BFT Financial

Consultive Approach. Individualized Guidance. Personal Relationships.

By

Mid-year Financial Check-Up

In the listicle of life, three things come to mind that we should pay attention to annually: your house, health, and wealth. 

There are plenty of checklists for your house and health, but what about your wealth? We’re often at the ends of the spectrum when we pay attention to a full review of our financial wellness. Usually, we do it at the beginning of our financial planning and then annually at tax time. However, you can benefit from a midyear review, especially when you know that your house and health can have a direct impact on your overall wealth. 

We’ve created a checklist to help you think about three main areas in your financial review.

Download the full checklist
  • Tax-advantaged accounts: Check your tax-advantaged retirement accounts to identify possible changes or a rebalance as retirement approaches. 
  • Investments: Review your investment portfolio to ensure it’s on track to meet your goals, ensure beneficiary designations are updated, and don’t forget to include your company stock plans.  
  • Insurance: If you’re an entrepreneur, get to know what Key Man Insurance is; if you own a home, it’s likely the value went up this year, and you may need to ensure you have enough coverage, and thinking long-term care now can help prepare future needs for you or your parents. 

With so much to review, you should also include people in your financial planning sphere to update life events or get their expert knowledge regarding changes from tax planning to estate plans. While your financial advisor and accountant are likely on your list already, also include your company’s Human Resource representative to assist in reviewing benefits or update beneficiaries, especially if you changed jobs this year. 

Regardless of where you are on your wealth journey, the common thread is having a holistic, well-coordinated effort to achieve your goals. And like all goals, reviewing more than once a year can give you confidence that you’re on track or identify adjustments needed. 

By

Financial Market Update | July 2021

Listen to the audio version or read the full update below.

A Recession Like No Other

Following a global recession like no other, households in developed markets are flush with cash. Since COVID-19 broke out last March, real disposable income has grown at its fastest 14-month rate ever, the S&P 500 is 24% above its pre-pandemic peak and home prices are up 14%. With social distancing measures hindering consumption as incomes rose, household savings have exploded.

If the cash is spent in line with economists’ expectations, corporate profits should remain very well supported in the coming quarters. At the same time, the bottom-up consensus forecast for earnings growth is muted.

Since April 2020 the equity market has recovered in line with the recovery in earnings, meaning that equity market valuations have not gone up. As we expect to see solid earnings in the quarters ahead, this should continue to support equity markets.

Global economic growth is probably peaking as several COVID-19 emergency support packages are running out, but growth will remain solid. Uncertainty about the strength of economic growth going forward can create volatility in the equity markets but the underlying trend remains positive.

Given the solid performance of global equity markets in the first half of the year, the risk-reward profile for stocks has deteriorated somewhat. Nevertheless, with few signs that the global economy is heading towards another major downturn, the macro backdrop remains positive for risk assets.

The Golden Rule is “remain bullish on stocks as long as growth is likely to remain strong for the foreseeable future.” Historically, bear markets rarely occur outside of recessions. With both fiscal and monetary policy still supportive, and households in many countries sitting on plenty of dry powder, the odds that the global economy will experience a major downturn in the next 12 months are low.

That said, we do acknowledge that the risk-reward profile for equities has deteriorated since the start of the year. Global stocks have risen 12% year-to-date, implying that investors have priced in an increasingly optimistic economic outlook. 

The economic expansion would imply rising real bond yields over the next 6-12 months. Therefore, we continue to favor equities over bonds, but expect more subdued stock gains going forward. We remain underweight on government bonds and generally expect low total returns over the next year from bonds.

The Global Recovery’s Path Forward

We think Europe and certain emerging markets, like China, are appealing given relative valuations and earnings upside.

Chinese stocks have underperformed due to the heightened regulatory scrutiny on domestic tech giants since late last year, the latest evidence of which being the authorities’ investigation of Didi, China’s largest ride-hailing app. Full details of the investigation have not been disclosed, so it is premature to make conclusions on this specific case.

The regulatory uncertainty adds to the risk premium on Chinese equities, but we doubt the impact will be long-lasting. We expect Chinese regulators will try to find a balance between catching up with regulations and avoiding overly tight restrictions that could suffocate the country’s tech sector.

