A Rescue Plan Is On Its Way: Is That A Good Thing?

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With former President Trump’s second impeachment trial over, the way is clear for Congress to move ahead on President Biden’s $1.9 trillion economic relief package. More on impeachment in a moment. But first: should investors welcome the relief — or rescue — package, or fear it? Markets seemed uncertain last week. A debate has broken out among economists and policymakers — mostly Democrats — about whether a big package risks igniting inflation, triggering tighter money and tipping the economy back into recession. Investors are right to keep an eye on inflation. But the risks of an overheating US economy in 2021 are likely overplayed. And with 10 million fewer jobs now than a year ago, concentrated among the lower paid, even the central bank seems ready to welcome an economy running hot, if it buys a faster return to full employment. 
Back to impeachment: acquittal of the former president was expected. But it underlines the uncertainty around US politics, which in turn worries the rest of the world. The former president remains a force in the Republican party, even as Senate Minority Leader Mitch McConnel excoriated him — after voting to acquit. What does this mean for more traditional Republican values, of free trade, limited government and lower taxes?
Observations and takeaways for investors:
1. Balancing risks: Investing is all about balancing risks, and rewards. So is policy making. 

There is now broad agreement among economists — at least in the US — that fiscal policy after the Global Financial Crisis erred on the side of going too small. The shift to contraction that began in the US and Europe as early as 2010 rested in part on over optimistic assumptions about recovery. It also came from a fear that excessive deficits and debt would lead to inflation and instability. Instead, a path of fiscal restraint led Europe to suffer a crisis of confidence in its currency and cohesion and the US to see an agonizingly slow recovery. Depressed jobs and wages contributed to a loss of confidence on this side of the Atlantic as well — confidence in the American Dream and the ability of governments to take care of its citizens. 

President Biden and his economic team — many of whom were in office last time around — do not want to make the same mistake again. They came out swinging against the argument put forward this month by former Treasury Secretary Larry Summers that the Biden proposal was so big that it risked being too big for the Fed to manage, as well as being poorly targeted. 

From Treasury Secretary Janet Yellen to Press Secretary Jen Psaki, the Administration’s response focused on the balance of risks: the risks of going too small far outweigh the risks of going too big, they argued. Support came from an “odd trio”: Nobel Prize winning progressive economist Joseph Stiglitz, former Clinton Treasury Secretary and Wall Street financier Robert Rubin and former Obama budget chief, Peter Orszag. In a new paper, the three argue for a risk-based approach to fiscal policy, with more automaticity built in so that policy adjusts to counteract the business cycle. Last week, they noted to the Economic Club of New York that the risks right now — to the economy and to society — of prolonged recession, and persistent unemployment among low income and marginalized groups, argue for going big. Some of the package — notably increased unemployment benefits — will fall off automatically if the economy recovers more quickly, Rubin pointed out. 

“The needs are much bigger than people realize,” said RockCreek Founder and CEO Afsaneh Beschloss when discussing the economic realities of Americans in the pandemic. “If we could as economists start concentrating on the bottom half versus getting distracted on the minutiae on the targeting we could get the economy to a better place,” she continued. Ms. Beschloss joined Willett Advisors Chairman and CEO Steve Rattner to discuss the stimulus package, retail investors, earnings and more with David Westin on “Bloomberg Wall Street Week.”

President Biden’s team believes that the Obama Administration also made a political mistake in 2009. That mistake was to try too hard to win bipartisan support in Congress for the post-crisis fiscal package. In the end, the argument goes, no Republicans voted for Obama’s stimulus, even though it was trimmed in an attempt to make it more attractive. The failure to spur a full-blown recovery was then blamed on the package itself, and not on its diminished size.

So — look for President Biden to push for most, if not all, of his $1.9 trillion to get passed quickly and for Democrats in Congress to support him, even at the cost of Republican votes. As Paul Krugman said to Larry Summers, in a match-up debate at Princeton “What would you cut?” The part that economists, including analysts at the Committee for a Responsible Federal Budget, have most doubts about, and that fiscal conservatives among Republicans have questioned, is also what is most popular: the $1,400 checks for most individuals, to bring the total to $2,000 this year. Even Biden has agreed that the checks could be better targeted, to lower income households. But a majority of Americans, including former President Trump, favor them. There is a new definition of bipartisan support being pushed by some in Washington: approval in the polls, even if not in Congress. And that makes smaller, or fewer, checks unlikely to be agreed.

In contrast to the 1990s, markets seem more likely to be spooked by an unexpectedly small than an over-sized bill. In part, this reflects a growing consensus that while the vaccine will certainly help to curb Covid-19, there will not be a magic moment when the global economy turns on again. New virus variants may evade the vaccine. New lockdowns — already likely in Europe — will hinder international travel and perhaps trade for some time to come. An underpowered US economy would endanger global growth. 

