By Paul Hoffmeister, Chief Economist
Covid cases in the United States have plummeted.
U.S. manufacturing and services sectors are rebounding sharply.
Inflation data is rebounding as well, similar to 2009.
When will the Fed start raising interest rates?
Value is outperforming growth meaningfully in 2021.
Tax increases from Washington look on hold for now.
Covid: Are We Near the End?
New York Times on June 6, 2021: “America has essentially lifted all rules for people who are vaccinated.” (As Vaccines Turn Pandemic’s Tide, U.S. and Europe Diverge on Path Forward)
Over 50% of US population has been vaccinated.
Texas led states in reopening in March. California plans to remove all capacity limits, physical distancing requirements starting June 15.
Rebound in Manufacturing and Services
The economy is strongly rebounding.
According to surveys by the Institute for Supply Management, the manufacturing and services sectors are growing at the fastest rate in more than a decade.
Unemployment: Heading Back to Pre-Covid Levels
With the global economy reopening, the U.S. unemployment rate has collapsed from 13.1% in June 2020 to 6.2% in March 2021.
Federal Reserve forecasts foresee the possibility of a 4.5% unemployment rate by year-end 2021.
According to Bloomberg surveys, the U.S. unemployment rate is expected to reach 5.4% by year-end, 4.2% by end of 2022, and 3.9% by end of 2023.
Inflation: Oil Price Rebound and CPI
As discussed months ago, the value of oil in relation to gold (which is arguably a more stable unit of account) is useful in presaging the direction of CPI.
Continued commodity price appreciation will likely push CPI to highs not seen in a long time.
However, we are not concerned about a round of secular inflation unless gold surges meaningfully beyond $2000/oz. and the dollar weakens significantly in forex markets.
Inflation: Big Jump for Now
Prices are jumping year-over-year in the United States, Canada, and Europe.
The “surge” is due in part to the current comparison to a low base a year ago when producers and retailers slashed prices to liquidate inventories, as well as current supply shortages.
Inflation Rebound After Crisis To Be Expected
An inflation rebound after a major economic shutdown, similar to 2008-2009, is to be expected.
Taper Tantrum in Next Year? When Will Fed Shift Course?
With U.S. unemployment falling toward pre-Covid levels and inflation jumping, when will the Fed begin raising interest rates?
As 1999-2000, 2004-2006 and 2018-2019 showed, market shocks tend to follow compressions in the yield curve spread; whereas a widening spread has correlated with strong returns in risk assets.
In the coming months and years, a rising rate cycle and narrowing spread environment should be navigated with caution.
2021: Value Is Shining
Arguably, a law of financial physics is reversion to the mean. So perhaps not surprisingly, growth’s outperformance over value in recent years was long in the tooth.
Year-to-date through June 4th, the Russell 1000 Value Index is up 18.3%; whereas the Russell 1000 Growth Index is up 6.3% (not including dividends).
Conclusion: Monetary Policy, Taxes and Politics
The Covid-19 pandemic and economic shutdowns look to be behind us, while economic activity and employment are rebounding sharply – as is inflation. Aside from a new, dangerous Covid variant, the biggest threat to financial markets is a taper tantrum episode where markets get ‘spooked’ by the Fed departing from its historically dovish policy posture.
The U.S. Senate reconvenes this week, and President Biden’s policy agenda is facing resistance – notably the tax and spending plans in his infrastructure proposal and voting reforms. At the moment, their passage into law looks unlikely.
With the Senate split 50-50 and Republicans united in their opposition, the most important politicians today may be Senators Joe Manchin (D – WV) and Kyrsten Sinema (D – AZ). In a recent op-ed for his home state newspaper, the Charleston Gazette-Mail, Manchin announced his opposition to the White House’s voting reform legislation and weakening the filibuster. Underscoring the obstacles facing the White House’s policy agenda, President Biden stated in a recent speech: "I hear all the folks on TV saying, 'Why doesn't Biden get this done?' Well, because Biden only has a majority of, effectively, four votes in the House and a tie in the Senate, with two members of the Senate who vote more with my Republican friends“ (source: Bloomberg).
Democratic concerns about taxes also exist in the House. A top Democratic Congressional aide told Bloomberg recently: “The thing that is missing in the conversation about these pay-fors is where Democrats won the House. We won by primarily winning in the suburbs, which tend to be tax-sensitive areas of the country.”
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Paul Hoffmeister is chief economist and portfolio manager at Camelot Portfolios, managing partner of Camelot Event-Driven Advisors, and co-portfolio manager of the Camelot Event-Driven Fund (tickers: EVDIX, EVDAX).
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