The U.S. dollar gained over 2% in June after a change in tone at the Fed’s Federal Open Market Committee (FOMC) meeting but we think the U.S. dollar will resume its weakening trend as growth momentum rotates from the U.S. to the rest of the world. 

While the stronger dollar and the slowdown in Chinese growth earlier this year could weigh on commodity prices during the summer months, the long-term outlook for metals is positive.

Inflation and the Fed

The U.S. Consumer Price Index (CPI) headline inflation came in at 5.0% year-over-year. We expected this number to be high due to several temporary factors, like rising used car prices because of a chip shortage, which limits the supply of new vehicles. However, this is not a structural phenomenon, and these price pressures will subside soon.

We always expected to see a spike in inflation in May, June, and July because of these temporary factors. And we expect inflation to soften after the summer. 

What we found surprising is that the Fed issued a more hawkish statement in its June FOMC meeting. Effectively raising their inflation forecast while at the same time raising the ‘dot-plot’, which is a vote count on when Fed board members think they will vote to raise rates.

In our opinion that does not make much sense. Why would the Fed governors spend the last few months reassuring us that the inflation spike will be transitory, and then right when Consumer Price Index (CPI) headline inflation spikes, as was expected, raise their forecast for inflation?

It could be that the Fed was surprised by the extent of the commodity price surge, which has been the key reason behind elevated inflation. This may prove to be backward-looking. The surge in commodity prices reflects supply-side disruptions during the pandemic crisis, but prices will likely moderate as the underlying economy normalizes, with the goods sector weakening and services strengthening. This is already happening in the U.S., which is why we are seeing a correction in commodity prices. 

The fact that the Fed decided to use their June meeting to raise their forecasts could either mean that the Fed has data we do not have, or it also got spooked by short-term data, or it fell victim to old-fashioned political posturing. The Fed is not as politically independent as we like to believe.

The U.S. President is the one who nominates the Chairman of the Fed and in four months, Biden can decide to re-nominate Powell or pick someone else.

The last Fed statement might not have helped Jay Powell to retain his job for another term. Even though Powell did his best to downplay the content in his press statement afterward. Timing is important, and it might not be on Powell’s side. If Biden’s infrastructure package gets approved in Congress, while at the same time monetary policy becomes less accommodative, this could offset the economic benefits of the additional fiscal spending.

For now, we stick with our view that the inflation spike is transitory and that the Fed is likely more focused on employment data than inflation.

Don’t Underestimate Biden

The Biden administration so far seems to be well organized and very focused on what Biden wants to achieve: more economic power for the middle class.

We think many economists don’t fully understand the impact of his policies. He is not a socialist but intends to bring back economic buying power to the middle class. Which is not necessarily the wish or to the benefit of Wall Street. While bringing back buying power to the middle class could have short-term negative implications for capital markets (for example through higher corporate and capital gains taxes) it will likely have a long-term positive impact on the economy and the stock market.

We think Biden is more resolved than people think. This means that despite so-called independence he would not want the Fed to stand in the way of his plans. We reckon Biden would want to see a supportive policy for his fiscal plans and for his desire for higher wages.

The moment of reappointment is the only moment that a U.S. President has a direct impact on Fed policy. This could lead to more dovish surprises in the coming months or alternatively Biden could pick a more dovish Fed governor like Lael Brainard.

The Future of Commodities

Structurally, oil faces a bleak future. Transport accounts for about 60% of global oil consumption. The shift to electric vehicles will undermine this key source of oil demand. Cyclically, however, crude prices could still rise as the global economic recovery unfolds. Supply remains quite tight, reflecting both OPEC vigilance and the steep drop in oil and gas capex of recent years.

In contrast to oil, the long-term outlook for base metals is favorable. A typical electric vehicle (EV) requires four times as much copper as a typical gasoline-propelled vehicle. By 2030, the demand from EVs alone should amount to close to 4 million tons of copper per year, representing about 15% of current annual copper production.

Strong demand from China should also support metal prices long-term. While Gross Domestic Product (GDP) growth in China has slowed, the economy is much bigger in absolute terms than it was in the 2000s. China’s annual aggregate consumption of metals is five times as high as it was back then. In the near term, however, base metal prices could stay weak because of slowing Chinese economic growth following last year’s recovery. 

