.5 billion toward “electrifying” buses.
Action on climate change – The bill would make several other investments meant to combat climate change, including $28 billion for power grid infrastructure and reliability, and $46 billion to help mitigate damage from floods, wildfires and droughts.
Water – The bill would spend $55 billion on clean water infrastructure.
The plan is to be paid for through repurposing unused stimulus funds and unused funds from various other government programs. However, the Congressional Budget Office (CBO) estimates that the bill will add $256 billion to the deficit over 10 years.
Our view – A lot can still change as the bill moves through the House; however, from a market perspective, this is a very positive development. The market loves government spending, particularly on things like infrastructure that can create jobs and pay dividends for generations to come. If passed, and if the past is any indication, this will be additive to economic growth.
Economic Slowing
This week we saw retail sales numbers fall well below economist projections, and we got a read on consumer sentiment, which plummeted in early August to a reading of 70.2, down from 81.2 in July. This is the lowest reading in several years. These data points can be volatile on a month-to-month basis, but what we are seeing is a bit sobering. It reflects consumers’ dashed hopes that the pandemic would be over by now, combined with inflationary pressures that have become too much for many consumers. These numbers have driven economists to reduce their economic growth forecasts. Goldman Sachs, for example, lowered its GDP forecast by a full percentage point in each of the next two quarters, has reduced its full year growth target down to 6.5% from 7 %, and sees growth slowing to under 2% in 2022. The consensus economic forecast for 2022 remains over 4% but is beginning to come down.
Our view – We have been writing for a while that the inflation surge, while transitory in nature, would ultimately prove to be a drag on economic growth, and we are seeing that play out. Sadly, the resurgence of COVID with the Delta variant will likely further detract from growth. That being said, we are not talking about a recession, but rather a slower growth rate. If this economy can really hit a 4%+ growth rate next year, that would be significantly higher than our pre-COVID growth levels and will continue to provide a backdrop where risk assets (stocks, real estate, etc.) can perform well. We continue to believe that a slowdown in growth will allow the Federal reserve to refrain from increasing rates for the foreseeable future.
Federal Reserve Taper Talk
Tapering has been in the news lately. What is it, and why does it matter? If you recall back to March of 2020, the Federal Reserve was staring down the barrel of an unprecedented pandemic with potentially dire economic implications. The Federal Reserve quickly cut the federal funds rate to zero and started purchasing large denominations of Treasuries and agency mortgage-backed securities to help support the market and the economy. These large assets purchases are known as quantitative easing (QE). Fast forward to today, the economy is rebounding strongly (even if we are seeing a slight slowing in the growth rate as discussed above). The Federal Reserve is beginning to talk about scaling back various stimulus programs. Tapering is the term used to describe the process of gradually reducing or eliminating asset purchases when there is no predefined end date or amount. This does not involve the outright sale of securities, but rather a reduction in purchases. While the Federal Reserve has not yet announced when and if they will begin the tapering process, most experts agree that this is likely to begin this year.
Our view – We agree a tapering process will likely be announced this year. In the past, just the prospect of tapering has been unsettling to markets. Our belief is that tapering is likely to be very gradual, and the Federal Reserve can shift directions as they see fit. What does tapering mean for markets? In theory, tapering should lead to higher interest rates, as there will be less demand for these bonds. However, the last tapering period, which began in 2013, saw yields rise on the announcement, and then gradually fall during the implementation period (see chart below, courtesy of Bloomberg).
We believe this reflects the power of the Federal Reserve’s communication. It wasn’t the Federal Reserve’s tapering that caused yields to decline, but the announcement that they would begin tapering. Counterintuitively, markets view tapering as the start of tighter policy, which generally results in slower growth and lower inflation down the road. Consequently, yields fell during the last tapering period. While everyone is terrified of higher rates, there is historical precedent that rates may peak before the tapering has begun and then slowly move lower.
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.