Imagine you are a global equity investor. You look to America and see stockmarkets at or near record levels on every measurement; you see a global health pandemic, which the US appears to be managing particularly badly; and you see a nasty economic contraction, which has floored the retail and hospitality sectors and wreaked havoc on the labour market.
At the same time, a new president is being sworn in, one who looks likely to back a barbed bundle of regulation for the tech giants that are driving overvaluation; one who has promised sharp rises in taxation (these could take 5%-10% off the earnings per share of S&P listed companies, says Luca Paolini of Pictet Asset Management); and one who has outlined a budget-busting spending programme.
Stockmarkets do seem to love Joe Biden – so far
With US public debt already near $28trn, at any other time in market history you might have looked at that list of misery and sold up, sharpish. But this time that would have been a bad idea (in the short term, at least). Last Wednesday, Biden’s inauguration day, turned out to have been the best for the stockmarket since Ronald Reagan’s inauguration day 36 years ago. The S&P 500 hit a new high, as did the Nasdaq, which was up 2% on the day.
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You can argue that this makes sense. Biden’s win means that a new political order is moving into the White House, the House of Representatives and the Senate. There will (we hope) be no more erratic government by Twitter. Instead, we will see a return to normal levels of stability in US politics, bearing in mind that no country is ever actually united and no number of fine words can make the US different. That domestic stability should make international politics a little less fraught. The US is all set to re-engage with every global acronym out there from the WHO to the WTO and Nato.
Biden is also working to get on top of the pandemic. He has mandated mask-wearing and social distancing in all federal buildings and has promised to move heaven and earth to get 100 million vaccines done in his first 100 days. Assuming a two-jab regime, that’s only one in six or so of the US population but nonetheless, if targeted, it can cover most of the over-70s and the frontline workers needed to give the country enough immunity to be on the move again before the summer. All good.
It’s all about the money
But the truth is that the relentless jolliness of the market in the face of every misery chucked at it is not really about these things. It’s about something less empathetic: the money. Biden’s additional Covid-19 package comes to $1.9trn – on top of the $1trn or so promised in December – and is very heavily geared towards households.
Most Americans will get cheques for $1,400 and there will be an extra $400 a week chucked in from the federal government to supplement state unemployment benefits. Add that up and it should be enough to at least offset the incomes lost to the pandemic so far. It also replaces income likely to be spent: Americans, just like the British, are suffering from severe cabin fever and pent-up demand syndrome. The $1.9bn might be just the beginning.
Next month, Biden is to outline his “build back better” recovery plan. If you go by his campaigning, this should come to another $2trn or so. He can count on support from his new Treasury secretary, Janet Yellen, who told the Senate finance committee this week that, “right now with interest rates at historic lows the smartest thing we can do is act big”.
Add in the fascinating discussions about debt forgiveness – Biden has extended the student loan repayment pause until October – and it looks like we are about to see round after round of deficit-financed fiscal stimulus over the next few years. That’s nice. One of the big market worries has been that as the pandemic tails off so will fiscal support. I think we can let that one go.
All this stimulus will mean higher growth. Yardeni Research is now forecasting a 5.4% rise in US GDP this year, after a decline of 3.4% last year, something that would mean the US will have recovered from the recession of the first half of last year by the first quarter of this – the fastest recession and the fastest recovery ever. It also means that earnings will look good, which makes valuations look less bad and so drives equity market momentum.
All this stimulus can only mean one thing: inflation
However, the other thing it is likely to mean is inflation. US firms and households have cash piles. The US savings rate is still way above normal at 12.9%. As the vaccines start to work, individuals will start to spend and companies will rebuild the inventories they have been drawing down over the past year. Most economists will now tell you there may be a little inflation this year as the effects of last year’s energy price collapse work their way through the numbers and lockdown ends. This is now consensus.
They may be surprised to find that there is more than a little. As Christopher Wood of US investment bank Jefferies points out, there is every reason to think that the past year has taken significant capacity out of the system (check out how many restaurants around you have disappeared) and “whether it is rising DRAM [computer memory chip] prices or indeed resurgent shipping rates, there is a lot of evidence of supply constraints in the system”.
Commodity prices, soft and hard, are also rising sharply. The key thing to note here is that once inflation gets going it may just keep going. With $8tn debt to roll over this year and Yellen (and presumably Biden) keen to spend, spend, spend into low interest rates, the Fed is more likely to let inflation rise than to let interest rates rise.
What do you do in this environment? For now, appreciate it. But bear this in mind as you do: the market isn’t on the up because Biden is an obviously nicer guy than Trump. It’s because he is promising more money.
• This article was first published in the Financial Times
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