We are generally positive on gold. Since peaking last August, the price of gold has fallen more than one might have expected based on movements in real bond yields. Gold will also benefit from a weaker dollar later this year. Lastly, and importantly, gold should retain its standing as a good inflation hedge.

Investing in a Sustainable Future?

The world of tomorrow is not going to look like the world of today. The US, Europe and China have all committed to carbon neutrality by 2050 and 2060. Quality food will give way to responsible food, cheap goods to sustainable goods. Everything is going to be digital and software/semiconductors will be everywhere. These trends will be the dominant themes during the 2020s and beyond.

Investing in these trends requires a dedicated approach – adding one stock to a core portfolio won’t have a big enough impact and buying the sector outright ignores the often very high valuations of companies in these categories

Our portfolio team has constructed a Sustainable Future portfolio that seeks to strike a balance between large companies and small, famous brand names and reasonably valued ones, promising ideas and sustainable businesses. We score stocks to ensure valuation, quality, distress, momentum and sentiment, as well as Environmental, Social and Governance (ESG) traits are considered. We diversify by region and sector with the goal of building a portfolio that takes advantage of these themes.

The portfolio is focused on four key areas of potential future growth: Sustainable Food, Green Energy, Health Innovation and Digital Infrastructure.

If you are interested in exploring these themes, please discuss with us if this strategy could have a place in your portfolio and how it might fit with your personal investment objectives.

PLEASE READ THIS WARNING: This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.

Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

* Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.

Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.
The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.  It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

Investments in emerging markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred.  Returns do not include reinvested dividends.

Diversification does not guarantee a profit or protect against a loss in a declining market.  It is a method used to help manage investment risk

By

Financial Market Update | June 2021

Should You Be Afraid of Inflation?

The focus in news reports and markets in the past weeks was on inflation. The headline U.S. Consumer Price Index (CPI) number in May came in at 4.2% on a 12-month basis, which was higher than most people expected.

To place this in context, April 2020 was when the global pandemic-induced recession bottomed. Since then money growth has exploded in the U.S. and to a lesser degree, in the other major developed economies. The increase in the money supply has been largely driven by stimulus checks flooding into household bank accounts and increased precautionary savings by corporations.

Why Is The Market So Concerned With Inflation Data?

Inflation is definitely better for the economy than deflation. It will stimulate consumers to spend or invest more. Employees can ask for higher wages, companies can generate higher revenues.

Inflation combined with low-interest rates is generally positive for risk assets like equities and real estate.

The fear factor is that sustained inflation can threaten economic stability and to avoid that happening central banks will step in and tighten monetary policy by raising interest rates. And this can have a negative impact on asset prices and that is obviously what investors are concerned about.

What is interesting to note is that bank lending has not accelerated in line with the sharp increase in broad money growth, however. After briefly jumping at the outset of the pandemic, U.S. bank loans outstanding have been shrinking. The subdued pace of bank lending will mitigate inflationary pressures in the near term. However, inflation could still eventually rise in a sustained manner once the U.S. economy begins to overheat.

It is possible that the Gross Domestic Product (GDP) growth in the second quarter will again surprise to the upside. One indicator for that is that the US Trade deficit number came in much lower than expected, which points to increased economic activity. Global economic activity is rapidly gaining back what was lost during the pandemic. While at the same time still millions of people are out of work. If jobs growth stays strong this will only add to GDP growth in the coming quarters.

Speaking of jobs growth. There was a lot of attention to the fact that the April jobs data in the U.S. came in much lower than expected. Immediately there were many news reports talking about stagflation, which refers to low economic growth combined with higher inflation. Subsequently, the May jobs data came in higher but still lower than expected. In our opinion, this shows that the U.S. economy is recovering but there is no reason for the Fed to make any changes to its policy any time soon.

Our base-case scenario is to expect strong growth and accommodative monetary policy. Strong growth is assured as long as the virus doesn’t come roaring back, and the Fed still isn’t even talking about tapering its asset purchases, much less hiking the fed funds rate. Which means our risk-friendly asset allocation recommendations remain unchanged.

The risk for markets is to get caught up in short-term thinking, especially in a period where there is not much other news. The next earnings season will only start in mid-July, the pandemic is subsiding in every country that is actively vaccinating, and there will be no new stimulus plan announcements. And we are getting closer to the summer period which is traditionally a period where we see trading volume in the markets, which can create additional volatility. Despite this, markets were very calm during May. The bond market does not seem to be too concerned about inflation pressures yet and bond yields came down. The equity market traded in a narrow range and ended slightly positive for the month, which was the fourth positive month in a row for equity markets.

