Insights for Investors: The Levers that Drive the Economy, Markets and Rates

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Maurice StouseBy Maurice Stouse, Financial Advisor and Branch Manager

This month we will do a review of the various levers – be those government, business or consumer that impact economic activity, the markets – stock, bond and money markets, and the cost of borrowing and the return when lending (bonds, CDs, money markets). A lever in the economy can have an impact on its own; or the collection of levers can have an even more significant impact.

Let’s start with the injection of money into the economy during the pandemic. There was quite a lot of that. The U.S. government passed record spending bills and the Federal Reserve created massive amounts of money. Just a few short years later, we are still feeling the impact in that there is a significant excess of money out there, wherever that might be. That may have come to an end. Bloomberg notes that other than the wealthiest 20% of Americans, people in this country have run out of excess savings. That lever – stimulus by the Fed – in other words, may have dissipated. On its own that provided for a lot of money that for a while (due to the pandemic) was chasing too few goods and proved to be inflationary. And the government has spent the last year and a half trying to reduce inflation.

Next, energy prices, most notably the cost of crude oil, are a significant lever as well. Crude prices have climbed over 30% since June of this year. That could have an impact on inflation over the next few months, and perhaps the slowing of liquidity (cash) might balance that out. Only time will tell.

Deficit spending. Like it or not, when the U.S. government spends or overspends, that injects a form of stimulus in the economy. That lever has an impact in several areas, however. One, it increases economic activity, but it also drives up the U.S. debt and makes the government compete for borrowing – potentially driving borrowing interest rates up. A potential effect is that this slows economic activity because private borrowing goes down and the economy slows down.

The federal budget. Two-thirds of the annual budget is made up of mandatory spending: Social Security and Medicare/Medicaid and other entitlements. As that is required spending it becomes a lever because it means the government has less flexibility on where it spends money. There is also the interest that the U.S. Treasury must pay on outstanding debt; that number is approaching the same amount that is spent on Defense. Interest paid is a lever because once again the U.S. government must compete for money thus driving rates up, which has the potential impact of driving economic activity down. The rise in longer-term (10-30 years) bonds recently helps explain that.

Social Security is becoming a growing source of income for many retired Americans. The number receiving benefits is now just shy of 70 million people. Social Security gets income from payroll taxes (individuals pay about 6.2% from their paychecks and their employer matches that). SS also gets income from the approximate $3 trillion in government securities that it owns (as of 2022 and with obligations of $6 trillion). It also gets income when Social Security benefits become taxable (about 50% of recipients pay taxes on their Social Security income). Whether or not benefits per recipient rise or fall, the sheer number of recipients is growing as the number of Americans over 65 increases. We can consider this another lever and its impact is seen on economic activity as well.

Rising long-term rates have an impact as well. For most of the past 18 months, interest rate increases were mainly at the short end of the yield curve (short maturities of 0 to 2 years). We are now seeing an increased supply of U.S. Treasuries and when supply goes up, prices usually go down. When prices for bonds go down, their yields go up. Result: the lever of rising rates impacts stocks – mainly growth-oriented or low-dividend stocks – the Technology Sector as an example – means institutional investors might sell growth stocks and invest in longer-term higher-yielding bonds. That impact was what explained some of the decline in growth and Tech sector stocks in September.

Real estate. We will start with housing. The higher yields have resulted in higher mortgage rates hence the slowdown in buying of new homes (existing or new construction). Many Americans who have locked in a low rate on their mortgages are reluctant to sell (despite their gains on their property) because that will push them into a higher-rate mortgage. Impact of the lever – fewer existing homes for sale. Add to it that the growth of new households continues (the U.S. population is expanding by more than 100k per month) and more people need and want homes. That has increased the demand for rental units for both homes and apartments. The Consumer Price Index includes the cost of shelter as its biggest component so we can see how that lever impacts inflation. There is also the lingering unknown of what the multi-trillion-dollar market of commercial real estate refinancing could have on the economy. This debt, which starts coming due at an accelerated rate over the next few years is mainly held by regional banks (vs. larger national or smaller local community banks). That lever could impact the banking sector and its ability to lend but only time will tell if that lever has a significant impact.

September and October have, over time, proven to be more volatile for investors and the exact reasoning isn’t really known. Is it a lever or more part of the reality of long-term investing? Regardless, some investors will chase returns and make short-term decisions even if they have long-term horizons. Many feel frustrated as perhaps not having owned the so-called super seven stocks which make up most of the market return year to date. We have seen over time that the tortoise tends to outperform the hare but that – FOMO, or fear of missing out, is a lever as well.

We believe that strategy is defined by goal, time frame and most importantly, comfort level (the sleep-at-night factor). And of course, a bit of patience. The ultimate lever for an investor or saver is all these things combined.

The U.S. dollar. Hardly a day goes by when we are not bombarded by ads, politicians or talk show hosts who talk about the decline of the U.S. dollar. There is fear that other countries will unite to bring about a new world currency or that foreign banks and governments will stop buying U.S. Treasuries. The reality, as of this writing, is that the U.S. dollar is up in value by over 2% year to date. 80% of world commerce and 60% of foreign central bank reserves are in the U.S. dollars. The dollar is always being challenged and is no stranger to the consistency of that challenge. The lever of the strength of the dollar can be seen in that it acts as a counterweight to inflation.

The size of the Federal Reserve balance sheet. That is the weekly reported statement of its assets and liabilities. In 2020 the Fed doubled the balance sheet to almost $9 trillion dollars. It did that by creating money, which it can do, and buying bonds with it. Thus, it injected money into the economy. That lever cannot be understated. The balance sheet has had two growth spurts in the last 20 years, once following the financial crisis circa 2008 and most recently during 2020 as the pandemic took hold. That lever released liquidity and stimulus which many argue staved off an economic depression. The Fed is slowly reducing that balance sheet and is doing so by letting bonds it owns mature and not renewing them. They are not selling bonds as that lever could be dramatic on bond values and borrowing costs. That slow drawdown could take several years, and the impact of the lever is just that: liquidity. Some might argue that has helped with the so-called soft landing in the economy.

Productivity. The U.S. and the world rely upon productivity for increasing revenues, maintaining, or lowering the cost to produce a unit of a good or a service. Productivity, at least in the U.S., despite inflation and rising rates has been increasing. The impact of that lever is significant in that it could lead to higher earnings and hence more growth for many U.S. companies.

Lastly, artificial intelligence. As we have noted before, AI has the potential to impact productivity and contribute to economic growth across just about every sector of the economy.

Diversification and asset allocation does not ensure a profit or protect against a loss. Holding investments for the long term does not ensure a profitable outcome.

Maurice Stouse is a Financial Advisor and the branch manager of The First Wealth Management/ Raymond James. Main office located at The First Bank, 2000 98 Palms Blvd, Destin, FL 32451. Phone 850.654.8124. Raymond James advisors do not offer -tax advice. Please see your tax professionals. Email: Maurice.stouse@raymondjames.com.
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