This past week saw US equities post modest gains with the S&P 500 rising 1.2 percent and the NASDAQ advancing 1.7 percent. Unlike much of last year, energy stocks led the market. Frigid weather across much of the US, including Texas, is powering energy this week against a backdrop of upward pressure on oil prices from reflationary forces and a reopening of the global economy on the horizon. The Biden Administration’s decisions to ban the Keystone XL pipeline and new permits for drilling on federal land will likely serve to dampen oil supply in the US, also supporting higher prices. US company earnings also were a bright spot. Roughly three-quarters of S&P 500 companies have reported Q4 earnings and it appears that the earnings recession that began in Q2 last year is over. Over 80 percent of companies exceeded expectations and profits are projected to have grown on average by 2.8 percent. This is a substantial improvement over the 9 percent decline analysts were expecting back in December.

2. Inflation: bring it on?

The main risk of too much federal spending this year is that the economy will not be able to absorb it, that inflation will rise as the government and consumers try to spend on goods and services that the economy cannot produce, and that the Federal Reserve will be forced to do an about-turn and raise interest rates or pare back quantitative easing to control inflation. Such a policy shift would in turn destabilize financial markets — perhaps cascading from bonds to stocks to emerging markets in a rerun of the “taper tantrums” that have rocked markets whenever central banks threaten to tighten policy. Continued high volatility suggests that financial players remain anxious, even as equity prices have climbed to record highs. 

Inflation concerns should not be dismissed. As former President of the New York Fed, Bill Dudley, laid out in a Bloomberg column in December, there are a number of reasons to expect wages and prices to rise above the Fed’s 2 percent target. And even if inflation can be contained, markets may have a tantrum whenever the Fed signals a future tightening. A big fiscal package makes that moment more likely to be sooner than later. So is easier fiscal policy, not just in the US but also in the UK, Europe and Japan, making life difficult for central banks?
Major central bankers likely beg to disagree. The past decade has seen them unable to anchor inflation expectations at their preferred targets, with consistent undershooting. The zero lower bound has made it difficult or impossible to manage monetary policy through usual short-term interest rate mechanisms. Negative interest rates complicate banking and have not been very effective when tried. Quantitative easing essentially works, senior central bankers believe, through lowering bond yields — flattening the yield curve and lowering risk premia when short rates cannot be driven lower. But QE pulls central bankers into markets that they would rather avoid. It has also inflated the value of financial assets to an extent that many fear. Against this backdrop, a modest rise in inflation, with fiscal policy supporting the economy, would be benign, and even welcome. 

Markets may see things differently. The disconnect of financial markets from the real economy, and in particular the disparity between the fortunes of the most wealthy and of those most impacted by recession and by the pandemic, is unacceptable for central bankers. Since moves to tighten monetary policy risk hurting the economy, and pushing inflation expectations even lower, they have been in a bind for as long as monetary policy was “the only game in town.” Leaders from Fed Chair Jay Powell and ECB President Christine Lagarde to the Bank of England’s Andrew Bailey urged fiscal expansion, even before the pandemic. A policy mix that would allow traditional monetary policy to operate while fiscal spending supports demand looks even more attractive now, after last year’s extraordinary liquidity provision. But the decade of easy money, low interest rates and ample liquidity has been generally good for investors, including those concerned with safeguarding pension assets, savings and non-profit endowments.

Looking ahead, the key for policymakers will be to calibrate what is happening to wage and price pressure. The Fed will tolerate a period of above target inflation — but it will need to explain for how long and why to help investors gauge what to do.

Most investors will agree that the current regime of rising real yields and breakevens in a growth and reflationary environment is to be expected this year. The sideways dollar coming from a weak base argues for interesting FX opportunities especially in EM. Developed market equities have a tailwind as do growth-sensitive commodities. We at RockCreek are positioned to capture this regime given our assessment of the fiscal and monetary landscape. Just as important to monitor is when or if we move into a scenario with real yields rising and breakevens declining. Under this environment, risky assets will see more turbulence and a long dollar positioning becomes the best trade. From where we are today it seems that the shift into this scenario would only happen with Fed tightening as inflation and inflation expectations move beyond the Fed’s comfort level. We are not at this point yet. But looking at future scenarios is helpful in assessing future markets and positioning. 

3. A new geopolitical balance between China and the US: or is it the same? 

President Biden spoke last week to China’s President Xi for the first time since taking office on January 20. The two know each other well — including from when they were both Vice Presidents — and spoke for two hours. Secretary of State Anthony Blinken has also spoken to his counterpart. It is likely that such exchanges will continue, with fewer surprises than occurred under President Trump. Investors wondering whether the new US Administration will change the substance as well as the tone of former President Trump’s posture towards China will have to wait a little longer. And it will pay to watch what happens in Beijing. But there are already some clues.