An important issue to watch will be new spending legislation. We think it is likely there will be a bipartisan infrastructure bill. In the end, Republicans will join Democrats since all want spending in their states and localities. Although we think the economic impact of Biden’s infrastructure bill will be limited in the short term as spending will be spread out over 8 years. If it passes it could have an impact on the Fed’s policy, as it would be counterproductive to tighten monetary policy at the same time the government is loosening fiscal policy.

Another argument why we think the Fed will not deviate from its stated plan to stay put is that Chairman’s Powell term ends early next year, and Powell and other candidates would be seeking to stay aligned with President Biden’s ideas.

The “Transitory” Debate

Most investors would agree that 3-4 months of higher consumer price increases would not be, in and of themselves, economically significant or investment relevant. But the question of whether even a temporary period of high inflation could persist over a 12-month or multi-year time horizon has become prominent in the marketplace, with some investors believing that it has high odds of supporting higher prices in a way that becomes self-reinforcing among consumers and firms.

A shift in the market narrative from a relatively benign longer-term inflation outlook to a belief that a more durable uptrend is developing, could trigger a taper tantrum-like surge in bond yields, with negative knock-on effects for risk asset markets. For now, the Fed is sticking with its view that any uptick in core inflation will be transitory, despite upgrading its own economic forecast. From an investment perspective, the outlook for inflation is important mostly because of its implications for Fed policy, and thus interest rates and equity valuation multiples.

We do expect inflation to rise significantly over the long haul. However, our view is that it will take another 2 to 3 years before we see structural inflation. As the example of the 1960s illustrates, a long period of overheating is often necessary to push up inflation in a sustained manner. The U.S. unemployment rate reached its full employment level in 1962. However, it was not until 1966, when the unemployment rate was two full percentage points below equilibrium, that inflation finally took off.

Also, the official core Consumer Price Index (CPI) likely overstates underlying inflationary pressures. The pandemic threw all sorts of prices out of whack. One needs more refined measures of inflation such as the Dallas Fed’s trimmed mean Personal Consumption Expenditures (PCE) indicator, which only rose a modest 1.8% in April. Similarly, relatively clean measures of wage growth, such as the Atlanta Fed Wage Tracker, do not point to an imminent wage-price spiral. All this means that the Fed can afford to sustain an exceptionally easy monetary policy. That should keep growth at an above-trend pace and continue to support equity valuations.

Equity Markets

The U.S. and global stock markets have been stuck in a narrow range for more than a month now. Not only that, but the strong equity market gains of the last 12 months can actually be accounted for almost entirely in terms of rising earnings expectations, which is exactly what all the textbooks say should happen. Markets seldom behave so perfectly in line with theory as they have done over the last year. Forward equity earnings already price in a complete earnings recovery, but for now there is no sign of slowing earnings momentum. Net revisions remain positive, and positive earnings surprises have risen to their strongest levels on record.

US GDP grew at 6.4% in the first quarter, powered by 10.7% growth in consumption. The six largest companies in the S&P 500 reported first-quarter earnings that exceeded expectations by an average of 41%, and the Fed remained resolutely dovish.

Within a global equity portfolio, there has been a modest uptick in global ex-U.S. equity performance, led by European stocks. Europe, which has badly lagged the economic performance of the U.S. in the last 6 months, is primed for its best period of growth since 2017 and should close the growth gap with the U.S. Moreover, the euro area has the potential to provide more positive economic surprises ahead, in comparison to the already roaring U.S. economy, especially as it has more exposure to the strengthening global trade cycle.

A resilient Chinese economy should support other emerging markets. Progress on the pandemic front should also help. The United Nations estimates that as many as 15 billion vaccine doses could be produced by the second half of 2021, enough to inoculate most of the world’s population. The shortages of vaccines in emerging markets could turn into a surplus by the end of this year, something that market participants do not seem to fully appreciate. The rotation in growth momentum from the U.S. to the rest of the world could put downward pressure on the U.S. dollar. A weaker dollar, in turn, usually coincides with the outperformance of international stock markets.

