Don’t Fight the Fed

Don’t Fight the Fed

Mark Lazar’s March 2021 Newsletter

A nation is not made wealthy by the accumulation of shiny metals, but it is enriched by the economic prosperity of its people. Adam Smith

In March, president Biden signed the $1.9 trillion COVID relief bill (American Rescue Plan), U.S. COVID vaccinations exceeded the 100 million mark, weekly COVID deaths have dropped 62% since the peak in January, states and schools are reopening at an increasing pace, and the country is forecast to achieve herd immunity by mid-summer. All of which bodes well for a robust economic recovery.

Because markets are forward-looking all of this was priced in months ago, which is why equity indices finished sharply higher in 2020, and are off to a good start in 2021.

Item
YTD Change
Dow Jones Ind Avg
1.21%
S&P 500 Index
1.72%
EAFE Foreign Index
0.99%
Barclays Agg Bond Index
2.21%
1st Quarter GDP Forecast
8.4%
Unemployment Rate
6.2%

*Market index data as of 2/28/2021

Let’s take a moment to better understand the economy and how it’s calculated. Gross domestic product (GDP) is the yardstick by which we measure the economy. The formula to calculate GDP is simply C + I + G + (X – M). Specifically, GDP = private sector consumption + gross investment + government spending + (exports imports). The 2021 GDP forecast is $22.3 trillion, or a 6% increase from 2020. GDP is expressed in real numbers, meaning net of inflation.

We can calculate average income per capita by dividing GDP by total population. The 2021 forecast is ~$67,000 per person ($22.3 trillion/332 million). When GDP is rising faster than population growth, real wages and, consequently, the standard of living is increasing. Conversely, when the population is growing (birth rate + net immigration), faster than the economy, the opposite is true.

For the past fifty years, federal spending relative to GDP has averaged slightly less than 20%. In other words, federal spending represents about one-fifth of the economy. However, in 2020 the federal government’s share of the economy exceeded 31%; the highest since WWII. When state and local spending data are included, 2020 total government outlays exceeded $9.78T; federal $6.55T; state $1.97T; local $2.04T.

In 2020, Uncle Sam collected $3.4T but spent $6.55T. The difference, $3.15T, represents the federal deficit, or the shortfall between tax revenue collected and what was spent. The national debt, which is the total amount of money that the government owes its creditors (government bondholders), is currently $28T, or $84,000 per person.

One might ask, where does Uncle Sam get the money? The simple answer is you; the taxpayer. When a household spends more than it earns, it must borrow the money (e.g., home mortgage, bank loans, credit cards, etc.) and the federal government is no different—just a lot more complicated, and involves both the U.S. Treasury and the Federal Reserve.

In a nutshell, the Treasury both mints currency and borrows money by issuing Treasury bills, notes, bonds, savings bonds, etc., whereas the Fed creates “Federal Reserves” (digital money) with which it purchases bonds (mostly Treasury securities) held by financial institutions. This effectively injects liquidity into the financial system, and lends money, albeit indirectly, to the Treasury, with banks being the middleman, so to speak.

At the beginning of 2008, the Fed’s balance sheet was $900B, whereas U.S. GDP was $14.7T, meaning the Fed’s balance sheet was 6% of GDP. Today, it’s $7.6T, or 34% of GDP; nearly six times the historic average. On top of massive fiscal stimulus, the central bank has embarked on an unprecedented combination of monetary stimulus measures (e.g. quantitative easing, zero interest rates, modern monetary theory (MMT), yield curve manipulation, etc.) intended to goose the economy, inflate stock prices, and punish holders of cash/cash equivalent savings.

There’s an old Wall Street saying; Don’t fight the Fed, which means if the Federal Reserve is attempting to boost the economy, stock prices typically benefit. Today, the Fed isn’t just dovish, it’s accommodative on crack. Similarly, Uncle Sam is writing checks so fast he’s developing a hand cramp. On top of an economy that is improving daily due to the reopening of businesses, the consumer has a lot of pent-up demand. Add it all together, and you have a recipe that should push stocks and real estate prices higher, bonds lower, and accelerate inflation; meaning cash loses money, albeit safely.

Mark Lazar, MBA
Certified Financial Planner®
www.pathwaytoprosperity.com

Views expressed in this newsletter are the current opinion of the author, but not necessarily those of Raymond James & Associates. The author's opinions are subject to change without notice. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Past performance is not indicative of future results. There is no assurance these trends will continue or that forecasts mentioned will occur. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success. The S&P 500 is an unmanaged index of 500 widely held stocks. The Dow Jones Industrial Average is an unmanaged index of 30 widely held securities. It is not possible to invest directly in an index. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification. Gross Domestic Product (GDP) is the annual market value of all goods and services produced domestically by the US. The information in this article is general in nature, is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security. Investments and strategies mentioned may not be suitable for all investors. The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The MSCI Emerging Markets is designed to measure equity market performance in 25 emerging market indices. The index's three largest industries are materials, energy, and banks. The Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members. Raymond James is not affiliated with any of the organizations listed above. Neither Raymond James Financial Services no any Raymond James Financial Advisor renders advice on tax issues, these matters should be discussed with the appropriate professional. Investing in commodities is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising. Gold is subject to the special risks associated with investing in precious metals, including but not limited to: price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have the potential for instability; and the market is unregulated. Be advised that investments in real estate and in REITs have various risks, including possible lack of liquidity and devaluation based on adverse economic and regulatory changes. Additionally, investments in REIT's will fluctuate with the value of the underlying properties, and the price at redemption may be more or less than the original price paid. Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification. Donors are urged to consult their attorneys, accountants or tax advisors with respect to questions relating to the deductibility of various types of contributions to a Donor-Advised Fund for federal and state tax purposes.