Investors’ Wants Can be Very Different from Their Needs
When the Rolling Stones wrote these lyrics back in 1969, they probably didn’t have asset managers, insurance companies and banks in mind – and certainly not in the aftermath of a pandemic half a century later. But as most financial asset returns continue their relentless march higher in 2021, amid new waves of fiscal and monetary stimulus, investors are increasingly being forced to confront, however reluctantly, the growing tension between their wants (assets purchased with a margin of safety) and their needs (income).
The source of that tension? The very policies aimed at arresting the disruptive impact of the pandemic on financial markets last year. Monetary and fiscal policy have combined to incredible effect, stabilizing markets, and the economy: central bank liquidity injections and fiscal stimulus amount to 57% of U.S. GDP and 36% of global GDP, respectively, and continue to rise. These policies were so effective in fact that when combined with the accelerating vaccination effort (500 million “first doses” of vaccines have been administered versus 150 million Covid cases worldwide), by the end of 2021 the U.S. economy will likely have closed its output gap. Then, we think the U.S. economy should be well equipped to operate above equilibrium levels for some time thereafter (as described in our recent commentary Unprecedented Times).
Is There a Disconnect Between Economic Policy and Reality?
One would not necessarily come to this conclusion based on the Federal Reserve’s (Fed) comments from its April 28 FOMC meeting though. While the Fed acknowledged some improvements, they reiterated that these improvements “[do] not constitute substantial further progress,” and that it was “too soon to talk about tapering” asset purchases, as “[they] are a long way from [their] goals.” Given that statements of similar effect had been made at prior meetings, dating back to as early as October of last year, despite a remarkable improvement in the economic data since that time, it’s no wonder that the “bull market in everything” continues to persist, with emergency policies in place amid a rapidly evolving economic expansion.
But at some point, doesn’t policy have to confront economic reality? If economists’ forecasts of GDP are to be realized (and we think they are in fact likely too low), then real rates will not have deviated this much from real GDP in the entire history of the TIPS market, since its inception in 1997 (see Figure 1).