Bond Markets

The U.S. 10-Year Treasury yield has traded sideways since mid-March. The strengthening economy in combination with the improving jobs markets should keep upwards pressure on bond yield in the next 12 months. Although we expect the rise to be more modest, we still favor a short duration stance within a fixed-income portfolio. Although our view is that inflation pressures will abate in the coming months, we keep exposure to Treasury Inflation-Protected Securities (TIPS) as a core hedge position in the portfolio.

Another key portfolio hedge is local currency emerging market government bonds. Two key drivers of Emerging Markets (EM) bond returns will offer a constructive backdrop in the year ahead. The U.S. dollar will likely soften in the face of strong global growth conditions, with economic momentum now firming up in lagging major economies such as the euro area.

In the meantime, rising U.S. Treasury yields are typically associated with spread narrowing for EM debt. In the case of EM local currency-denominated debt, there is plenty of room for nominal spreads to tighten, and real yields are already positive with plenty of room to fall as global inflationary pressures build up. Strong global trade momentum and firm commodity prices, along with a relatively high nominal yield and generally undervalued currencies, are additional tailwinds for emerging market bonds.

Digital Assets

Cryptocurrencies experienced a ‘flash crash’ in May with the whole crypto market falling by more than 50% in a few days’ time. There are many reasons cited in the media, including Elon Musk’s tweets, but the main reason is an old-fashioned one: Cryptocurrencies are being used as an investment asset and a speculative bubble was building up, which was bound to correct at some point.

We do not think this is the end of cryptocurrencies as the underlying technology is potentially disruptive for a large part of the financial ecosystem. Interest in digital assets is growing among private and institutional investors. We do believe in the potential of cryptocurrencies, but we do not believe there will be room for that many of them. Therefore, we prefer to only invest in the largest ones and that constitutes an original technology like Bitcoin and Ethereum.

PLEASE READ THIS WARNING: This newsletter contains general information that may not be suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.

Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

*Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.

Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.  It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

Investments in emerging markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred.  Returns do not include reinvested dividends.

Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market. They are methods used to help manage investment risk.

By

Financial Update | May 2021

Listen to the audio version or read the full overview below.

Strategies for a Sustained Asset Bubble

In the past month we have seen strong first-quarter corporate earnings, a sharp decline in Covid infections in the U.S., the announcement of President Biden’s American Families Plan, and a dovish Fed statement, all of which are supportive of equity markets.

In February and March, we witnessed a sharp upward move in long-term U.S. bond yields, temporarily causing a sell-off in global equity markets and especially growth stocks.

In April we saw bond yields retracting, which triggered a healthy gain in equity markets, supported by very solid first-quarter corporate earnings. Of all the S&P 500 companies that have reported so far, earnings were on average 3% higher than the average analyst forecast.

Looking forward, we remain confident about equity markets. We still see ingredients for a strong recovery in the global economy, and although we believe there might be longer-term inflationary forces at work, fears for higher inflation in the short term are overblown.

Developed economies continue to transition towards a post-pandemic state. Europe has further to go, but it is lagging the US at a constant rate and is thus merely delayed – not on a different path. This ongoing transition is also reflected in the global macro data, which continues to surprise to the upside.

Despite elevated valuations, there is the potential for the Federal Reserve’s monetary policy to inflate a new speculative bubble. This bubble could run a lot longer than we think. Therefore, we continue to expect positive absolute returns from stocks over the coming 12 months and would recommend that investors remain overweight stocks versus bonds in a multi-asset portfolio.

Bond Yields

Whenever bond yields rise, you must remember that the bond market is trying to tell you something about the underlying economy. Rising bond yields are typically reflective of stronger economic growth. The ISM Manufacturing Index is at its highest level since 1983 – the world economy is in a strong recovery mode. Higher yields are consistent with the economy getting stronger. Under these circumstances, we would be more concerned if bond yields did not rise.

How Do Inflation Expectations Impact the Bond Yield?

Currently, there is no breakout in inflation expectations. We should not forget that in the decade after the global financial crisis, inflation expectations have fallen to very low levels. In the past decade we were collectively much more concerned about deflation. Inflation breakeven rates currently are between 2 and 2.2%, whereas the average range during the decade before 2009 was more like 2.5 to 3%. So, inflation expectations are returning to normal levels.

