Keeping Watch of the Fed, Elevated Stock and Real Estate Valuations, and Afghanistan Fallout
Those of us in developed economies are well advanced in coping with COVID-19 compared to our status one year ago. Economic growth and vaccinations are well underway and, with cash levels on consumer and business balance sheets at record levels, the economy has ample liquidity to fuel sustainable growth. With the Fed continuing to suppress interest rates, which reduces the cost of financing government deficits, asset prices may well continue to rise in the next twelve to eighteen months with periodic declines.
While Fed actions are important to our outlook and strategy, other factors come into play including elevated prices and valuations of stocks and real estate, and the disturbing developments in Afghanistan. For the latter, the ugly U.S. exodus from this war-torn country has caused global consternation, which may have negative repercussions domestically and abroad. Will the perception of our troop withdrawal result in the loss of political capital for the administration and, perhaps, impair pending stimulus and budget proposals? With hundreds of U.S. citizens unable to leave the country, is it possible, even if unlikely, that we see a 2021 Taliban version of the 1979 Iran Hostage situation? (click the toggle below for a brief refresher of this stressful time in U.S. history 40 years ago).
With massive amounts of monetary and government stimulus injected into the economy, and with more underway, risk assets continue to have the wind at their back. While inflation is evident in many areas, the Fed considers current price pressures as transitory, which is logical as most price rises are due to supply-chain disruption and product shortages. These imbalances will work into balance over time. If the economy follows the anticipated path, the Fed will begin reducing bond purchases in the coming quarters and hike rates in late 2022 or 2023. We expect higher levels of volatility as this transition unfolds.
Elevated Prices & Valuations
Asset price inflation is evident in the valuations of stocks and real estate, and in speculative areas more prone to price manipulation such as crypto currencies and stocks promoted on social media websites. These ingredients typically result in a “healthy correction” (it is healthy if it cools speculation with just a modest repricing of more solid assets). Though these signs of excess give us pause, they are unlikely to evolve into a bear market and recession in the remainder of 2021 and into 2022.
For now, odds favor stock prices rising in sync with growing revenues and earnings. If price rises become extreme with unfavorable risk/reward probabilities, then we will trim risk assets further. In the interim, we are not making any investment policy changes.