Last week we learned that Personal Income soared again in January as the federal government began sending out checks tied to the second round of COVID economic assistance. Consumers brought in $21.5 trillion (seasonally adjusted annual rate) in January, exceeding the previous record in April of last year following the distribution of the first round of economic support. As was also the case last April, the entire increase in Personal Income in January was due to a surge in transfer payments. In the charts below you can hopefully see that Personal Income would not have grown at all, either sequentially or year-over-year, without the increase in transfer payments.
The growth in Personal Income, however it is derived, is obviously a positive for the economy over the near term. This is true even though the fiscal stimulus comes at the cost of massive budget deficits. However, as was the case the first time around, the impact of the government stimulus checks is being muted by a reluctance on the part of recipients to spend those windfalls. Consumer spending actually fell a fraction of a percentage on a year-over-year basis in January compared to the 13.1% YOY increase in income. That reluctance to spend, most likely due to fears associated with COVID, is temporarily holding the economy back from growing at a much faster pace. The skittishness is also causing consumer savings to accumulate at a record pace. The savings rate for January spiked back up to 20.5% after peaking last April at 33.7%. These savings represent firepower for future spending and economic growth.
Perversely, though, the sudden volatility we’re seeing in the capital markets is a direct response to the buildup of consumer savings. Investors are understandably wondering if a combination of massive savings, another round of economic assistance of up to $1.9 trillion, and the successful rollout of several vaccines will hit the economy all at once, causing surges in demand for all kinds of goods and services. The risk is that the surge in demand will outstrip supply, and price levels will rise at an uncomfortably high rate. The key question will be the pace at which consumers gain the confidence to come out of their shells and engage in the types of activities they have so sorely missed, like travel, sporting events, restaurants, and bars, etc. The Fed is well aware of this risk, and it continues to say that this type of “transient” surge in demand and prices will not cause the central bank to remove its unprecedented level of monetary support anytime soon. But can anyone be so sure?
Interest rates are rising, commodity prices are soaring, and the types of stocks that benefit most from low interest rates are falling. So far, the damage has been contained, but incoming economic data over the next several weeks are unlikely to provide investors with evidence that the aforementioned risks will moderate. As the population gets inoculated and the economy opens up, economic indicators are likely to improve. Each incremental data point is likely to lend support to the narrative that the Fed will be forced to act. For investors, this may mean that the days of 0% interest rates, and all the associated froth and euphoria, may be drawing to a close. Or maybe this is just another head fake.
The best guesstimates for the upcoming economic surge and jump in inflation are looking towards August or September. Many economists, including several at the Federal Reserve, expect this surge to be transitory. It may last a few months, but the economic elite think a return to 2% GDP growth will occur by early 2022. From a GDP growth perspective, this makes sense as growth is measured by adding increases in employment to increases in productivity. The Federal Reserve says they will be patient and allow inflation to run hot for a time. No one knows how long their patience may last. There are so many variables in this rosy forecast, that any other outcome could hardly be a surprise. We believe that all of these outcomes continue to argue for our conservative allocation of companies currently performing well, those that are inexpensive and recovering, and those that will benefit from reopening. Remember that time and not timing makes money for patient investors.