Weekly Email 04/18/2021

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Hello!Among the hot investing topics, the idea of a “bubble” is one of the hottest. Bitcoin? Seems like a bubble. Housing market? Jeff Greene says it is, and he made hundreds of millions shorting subprime mortgages in ‘08. Must be a bubble right? Stocks? Spongebob would lose his mind. I think Spongebob might even like the name people have been giving it: the "Omni-Bubble" or the “Everything Bubble”. And yet, the narrative that markets are in a bubble has been ever-present. An opinion piece by Paul B. Farrell called for the stock market crash of 2016. From the day the article was written in 2015, the S&P 500 has doubled in value. Instead of trying to predict a crash or tell you whether we are truly in a bubble or not, I’m going to explore one of the main reasons markets have done so well, and one of the reasons they may come crashing down: the Federal Reserve.There is a rather simple reason the US economy has been doing so well despite everything: money. To be exact, $9 TRILLION in new money printed in 2020 alone! Between fiscal and monetary stimulus, the United States has added almost a quarter of the total US Dollars in circulation in the last 12 months. This money, combined with exceedingly low interest rates, has increased the “risk appetite” of investors and caused them to speculate more. This year, investors have borrowed $800 billion in their brokerage accounts to buy stocks. This increase in risk appetite means that people will buy stocks, houses, cryptocurrency, and really anything at a very high price. This has caused inflation, but we don’t call it inflation because it hasn’t happened in consumer goods like bread, eggs, and toilet paper. Instead, we call it growth because it’s happening in capital markets. This brings me to the topic that will determine the future growth of the economy and the markets: inflation and how the Fed will react to it.With all the new money in the economy, it would make sense that inflation would happen. In a vacuum, if you give everyone a dollar it’s as if you gave them nothing because it raised everyone’s standard of living by the same amount. You would expect the price of all goods to go up by a small percentage in reaction to that one dollar being distributed, but that’s not what we’ve seen. Despite record money printing, inflation is still at one of the lowest levels in history. How is this possible? According to Jerome Powell, chairman of the Federal Reserve, we need to shift our entire framework for how we measure inflation and its causes. According to Jay, “The economy has changed”. I agree with him, but I also think there is an explanation using our accepted framework.To understand how the economy has shifted, we need to understand the Quantity Theory of Money.  According to QTM, the following equation must balance: 

Money Supply x Velocity of Money = Price Level x Real GDP 

The “Price Level” is inflation in dollar terms, so assuming Velocity and GDP remain constant and Money Supply rises, you would expect inflation to rise. One argument for inflation staying low is that the Velocity of Money is slowing and the Real GDP is rising. In 2021, private-sector forecasters are projecting a 6% GDP growth rate, the highest in 30 years. The personal savings rate is also sitting around 13%, more than double the average for the last 20 years. This is causing the Velocity of Money to slow down drastically. This provides a viable explanation for why inflation is staying so low. 

So, inflation is staying low, the economy is cruising, and people are getting vaccinated, but are we in a bubble?

The best way I can answer this question is, “It’s not a bubble until it pops.” As long as people keep saving, the GDP keeps growing, and the Federal Reserve keeps printing we will continue to see sustained growth. The issue will arise if the savings rate drops and the velocity of money climbs, causing inflation. The same could happen if we continue to print money and GDP doesn’t react. Either way, the issue would compound on itself when the Federal Reserve clamps down on inflation by raising interest rates. This would slow business growth and scare the pants off of investors. It’s this spiral that is most likely to cause a market contraction. 

So when will this happen? According to Jerome Powell’s 60 Minutes interview last week, “... we want inflation to average 2% over time. And when we get that, that's when we'll raise interest rates… I think it's highly unlikely we would raise rates anything like this year, no.”  

Long story short, we have at least 2021 and most likely 2022 before we see any drastic action out of the Fed. Inflation may heat up over the course of the year and that can be a good thing in small doses. If anything, it is a great argument for staying out of cash and being 100% invested. 

If you’re interested in learning more about Hoskin Capital’s strategy and how we are navigating the current market environment, feel free to schedule a free discovery meeting with me using my calendar link. 

Have a great week! 

Best,

Nate Hoskin, CFP®

Chief Investment Officer