This means that 10-year Treasury yields are probably at fair value today given the state of the economy. Markets will always fluctuate, so it is possible that bond yields rise a bit further, but we don’t think that US Treasury yields will exceed the 2% level as long as the Fed continues its ultra-dovish stance.

Although global bond prices have come down circa 3% since the start of the year, we are a little bit more positive for the remainder of the year. As we do not expect bond yields to rise much further, the higher rates today will translate into higher income yield for the remainder of the year.

Inflation Outlook

We are not concerned that inflation will be structurally higher in the short term. Having said that, we could see higher headline inflation numbers in May and June, but we think that this will be temporary inflation and mostly because of the base effect compared to 12 months ago when the whole world was in lockdown. That said, we could see more structural inflation pressure in a couple of years from now if aggregate demand keeps building on the back of structural government investment.

If we look at the fiscal position of the United States, the budget deficit is almost 20% of Gross Domestic Product (GDP). The Fed balance sheet has expanded by $7 trillion USD since the beginning of the pandemic, and the money supply measure M2 has exploded upward. This must be inflationary, right?

What happened is this: For all of 2020, the U.S. government unleashed $3.5 trillion in various rescue packages, because of which the federal government debt rose by $3.6 trillion. At the same time, the household sector’s disposable income increased by $3.5 trillion, and household savings shot up by $5.5 trillion. In other words, American households not only saved up all the transfer payments they received from the government, but they even saved $2 trillion more from their own income. These rescue programs did absolutely nothing to generate additional demand or GDP growth. What we have seen was not a fiscal stimulus to boost aggregate demand, but a transfer payment. This was no different than a one-time tax cut. We know that people’s spending behavior is determined by their outlook for sustainable income. If you give them a one-time tax cut, they will save it.

Now that the U.S. and Europe are reopening, we will likely see a demand surge. Consumption spending has been repressed for over a year as a result of Covid-19 related restrictions. When the world economy reopens, this spending will be released. But this is not inflationary, as the boom will be temporary. People will not party for the next twenty years. They will party for the next six months or so. For inflation to be a structural threat, you need aggregate demand exceeding aggregate supply on a sustainable basis.

We do not see that happening any time soon. The government subsidies simply amount to a huge balance sheet swap: government debt as a share of GDP has gone up, while consumers’ net worth has gone up even more. This balance sheet swap has nothing to do with additional aggregate demand.

What could be the driver for more structural inflation is real government spending, rather than stimulus checks. Extensive investment by governments in, for example, infrastructure could have this effect, as this could also lead to a boom in corporate capital expenditure, which has been relatively low since the global financial crisis.

President Biden’s American Jobs Act is a step towards that kind of transition. But it is not as big as the headline number suggests, because it envisions spending roughly $2.2 trillion over eight years, so each year it would add only about 0.8 or 0.9% of GDP. On top of that, Biden is proposing higher taxes to fund it. So, his infrastructure plan creates some growth on one hand, while taking it away with higher taxes on the other hand. Its net impact will only be around 0.4 or 0.5% of GDP per year. This will not be a game-changer in terms of inflation.

However, if this is done on a global scale in Europe and Asia as well, it could have a more structural impact on commodity prices or wages, which could translate into structurally higher inflation in a few years from now.

Dovish Central Banks

There is a tug of war going on between the Fed and financial markets: The Fed says they will stay dovish for a long time, while markets expect a lift-off in short-term rates next year. Who is right?

If you think about the last decade, Fed policy was always tight: The projected interest rate path by the Fed, as seen by the so-called Dot Plots, was always higher than market expectations. Because of that, we had several financial tremors: The taper tantrum in 2013, the collapse in oil and commodity prices in 2015, the collapse in stock markets in late 2018. We had almost ten years of low inflation and periodic stock market chaos because of monetary policy being too tight. In the end, the Fed always caved in and moved towards the market.

Now it is the other way round: The Fed is more dovish than market expectations. The market has priced in four or five rate hikes through 2023, while the Fed suggests they will not do anything before 2024.

