Notes to Know: 2020 in Review

"If I'd have had more time, I'd have written a shorter letter" ~Blaise Pascal

Another Oaktree Overview from Howard Marks

As the first quarter of the new year draws to a close, it is fitting that we review Mr. Marks’ latest letter entitled “2020 in Review”. To spare the suspense, I’ll skip ahead and cut right to his conclusions:

  • “Is inflation a threat any time soon? The answer is clear: Who knows?”

  • “With arguments on both sides, I feel the prices of most assets are in a gray area-certainly not low, mostly on the high side of fair, but not so high as to be unreasonable.”

Though abject clarity might be a little lacking in the above conclusions, the letter is once again extremely well written and is worth the read, and you can find it here. In it, Marks recounts some of the amazing events of the past year:

  • In the second quarter, the U.S. experienced the worst quarterly drop in real GDP in 74 years of recorded quarterly history, an annualized decline of 32.9%

  • But in the third quarter, it saw the biggest annualized gain in history: 33.4%

  • Unlike the credit crunches that accompanied many past cycles, capital flowed like water (albeit after a brief but terrifying freeze). High yield bond issuance for the year was $450 billion, up 57% from 2019 and well above the prior record set in 2003. Investment-grade debt issuance totaled $1.9 trillion, up a similar 58% from 2019 and ahead of the previous record, set in 2017.

Marks points out that we had a health emergency, an ailing economy, the most generous capital market of all time, and strong stock and bond markets. For creating this, Marks credits the aggressive actions by the Fed and U.S. Treasury.

I believe it is extremely important to understand the scale of the “relief” that has been passed into this economy. Marks quotes progressive economist Larry Summers:

  • A comparison of the 2009 stimulus and what is now being proposed is instructive. In 2009, the gap between actual and estimated potential output was about $80 billion a month and increasing. The 2009 stimulus measures provided an incremental $30-$40 billion a month during 2009, an amount equal to about half of the output shortfall.

  • In contrast, recent Congressional Budget Office estimates suggest that with the already enacted $900 billion package (but without any new stimulus), the gap between actual and potential outlet will decline from about $50 billion a month at the beginning of the year to $20 billion a month at its end. The proposed (and subsequently passed since the time of writing) stimulus will total in the neighborhood of $150 billion a month, even before consideration of any follow-on measures. That is at least three times the size of the output shortfall. (Emphasis added)

  • In other words, whereas the Obama stimulus was about half as large as the output shortfall, the proposed (now enacted) Biden stimulus is three times as large as the projected shortfall. Relative to the size of the gap being addressed, it is six times as large. (That emphasis is all Summers)

The concern becomes that this flood of capital, in essence, filling an economic gap that doesn’t even exist, could lead to inflation pressures like those unseen for a generation, with “consequences for the value of the dollar and financial stability.”

Toss into the mix that the administration is now looking at an additional $3 trillion spending package, effectively doubling the amount of stimulus in the system, I’ll admit that I’m a bit more concerned about the potential for inflation than Marks appears to be as indicated by his “Who Knows” comment above.

From where I sit, it would appear that the economy has no excuses to do anything except explode to the upside from here… inflation pressures be damned. When you consider not only the massively overwhelming stimulus already passed, with the potential to possibly even double that amount, and:

  • Globally, and particularly in the U.S., we appear to be turning the corner on the pandemic, with states cautiously (and some less cautiously) allowing for expanded economic interactions as we enter the summer.

  • Vaccines are proving effective, and the concept of “herd immunity,” however you choose to define it, appears to be within reach.

  • Demand is pent up… for travel, dining out, for movies, for clothing, for concerts, for sporting events, and a myriad of other things we have all avoided for the past year.

I agree with Marks in thinking that we may well be at the very beginning of an economic up-cycle that is likely to run for years.

Marks then brings another point I hadn’t considered: the potential for well above average consumer spending. Not only have many families spent less this past year than usual (a fact we can confirm through our regular conversation with our clients), many households actually made more money last year than they did the year before. Starting with the households that received support checks but didn’t suffer job losses, real personal income grew in 2020 at the fastest rate in 20 years. Harvard economist Jason Furman estimates that the combination of above-trend income and below-trend spending has created roughly $1.8 trillion of extra disposable personal income since the beginning of the pandemic. Add to this the wealth effect from strong stock and bond markets, and even more on easily-accessible equity in homes… and there is a lot of cash out there to spend.

All these factors combine to lead to an understanding of Marks’ other conclusion: The markets are expensive, but when you consider all the above… maybe not that expensive.

Or maybe they are…

Make it a Great Day!

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