As the economy reopens the lasting differences begin to reveal themselves
As stores, restaurants, schools, offices, other indoor public spaces and travel across the country transition from closure or restrictions to open with entry, participation and usage by choice, we begin to see some of the lasting behavior changes post- vs. pre-pandemic. It was always expected that vaccines would restore most old norms; but the key question was: What will be different? One viewpoint was that nothing would be different upon vaccination; but another was that the pandemic and its trials and innovative triumphs would change things, producing distinct differences that would mark the beginning of a new era.
Distinct differences are appearing in the early days of the post-pandemic epoch
The biggest change is accelerated digitalization. Perhaps the most pronounced is the substitute of commuting, business travel and working in an office to digital communication and connectivity. It can never fully displace in-person collaboration, but we think digital connectivity will forever be a large and necessary part of interaction. There is more internet retailing, digital entertainment, digital payments, digital endorsements/contracting, digital health exams/monitoring/treatment. This means it’s more likely every individual in a household needs a computing device, or several, and microchips are in everything. A more digital world enables a greater spaced physical world and a resurgence of the suburbs and overlooked cities. It also provides more time for some by reducing commutes and travel. More space and time make our home more than just where we hang our hats. More time for family, cooking, entertainment, exercise, quality of life or even just doing more work. Given the circumstances, health and wellness are top of mind and lifestyles in transition. Many baby boomers retired and many young people have left the bigger/crowded cities. And greater awareness and call to action on environmental and social issues has emerged.
New political leaders and policies with uncertain costs and means to pay
U.S. elections amidst the pandemic sent voters to the polls largely with a mindset of seeking more government and leaders that would provide calm, better communication, reassurance, more safety nets and policies to address environmental and social issues and perhaps an attempt at bridging the partisan divide or just something different. Democrats took the White House and control of the Senate after runoff elections in Georgia and kept the House. We’ve described the fiscal policy since as: Spend more now, tax later or not until the bond market objects. Fiscal and monetary policy are probably the key policies for investors, but regulation, trade, and geopolitical issues are also at play. The U.S. relationship with China is uncertain and so is the future of globalization. Perhaps globalization slows in the physical world, but accelerates in the virtual/intangible/knowledge world. We expect new policies to lead to moderately higher taxes and inflation than what otherwise would’ve been. Great uncertainty remains for normal real interest rates and when they begin to climb.
Inflation and interest rates: Cyclical vs. secular trends… we believe cyclical will pass
Recent inflation reports show jumps from what in many cases were depressed prices a year ago. But prices also climbed elsewhere as consumer spending shifted from services to goods, from city to suburban life, etc. Thus, lopsided demand, supply-side disruptions in materials and manufacturing also spiked prices. This is likely short-term, driven by quick spending-mix changes and reopened service businesses not yet at full capacity/productivity. We expect high prices to fix high prices at the cyclical sources and also where caused by structural demand shifts, such as toward more housing, over time. That said, we think the risk of inflation staying above the Fed’s 2.0-2.5% target this cycle is elevated owing to fiscal and monetary policy. Deficits that exceed GDP growth, real interest rates that are well below neutral and double-digit growth rates of cash in circulation suggest inflation could stay above the Fed’s target as cyclical transitions into a more broad-based secular inflation. We’ll watch legislation from Congress this summer and how the U.S. dollar and bonds react.
Inflation is uncertain and accordingly the outlook for real interest rates remains uncertain as it’s unknown if and what actions the Fed will take to curb inflation. We think Banks and intangible-asset-based businesses offer good protection against secular inflation risk, while being well positioned in the new epoch. While growth stocks are long-duration assets, they are long-real-duration assets. Real rates remain negative and near all-time history lows.
S&P Optimism Gauge: Valuations at secular growth remain benign vs. history
We reviewed observed S&P 500 valuations and by sectors. PEs are high, earnings yield vs. real interest rates are reasonable, yet implied long-term economic profit- growth potential is undemanding.. Markets risk underestimating the ability of the innovators, again.