The question is which side is right? If you only looked at the lessons of the last decade, you would say the market is right. But the difference today is that the Fed has abandoned its old reaction function and wants to stay ultra-stimulative until inflation is above 2% for a while. The Fed is now adamantly saying they are willing to be late this time, allowing the economy and inflation to run hotter than they would have in the old days. If that is the case, then markets may be wrong because they still assume the old reaction function of the Fed. So, we do not know yet, but it’s possible that the Fed will stay dovish much longer than markets think.

The consequence of this new Fed policy could be quite positive for risk assets. The stock market has already performed well and could go even further. If you look back in history you notice that asset bubbles grow back every ten years or so, and they are usually driven by easy monetary policy and lots of liquidity. So, this new reaction function by the Fed, plus the support from fiscal policy, means that markets could go through a bubbly period. This could apply to all risk assets including equity markets, but also real estate and digital assets can profit from this.

How Big Can An Asset Bubble Get?

If you look at history, all speculative bubbles burst eventually by tightening monetary policy. You never had a bubble burst while monetary policy was still easy. Asset bubbles pop when central banks tighten policy to a point of yield curve inversion. Today, we are far away from that. That is why this bubble could get a whole lot bigger.

Currently, we could be in the early stages of a stock market bubble, especially in the United States. There are many signs of speculative behavior, be it Bitcoin, Gamestop, and so on. But it is not as pervasive yet as it was in the late 1990s. When the technology bubble burst in 2000, everybody was bullish. Today, many people, even large investors, are still bearish. When they throw in the towel, then the final phase will begin. This bubble could be bigger than the 90s and it could run a lot longer than we think.

Could Rising Bond Yields Hurt the Equity Market?

Historically, rising yields hurt the economy and stock prices only when both long and short interest rates were moving up. It is unusual to see the long end of the curve move way up while short-term rates remain pressed down, as is actually the situation today.

There is a limit to the pain long-term rates can create for the economy because borrowers can always slide down the maturity curve to avoid having to pay higher interest rates. That is why we think 10-year Treasury yields are unlikely to move much higher than their fair value, while short-term rates remain at zero.

Based on this a possible scenario is that we will continue to see rising equity market for the next two years, with multiples going higher still. Then comes the point where the Fed just cannot remain dovish anymore and they will raise rates. At that point, the end would be nigh and that is the moment we could potentially see the next bear market but timing that is near impossible.

Currencies

Late last year, everyone was bearish on the dollar. After staging a rebound in the first three months of the year, the U.S. dollar has resumed its weakening trend.

We expect the dollar to drift lower over the next 12 months, as global growth momentum rotates from the U.S. to the rest of the world, the Fed maintains its ultra-accommodative monetary stance, and the U.S. struggles to finance its burgeoning trade deficit.

China will provide adequate fiscal and monetary support for its economy, which can drive up commodity prices, the yuan, and other emerging markets currencies. The Euro/USD could rise to 1.25 by year-end. At the same time, the pound should strengthen against the Euro.

Emerging Markets

A global economic boom and a weaker dollar should be bullish for emerging markets. However, we must keep in mind that today’s emerging markets are very different from 20 years ago. Today, more than 40% of the MSCI Emerging Markets (EM) Index is made up by China. In China, the equity market is predominantly driven by big tech, with stocks like Alibaba and Tencent. So, China has a similar issue like the US tech sector: In an environment of rising bond yields, growth stocks tend to underperform.

The stock market is very sensitive to changes in liquidity conditions. We see a world of inverted roles: After the financial crisis, China embarked on a huge monetary and fiscal stimulus. Today it is the U.S., while China is tightening.

Last year Chinese growth stocks performed very well. This year their stock prices are struggling while earnings remained robust. So, we have seen valuations in some of Asian largest companies come down quite a bit. In the short term, the stock market is very sensitive to changes in liquidity conditions. If credit growth is slowing down, stocks perform poorly. From a longer-term perspective we think the Asian stock markets offer an attractive entry point now.

We offer an Asia Leaders Portfolio, which invests in leading companies across sectors that benefit from the growth of the domestic consumer in Asia. Recent underperformance offers an attractive entry point as we believe this strategy could outperform over the coming 12 months.

Portfolio Diversification

Other than equity risk exposure we have been observing commodity assets since the beginning of 2021. In our core portfolios we have included a commodity position that has exposure to diversified industrials and precious metals, energy, and agriculture positions. Thus far, commodities have risen nicely, and we expect this addition to help hedge against short-term inflationary pressures.

