Against the backdrop of improved corporate earnings and the hope for more massive stimulus, as I type, the S&P 500 has gained roughly 1% for the week and 4% YTD (it is worth noting that our own moderate growth portfolio has gained 5% through yesterday’s close). While I remain optimistic for the market over the coming months for reasons I have shared in past emails—notably massive liquidity—there are areas of potential future concerns that I will closely monitor as the weeks and months pass. I will pay particular attention to the pending $1.9 trillion stimulus package, the potential inflationary impact this may have, and the new administration’s economic agenda.

Without the need for bi-partisan support, it appears the new $1.9 trillion stimulus package may pass soon, if in an amended form, after Congress turns their focus away from impeachment. That could happen perhaps as soon as this weekend as it looks likely an impeachment vote will take place Saturday. Fourteen-hundred-dollar checks may be in the mail to many millions of Americans within a couple of weeks. That, along with several other provisions of the bill could add massive stimulus to economic growth. As well as to corporate earnings growth and thus possible stock market growth.

While massive stimulus will likely accrue positively to the markets for the next couple of quarters or more, there is growing concern about whether this will be inflationary. An argument has erupted between well-known left-leaning economists about President Joe Biden’s $1.9 trillion stimulus package, with warnings that it is so large it risks runaway inflation and the crowding out of other, more productive, spending plans.

The concerns being voiced by Lawrence Summers, former Treasury secretary to Bill Clinton and director of Barack Obama’s National Economic Council, and Olivier Blanchard, former IMF chief economist, seem reasonable at first glance. After all, this stimulus comes just weeks after a $900 billion stimulus by the last administration which itself was on top of a $2 trillion stimulus last spring. In fact, Lawrence Summers has recently called the sum of this latest bill outlandish and said, “There is a chance that macro-economic stimulus on a scale closer to World Was II levels will set off inflationary pressures of a kind we have not seen in a generation.”

However, Federal Reserve Bank of San Francisco leader Mary Daly said the U.S. central bank is unlikely to pull back on its bond-buying stimulus this year, and that another round of government aid shouldn’t overheat the economy. She said she continues to expect the U.S. economy to gain momentum over the second half of the year as vaccinations roll out and allow the economy to get back onto its pre-pandemic footing. However, she suggested that even as the country emerges from the crisis, it will not yet be time for the central bank to pull back on its $120 billion a month in bond buying or shy away from more stimulus.

Fed Chair, Jerome Powell echoed these thoughts in his public comments Wednesday. In fact, he said he welcomed data that showed market-based expectations of future inflation are on the rise, and attributed a good part of that move up to the Fed’s new inflation guidelines. Late last year, the central bank said it would allow inflation to overshoot its 2% target to make up for times where it has fallen short in an effort to help deal with persistent weakness in price pressures.

Still, markets show no sign of concern, either in the average expectation of inflation implied by the bond market or the likelihood of very high inflation in the options market, both of which are back to where they stood in 2018. Traders are not anticipating much danger of inflation taking off and staying high. Option-implied probability of U.S. inflation rate for the next five years is around 1% -2%. They predict slightly inflation higher in the next few years but scaling back down after that. Given the terrible record of economists to predict future economic events, I side with market traders.

In fact, there may be several reasons to not fear Lawrence Summers comments. To list a few:

First, huge stimulus is not yet a done deal. The $1.9 trillion plan might not make it through Congress in full, especially with several senior Democrats weighing in against it. At least in part such as an increase of minimum wage to $15/hour.

Second, there is much disagreement about how much stimulus the economy can absorb without pushing up prices with economists on one side and traders on the side of lower inflationary expectations. I find it comforting that traders are on the side of sustainable inflation levels

Third, there is still a pandemic that is hampering economic activity and despite Dr. Fauci recently suggesting that as early as April vaccines should be available for everyone, I believe it will take longer than we ever before believed for the economy to get back to full normal.

And finally, the new Administration’s economic agenda at first glance does not appear to be pro-growth. This could help offset fears of an over-heated economy in the coming months mitigating concerns of higher interest rates and inflation.

There are several balls in the air that will play out over the coming months and quarters that will warrant careful monitoring, more so than usual. We will continue to update weekly.

In the meantime, 4^th quarter corporate earnings have reported stronger than most expected. More than 75% of companies in the S&P 500 have reported results with over 80% reporting upside surprises for both earnings and revenue. If this trend continues it could be a record quarter for upside surprises. With current levels of liquidity already at record highs and likely to grow higher still, 1^st quarter 2021 earnings could match or surpass this record. We’ll find out in April.

On a final note, I know many of you forward this email to friends, family, etc. I am happy to have you do so. At the same time, they are welcome to subscribe either by forwarding their email to us or clicking the subscribe button on the email itself. As well, please be aware these commentaries are posted each week to our Barcomb Asset Management Facebook page.

In the meantime, stay healthy.

Scott Barcomb