Dear Clients & Friends,
The S&P 500 (and other equities markets) had a very strong month posting 5%+ gains after a subdued March which saw markets mostly move sideways. $DOGE has defied gravity as more people are exchanging their dollars for dog money. If you haven’t heard that line, check out this fantastic rap video. As funny as it is, there are some real truth bombs being dropped. The level of inflation we’re experiencing is much more than what we’re able to earn buying bonds and especially in savings accounts. In fact, when you factor in inflation (and expected inflation) the entire US treasury bond market curve is negatively yielding.
Though the baton was passed from $GME to $DOGE, it’s shocking so many people are speculating on a crypto asset that truly has no use. Although there are likely many people out there who believe the same is true with $BTC and $ETH amongst others but we’ll leave that question for another day. I do believe $DOGE is representative of speculation and froth currently in these markets. Earlier today, I saw a post liked by a respected person in the financial markets highlighting some of this excess as Llana Rhodes (supposed adult film star) was promoting @titcoin. People seem to be willingly trading in their $ for many useless tokens besides dog money.
Crypto markets started off the month strong and pulled back right around the same time that Coinbase went public. Some claim the lack of rise in $COIN’s stock put the brakes on the crypto market as we saw $BTC drop from a high of ~$65,000 to almost $47,000 over a 2 week time frame. That’s a 27% decline while most altcoins experienced a larger decline. Another factor that played a role was during this time, President Biden proposed almost doubling the capital gains tax rate for those earning $1 million or more to 39.6%. When you include the net investment income surtax, the total potential capital gains tax climbs to 43.4%. This doesn’t include any state capital gains tax and if you’re in SF or NYC, you’re now above a 55% tax on capital gains potentially. This is a long way off from being a law and based on what I’m reading I don’t believe this will pass as is. However, I do believe higher tax rates are on their way.
I’ve seen countless tweets highlighting CEO’s of America’s companies saying inflation is coming and prices are going to be passed along to the consumer. Take a look at the charts below and LMK if you see a trend (I know I’ve highlighted inflation in past months but stay with me).
As I’ve mentioned, the way the Fed measures inflation it’s not going to show up in the data as red hot for awhile and by that time you (the consumer) will have lost a lot of purchasing power unless you’re owning assets who’s value are able to keep pace. Unfortunately, safe assets like treasury bonds are not going to cut it anymore.
For some good news, US nominal GDP (real GDP + inflation) is above pre-pandemic levels.
And if Goldman is correct, 2021 growth levels are going to be very elevated over what we’ve experienced in recent years. However, once we get past Q2 2022, growth levels appear to return to levels we had seen prior to the pandemic. Thus the debt spurred boom is very short lived.
We’ve accumulated a lot of debt during the past year with potentially more to come via an infrastructure bill. If you look at debt/GDP ratios, they have been climbing and have moved past the 90% mark which Reinhart and Rogoff marked as a significant level in a landmark paper. Essentially, they hypothesize that once you breach this key level, your growth rates tend to fall for a variety of reasons.
Some state that this ratio either isn’t actually significant or is no longer relevant. In fact, John Oliver did a show on the level of our debt recently which I just watched. I met with an economist from a large firm who believes a better way to look at the national debt was as interest we pay in total as a % of GDP. Since interest rates have fallen precipitously, the amount we spend on interest on our debt today doesn’t look out of control.
However, I’d take the stance that Reinhart’s and Rogoff’s 90% threshold might actually hold water. As debt levels rose, GDP levels declined which is congruent with our GDP following the financial crisis of 08/09. Since then, our debt/GDP levels have doubled from 60% to 120% and aligns with weak GDP growth over that time frame relative to our long term GDP levels.
source: https://www.macrotrends.net/countries/USA/united-states/gdp-growth-rate
I see 2 potential paths for the next 5-10 years. 1. debt levels will continue to rise and GDP growth will be subdued leading interest rates to stay low for a long time thus keeping the interest paid/GDP ratio in check. And 2. the Fed will be forced to raise interest rates as inflation has taken off spiking the interest paid/GDP ratio to much higher levels than we’ve seen as we have to refinance our debt with higher interest paying debt. Since the US has laddered it’s debt in a variety of treasury bonds, it won’t happen overnight but if the Fed starts moving rates higher and the market demands higher rates to offset inflation, the spike can happen fast. I’m unsure who said it first, but risk happens slowly and then all at once. And if/when interest rates spike, the level of our national debt will take center stage yet again.
Some good news for equities markets is that S&P 500 EPS expectations are rising for the entire year. A significant increase in 2021 EPS will bring down the PE ratio which is currently off the charts high (imho).
However, corporate insiders have been selling stock at a feverish pace this April as markets have been hitting new highs.
When you see how much money has flowed into global equity markets over the past 5 months, it’s no wonder why they’re going higher. More $$ has flowed into them during the past 5 months than in the past 12 years combined!
Margin debt (rate of change) has also spiked which likely makes up a large % of the past 5 month inflows as highlighted above.
I’ve been saying the same thing for about 5 years; it’s getting more difficult as an allocator. And this still holds true today. If I can say one thing, I’d say this job definitely keeps me on my toes. Be careful out there!
I hope you enjoyed this quarters financial markets update. If you have any questions please contact us directly. If you’re interested in a topic that you’d like us to address, please email us so we can include them in future updates.
If you’re interested in starting a dialogue and learning how we can help, please contact us.
Best Regards,
Jared Toren
CEO & Founder
Sources: Edges & Odds, WSJ Daily Shot, 361 Capital, Steve Blumenthal’s On My Radar
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