PLEASE READ THIS WARNING: This newsletter contains general information that may not be suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.

Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

*Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.

Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.  It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.  There are risks associated with these types of investments and include but are not limited to the following:  Typically no secondary market exists for the security listed above.  Potential difficulty discerning between routine interest payments and principal repayment.  Redemption price of a REIT may be worth more or less than the original price paid.  Value of the shares in the trust will fluctuate with the portfolio of underlying real estate.  Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes.  This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein.  The offering is made only by the Prospectus.

Investments in emerging markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred.  Returns do not include reinvested dividends.

Diversification does not guarantee a profit or protect against a loss in a declining market.  It is a method used to help manage investment risk

By

Spring Cleaning. Clearing Out the Financial Clutter.

Spring has arrived in Texas. I know this because my back is sore from raking leaves and clearing out gutters. For my family, this time of year is all about taking advantage of the nice weather with soccer games on Saturday mornings, bike rides, and trips to the park. While we enjoy the more fun family activities, the change in season is also a convenient reminder to catch up on necessary activities. Yardwork, testing smoke and carbon monoxide detectors, and replacing air filters. What does this have to do with finance? Regular maintenance is the key to keeping a house in good shape. In the same way, your finances need a few annual tune-ups. It might feel like a pain (like it did when I was doing yard work), but now is an excellent time to get a few essential items done to get your financial house in order.

Clear out the clutter

You should file and keep certain documents, like tax returns and statements for non-qualified brokerage accounts. However, it would be best to shred many of the financial documents you receive, like pay stubs and checks deposited online. Why shred? To protect your information. Yes, it’s an unfortunate reality that your paper documents are susceptible to identify theft, but you don’t have to invest in a commercial level shredder. Several micro-cut shredders are available through an office supply store for less than $100 – which isn’t a bad investment for the protection it provides. 

For those who have gone digital with financial documentation, check your computer files or cloud drives to clean out what you need and permanently delete files you don’t. Many institutions can also archive your statements for years, saving time in managing documents and keeping them in a more secure setting. 

Whether you’re clearing out physical or virtual clutter, it makes it much easier to find what you need in the future.

Annual credit report

Once every 12 months, everyone is entitled to a free credit report check at http://www.annualcreditreport.com. This is the only official website authorized by federal law. Be wary of any other services that pose as the official program and charge a fee. While your report is free, if you want to see your actual credit score, there is a cost at each of the credit bureaus. 

Another place to get your annual report is with your current credit card provider or banking institutions. It’s becoming more popular for financial institutions to partner with the credit bureaus and give customers free credit monitoring and offer ongoing access to your score and annual report. It’s worth checking if you can sign up or if you already have it. 

Annually reviewing your report can help you catch the signs of identity theft early or even discover and fix incorrect information.

Review subscriptions

From food subscription boxes to video streaming, this has to be the year of subscription services. Even before the pandemic, the average person in the U.S. had 12 paid media and entertainment subscriptions. If you live in a multi-generational household, that number could be as high as 17.

There’s a reason so many companies offer a monthly subscription or free trials. It’s easy to forget about it and not realize that you’re being charged month after month. Now is a good time to scroll through your expenses and see what subscription services are charging you each month. Either update the subscription level to an amount you actually use or say goodbye to the ones you don’t. 

Check on your estate plan

First, make sure you know where your essential estate documents are located. Then, review them to see if they need to be updated. Is there a need to change any of the designations you’ve made? Also, be sure to look at your financial accounts because named beneficiaries on accounts or insurance will supersede anything written in a will. If there has been a significant life change (e.g., birth, death, or divorce), there may be a need to update your documents. 

It may go without saying, but if you read this last item and said, “I don’t have an estate plan,” then your annual spring cleaning is more of a yearly to-do list. Having an estate plan is one of the essential items in your financial planning basket, as is having an emergency plan for the home. 

This list is not meant to be exhaustive, but instead a few quick items to help keep your financial house in order after a particularly challenging year. If you run across any questions as you work through the steps, please reach out to your Financial Advisor for help.

DISCLAIMER: The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of BFT Financial Group. Neither BFT Financial Group nor the author makes any warranty or representation as to the accuracy, completeness or reliability of this information. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall BFT Financial Group be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither BFT or the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.