The last day of 2020 saw both the S&P 500 and the Dow Jones Industrial Average close at record highs, thanks to positive reactions to the passage of the latest round of fiscal stimulus intended to give the economy a boost entering 2021. For 2020, the stock market recovered handsomely from the COVID-19 drop, as the NASDAQ, the Russell 2000, the S&P 500, and the Dow indices all closed well ahead of their 2019 year-end value.
However, the Consolidated Appropriations Act of 2021, combines $900 billion in stimulus for pandemic relief with a $1.4 trillion omnibus spending bill for the 2021 federal fiscal year. This adds about $2.3 trillion to the national debt, which we grew by $4.4 trillion in 2020. The main concern we have is inflation given government spending. We believe government money in the hands of retail investors has caused the initial wave of inflation to occur in the stock market.
We have been closely watching the money supply throughout last year as it continues to spike higher. Stimulus measures put cash in the hands of the consumer. At one point during 2020, those unemployed because of shutdowns could have been making more than they did when working because of the additional unemployment benefits the government provided.
Money in circulation plus checkable deposits in banks is up nearly 80% from the norm. With more money supply available and vaccines to quell the possibility and fear of contracting COVID, we expect to see some normalcy return to the economy in 2021. While still expanding, the pace of economic growth will likely be slow as unemployment takes its toll in the first quarter.
The stock market is forward-looking, meaning investors price in what is expected next. We’ve been saying stock valuations have been extremely high for nearly a year. The historically low interest rate environment has pushed investors looking for yield into stocks. The S&P 500 provides a 1.7% dividend, slightly less than twice that of a 10-year Treasury. As more investors shift into equities, this can push up equity valuations without any change in earnings. Stock prices also generally respond to news faster than earnings; therefore, short-term returns reflect a rise in multiples, while long-term returns are commonly driven by earnings. It’s not unusual for a multiple expansion to drive the first leg of a stock market rally, with earnings usually following.
Political uncertainty should become more evident this week when the final configuration in the U.S. Senate is decided. Should Democrats win, more support for the working class should follow, making inflation even more likely. Democrat control is more likely to mean inflation, but Republicans blinked on the initial late-2020 negotiation for stimulus, allowing passage of the final bill, which included $600 per person. We will not be surprised if $2,000 per person is ultimately passed.
In our opinion, the national debt has become too comfortable, and the system heavily burdened. While low interest rates have allowed the United States to service this debt without much grief, inflation could force rates higher, and servicing this debt could then become much more difficult. Global investors will not let this situation pass unnoticed. We believe recent weakening in the dollar is evidence of this situation.
By year-end, we believe it will seem normal again to eat in restaurants, fly on airplanes, take a cruise, and go to theme parks. While this will allow economic recovery, it would be healthy for earnings to catch up with market prices.
If you have questions on how inflation may affect your portfolio and plan, the experts at Henssler Financial will be glad to help:
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