COVID-19 brought on a recession and in some industries an outright depression – but it is no match for a vaccine coupled with unprecedented monetary stimulus from the Federal Reserve and the US Treasury. The vaccine alone has enough healing power to revive the beleaguered economy, but coupled with monetary stimulus of historic proportion, one can envision an economic boom the likes of which we haven’t seen since post-war periods or, as some have suggested, the “Roaring 20s.” This is an exciting period to be an investor and may bring about several investment themes not seen in decades…namely significantly higher interest rates, inflation and the basis for higher tax rates.
We agree with Goldman Sachs’ recent projection of economic growth of 6-7% over the next year – the US economy has never experienced growth at these levels. When we align the vaccine, monetary stimulus and the overwhelming pent-up consumer demand and savings rate we arrive at a similar conclusion. All of this is positive for global growth, employment, and financial markets – so long as investors are prepared for the cause-and-effect strong economic growth can have on various securities. For much of the past 15-20 years, US and global growth rates have been muted so investors may want to dust off their history books to prepare for changes in financial markets.
Strong global growth leads to higher interest rates. Since rates are just starting to turn upward from historically low levels, investors should prepare for a continuation of this trend and its effects on different types of stocks, bonds and real estate. In addition, strong global economic growth has a long history of bringing about the ability for companies to raise prices for certain products that become high in demand – otherwise known as inflation. We are already seeing rising inflation in raw material prices and expect a continuation of this trend as economic growth spirals upward.
What are some of the best ways to invest during periods of strong global growth, higher interest rates and inflation? Many stocks can perform great during these periods – but not all. The best stock market results will most likely benefit those sectors that gain profitability through any of these three factors. Banks and other financial companies benefit from higher rates, industrial and consumer discretionary companies benefit from economic growth, and raw materials and energy companies thrive during periods of inflation. You may have noticed that we have been rotating your portfolio’s holdings into these sectors in order to best benefit from these important changes. Though technology stocks should perform well going forward, they may not have the excessive leadership that investors have become accustomed to in recent years.
In terms of the bond market, higher interest rates and inflation tend to put downward pressure on bond prices. Individual bonds have maturity dates, so they are much less affected by rising rates since, at maturity, we receive our principal back. However, bond funds do not have maturity dates and can continue falling as rates keep rising. We would advise investors to avoid having significant exposure to bond “funds” and stick with individual bond holdings. The continued rise in interest rates will eventually provide a great opportunity to buy high quality individual bonds with attractive yields – something we haven’t seen in years!
A stronger economic expansion will make it easier for our administration to raise taxes and their first target will likely be corporate tax rates, followed by high income earners. A stronger economy should allow both groups to afford higher tax rates without negatively affecting economic growth. We have borrowed an unprecedented amount of money to survive COVID-19 so it is important to create policies to repay these debts for our future generations. Strong economic expansions can generate tremendous corporate tax revenues and go a long way to paying down these borrowed funds. During the strong expansion of the 1990s, corporate revenue tax alone nearly wiped out all the indebtedness left over from the 80s – an important fact to recall when we shudder over increasing tax rates.
We are very optimistic about the future of global health and the beginning of economic recovery. Though higher rates, inflation and taxes may change the shape of the stock and bond market, we are prepared to “roll with those changes.” If our optimistic view does not come to fruition or some unexpected “black swan” event negatively affects the global economy, our Active Risk Management process is always engaged to reduce your allocation to stocks, shift your sector exposure and allow our carefully placed stop loss orders to be executed in an effort to mitigate catastrophic loss.
Thanks again from all of us for your continued vote of confidence!
If you have experienced any changes in your financial situation or have questions about your portfolio, please let us know.
Your Team at Main Street Research
If you have any friends or colleagues who you feel may benefit from our services, we would be happy to introduce ourselves to them with a no-obligation introductory meeting.