The Biden team is clear that they see China as an economic competitor, who has taken jobs from Americans with unfair practices and subsidies. The first remedy, in their eyes, is to beef up support for key sectors at home. Looking back at Biden’s comments when meeting Xi in 2012, he sounded similar themes. This president is all about decent jobs at decent wages here at home. But he will not want to put in place measures that disrupt American production.

On both human rights and national security, the Administration is likely to hang tough; Blinken agreed with his predecessor’s characterization of the treatment of Uighurs as “genocide.” Although the readout from Biden’s call did not repeat that term, he has stressed the importance of human rights. Already, Biden has sent an American destroyer on a “Fonops” or “Freedom of navigation operation” in the South China Sea.

But the President also signaled areas for cooperation — notably climate, where technology advances will also be critical for success. Can the two work together?

4. The year for emerging markets? 

In what was supposed to be a quiet week leading up to the Chinese Lunar New Year, emerging Asian markets were anything but uneventful. Chinese equities had a strong week, led by materials, technology, and consumer related sectors. Technology stocks continue their impressive run in 2021. Although we see cyclical sectors including banks and materials performing better as the global economy reopens, technology companies have shown no signs of slowing earnings growth or waning investor interest. Out of the top ten stocks in the MSCI EM Index, eight are technology and seven of the eight technology stocks are up double digits — outperforming the index itself. 

 
Strong emerging markets performance especially from Chinese equities has continued to attract foreign investor flows. Last week alone saw equity flows into EM markets double to $6 billion across both ETFs and active strategies. While North Asia led the pack, all emerging market regions saw significant net inflows. Local EM currency flows saw a similar trend and inflows surpassed hard currency interest for the first time in 2021 — a sign that investors are looking to capture attractive yields coupled with a positive outlook on EM currencies. 

Despite a trend of positive sentiment, EM positioning remains light by historical standards. The share of emerging markets in global mutual funds is currently 7.4 percent versus the twenty-year historical average of 9.0 percent. This represents a difference of $390 billion waiting on the sidelines. 

Key drivers for a bullish positioning in emerging markets remain. Steepening yield curves, a likely acceleration in PMIs in Q2, and global growth and reflation optimism support emerging markets investments. Our emerging markets investments continue to perform well with a bias towards North Asia for now. A potentially different type of dynamic between the US and China going forward with less geopolitical surprises between the two countries could create a more positive background for our emerging markets positioning.

5. Opportunities abound in 2021.

Opportunistic investing has never been as important as it is in today’s markets. With so many different areas popping up globally such as arbitrage between markets, new products and innovations, SPACs — investors are searching for new and interesting ways to generate return and/or protect from market risks. Cryptocurrencies have been a popular topic for some time and rapidly gaining institutional credibility. Bitcoin saw its price surge 23 percent to $46,750 on Monday of last week after Tesla disclosed in a filing that it acquired about $1.5 billion of the cryptocurrency on its balance sheet and expects to “begin accepting bitcoin as a form of payment…in the near future.” While we see bitcoin as a possible addition to opportunistic and high volatility parts of a portfolio, given bitcoin’s volatility we don’t see it as a replacement for cash.

Signaling broader institutional acceptance of the digital asset class, RockCreek continues to study the investment case and implementation of a bitcoin allocation. We are not alone as the world’s largest custodian bank, BNY Mellon, hastily announced on Thursday that it has created a new enterprise — a Digital Assets unit — that will “accelerate the development of solutions and capabilities” related to digital assets and “pending further evaluations and approvals” will begin to offer a “secure infrastructure for transferring, safekeeping and issuing digital assets” later this year. Whatever your view of the use case for and intrinsic value of bitcoin, it is clear institutions can no longer ignore bitcoin or dismiss it out of hand. Investment committees, boards and shareholders are demanding a rigorous assessment at a minimum. Bitcoin has continued to see its price rise through the weekend, reaching new all-time highs and nearing $50,000. More to come from RockCreek on the best way to invest in bitcoin. 
RockCreek Update
RockCreek continues actively investing in sustainable and impactful investments. Creating new investment strategies is key to building a marketplace and increasing capital towards gender lens investments. RockCreek announced the issuance of our RockCreek and The Canadian Equality Fund World Bank Sustainable Development Bond linked to Gender Equality. With our World Bank roots we were particularly pleased to develop this innovative fixed income investment and provide financing for global projects tackling inequality. Alifia Doriwala, Managing Director at RockCreek commented “These types of solutions allow institutions to meaningfully invest in impact, generate returns, and scale their mission and will be a model for future investments.” We have been working with the Equality Fund and Toronto Foundation on an institutional gender lens investment portfolio — one of the first of its kind. For more information on our issue of the World Bank Gender Bond, read here.

Last week, Afsaneh Beschloss appeared on CNBC’s “Squawk on the Street” to discuss the GameStop phenomenon, what it means for regulators and the larger ramifications for the finance industry as a whole.

Team RockCreek

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