Julie Hyman, Brian Sozzi and Myles Udland of Yahoo Finance discuss the market outlook for 2021 with Ironsides macroeconomics managing partner Barry Knapp.
Video transcription
MYLES UDLAND: Let’s talk a little more about the impact that this stimulus package can have on the economy as we move forward in 2021. Barry Knapp is with us now. He is a managing partner at Ironsides Macroeconomics. Barry, it’s always good to talk to you. Thank you for joining this morning. Let’s start with the stimulus and if this is something you hoped you would end up with, if it changes the way you’re thinking about next year. It certainly helps to keep the balance sheets of consumers sustained, and we saw how much it benefited the economy during the summer and fall.
BARRY KNAPP: Yes. We expected that to happen almost the day after the elections. We didn’t expect any fiscal agreement until 2021, but as soon as we get the election result, which we did, which basically implies that we will have a divided government – the Senate will likely remain Republican, although we should go back to that to point out a little bit because President Trump looks have somewhat damaged Republican chances. But we thought we would get an agreement at the lame duck session, and that agreement would, in essence, extend these unemployment benefits until 2021, until the first part of 2021. That was our expectation.
For us, the main result or thing that changes around all of this is because of what we describe in our note this week entitled Fiscal madness. It seems that the Republicans’ chances have been impaired in some way in Georgia. The betting markets fell 5%. They were solidly in the Republican camp. Call 71% to 29% that Republicans would control the Senate. But that five-point hit is not insignificant, and this, for us, is the biggest risk.
Between now and at least the point where the Fed starts to normalize policy or slow the rate of change, presumably sometime in the second quarter or so, we don’t think there was room for a significant correction of 10% or more. But if Democrats won a shocking victory on January 5, the risk of tax increases increases considerably, and we would not be shocked by a 10% retrenchment in S&P. So you know, last week was not a good week for the market outlook from our perspective.
JULIE HYMAN: At the same time, Barry … Hey, it’s Julie. At the same time, doesn’t the risk of more stimuli increase, or does the chance of more stimulus increase if Democrats actually win this victory? I mean, even if there were tax increases, one would think that they will not come for a long time, given the state of the economy and the fact that we are still in a very fragile situation. So, couldn’t you imagine a scenario where you would really get the most positive effects out of it? And if you are going to get the negative effects to the market that are the tax increases, wouldn’t that be a long way to go?
BARRY KNAPP: Julie, we can call this the Goldman Sachs thesis, right? Because that was, in essence, their argument – that you would get a lot of stimulus now and not have a tax hike until later. My problem with this is what could very well happen and probably would happen is something along the lines of the US Recovery and Reinvestment Act in 2009, where you don’t get Republican support for another fiscal stimulus plan, which means that you need to use reconciliation. Democrats would need to use reconciliation to approve it.
Reconciliation would imply that it needs to be paid. The way to pay for it is to pull those tax increases. Therefore, if we understand this scenario and they need to advance tax increases to pay for additional stimuli, you will have to think about the multiplier effects of government spending in relation to the negative effects of tax increases. And from our perspective, government spending is always less effective – that’s like the word of the year, right, effectiveness – but they are always less effective than the negative impact of rising taxes.
And this is the scenario that concerns us is that Republicans do not support any further stimulus. Democrats go too far. So they have to push tax increases forward. And this is the risk that we think the market could be concentrated in and could cause a 10% retraction.
This is not our official forecast. We think Republicans are going to occupy the Senate. We will have a mixed government. In fact, we think it is a very good result. We are not on the scene. This is a negative scenario. We think we’ve probably done enough for now to extend unemployment benefits until April, and that will be enough to help us with the vaccine, and the economy will recover very well. As in August, we were not concerned about falling from the fiscal chasm and there really was no negative economic impact when we fell from the fiscal chasm. Therefore, we think that the prospects are good. I’m just a little concerned that what happened last week will cause this scenario that increases the risk of tax increases.
BRIAN SOZZI: Barry, you are looking for double-digit equity returns in 2021. Is that out of the question if Democrats win in Georgia?
BARRY KNAPP: No. Listen, the main factors here I think are very much present. This means that we will have a very strong recovery in global manufacturing. We are getting a very strong recovery in global manufacturing and trade, not just because of the pandemic, but because of the 19-month trade war that took place before it. We had the only period since China’s integration into global supply chains when global trade growth was negative and world GDP was positive.
So you could see that last night in the numbers of Vietnamese exports, which were so strong. It was the first number we received in December. This will persist and will be a major positive momentum at the beginning of the year. We believe that we will have a really robust recovery in capital expenditures. This could be somewhat impaired if my tax scenario were to happen and the corporate tax rate would increase significantly, but we still think that the argument is in favor of a very strong period of capital spending.
And the history of reflation is also intact. This was not the same type of disinflationary shock in the financial sector as the global financial crisis. And so inflation is rising. This will eventually be negative for the markets, but in the early stages, the reflection is positive. So those forces that we think will persist and push markets upwards, even if we have a policy shock earlier than we expected. Our concern is that we will have a policy shock related to the Fed around the middle of the year. We could get one sooner if the Democrats who hold both seats in the Republican Senate pass. I still think, however, that it is less likely.
MYLES UDLAND: Barry, finally, you know, the title of your newsletter, is never different this time, right? But I think the lack of a thesis on the financial crisis that you were just outlining really impressed me on your note, because it is very different from what we saw coming out of 2008-2009. And when you talk about policy shock, is it a risk that, suddenly, in 2022, we are thinking about an increase in Fed rates? Is it some kind of big election event? And that is only two years away, right, the resumption of the middle of the cycle. How are you thinking about that?
BARRY KNAPP: Yes. It is never different this time, but it doesn’t just refer to the last business cycle, as you rightly noted. And then, when Reinhart and Rogoff released their book, and Carmen and Vince Reinhart released a shortened version of it in 2010, they talked about how financial crises – the most persistent economic effect is a decade of disinflation. This was not a financial crisis, right?
Therefore, the inflation perspective – the argument for higher inflation from a monetary perspective is very attractive, from a cyclical perspective it is attractive. And if you think about where the disinflationary pressures in the last three decades come from, this is a consequence of the integration of China and the Soviet bloc into the industrialized world and the pressure of falling goods prices.
Now we’re likely to move from just-in-time supply chain management to just-in-case, right? And so you will not see the same persistent disinflationary effect on the prices of goods. Therefore, inflation is rising, and I think this will generate some uncomfortable moments at the FOMC meetings already in the middle of the year, when we are starting to push the inflation target. For now, when they are looking at the breakeven point of inflation rising to 2%, they are patting themselves on the back, saying, wow, we are finally winning. But I think there will come a point later this year when they will start to be a little uncomfortable with the prospect of rising inflation. And then it will be a very different business cycle from the previous one, not different from all cycles, but different from the new normal period from 2009 to 2014.
MYLES UDLAND: All right. Barry Knapp with Ironsides Macroeconomics. Barry, it’s always good to know your opinion. Thank you so much for joining the show this morning.
BARRY KNAPP: Thanks. Thanks for receiving me.