April 16, 2021 Letter to Clients

With warmer weather ahead, strong market performance and many of us finally getting a vaccine appointment, the outlook for 2021 is looking bright. Contributing to this positive outlook are factors such as a record number of Americans having excess savings, huge deficit spending, positive news from the Federal Reserve, a new potential infrastructure bill, a successful vaccine and euphoria around the end of the pandemic. But the outlook for the rest of the year will depend on whether the bad news about the new virus strains or the good news about the vaccines dominates. So far, the good news appears to be winning and many Americans are shifting focus to the next chapter in our transition to life after COVID-19.

Like pollen in the Spring, economic optimism is in the air. The velocity of the U.S. economy’s rebound will hinge on the pace of vaccination efforts, which so far is ahead of the Biden administration’s date by which all adults are to be eligible. With many Americans and businesses expected to put pandemic-related uncertainty behind them, we examine the main factors that will contribute to or hinder economic growth in the short and long-term.

What Factors Will Drive Economic Expansion?

Personal Consumption: With the virus having caused many Americans to stockpile cash and limit spending, U.S. savings hit a record high over the last year. And interesting to note, more money has been poured into the stock market in the last 5 months than in the last 12 years combined. Of course, excess savings won’t all be spent at once, but it should provide a boost for consumers’ purchasing power and increase confidence. If health news continues to brighten, consumers are poised to go beyond home deliveries and refocus spending on the experiences and services they’ve missed during the pandemic.

Business Investment: Like consumers, many businesses decided to save rather than spend last year. Capital spending will likely grow just as quickly, if not more so, than consumer spending as businesses look to resume expenditures postponed in 2020 due to the pandemic. The pandemic accelerated already developing trends, but one area that has seen tremendous growth is digitization, covering everything from online customer service to remote working to supply-chain reinvention to the use of artificial intelligence (AI) and machine learning to improve operations. Businesses have been forced to seek more efficiency and adapt to changing consumption habits in a post-pandemic world, and with this comes an increase in investment needed to “keep up with the times.” Capacity-enhancing projects such as warehouses, distribution centers, machinery, computers and software will play an integral role in this next wave of innovation as companies reconfigure their operations.

Government Support: With the latest round of legislation enacted in March, known as the American Rescue Plan, which included, amongst other items; stimulus payments, an extension of unemployment benefits, aid to local governments, tax incentives and aid to educational support, the administration will now shift efforts to bolstering the post-pandemic economy through self-sustaining growth. This will come in the form of a more than $2 trillion infrastructure package, known as the American Jobs Plan. Key highlights of the proposal include:

Putting $621 billion into transportation infrastructure such as bridges, roads, public transit, ports, airports and electric vehicle development
Direct $400 billion to care for elderly and disabled Americans
Inject more than $300 billion into improving drinking-water infrastructure, expanding broadband access and upgrading electric grids
Put more than $300 billion into building and retrofitting affordable housing, along with constructing and upgrading schools
Invest $580 billion in American manufacturing, research and development and job training efforts

Although there is little debate amongst Democrats and Republicans as to the need for infrastructure investment, the debate continues over what to prioritize, the final size of the bill, as well as how to fund the bill. If the proposal includes tax increases for corporations and wealthy individuals to generate sufficient revenue for a large share of the infrastructure investment plan, the Biden administration will likely have to negotiate on the details as there is resistance even within his own Democratic party.

What Might Hinder the Economic Expansion?

Despite light at the end of the pandemic tunnel, the global economic outlook depends not only on the outcome of the battle between the virus and vaccines, but on how effectively economic policies deployed can limit lasting damage from the crisis. Even after the pandemic ends, there will likely be significant problems that could postpone a full return to normalcy. Three come to mind.

Rate of Suppression of the Virus: The economic recovery will be largely dependent upon the rate of vaccination efforts in different parts of the globe. Suppression of the virus will probably happen at different speeds, with emerging economies likely to be the slowest. This will likely disrupt or restrict travel, thus hurting industries such as tourism, hospitality, aerospace and energy.

Effectiveness of Vaccines: So far, evidence suggests that the currently available vaccines are widely effective against the known strains of the virus. However, if the virus continues to have opportunities to mutate through continued transmissions from one person to another, the effectiveness of these vaccines may ultimately be reduced. Failure of some governments to inoculate populations quickly could expose the whole world to new risks. If multiple governments are forced to impose new restrictions on economic activity and travel, a global economic recovery would be further delayed.

Scaling Back of Monetary & Fiscal Stimulus: Monetary and fiscal stimulus throughout the pandemic has provided a lifeline for economies around the world. At some point, however, the governments of advanced economies such as the U.S. will choose to scale back these responses once economies appear to be self-sustaining, when the virus appears to be mostly suppressed and/or when they feel continued stimulus will create an unacceptable risk of inflation or financial stress. This process of unwinding will have a negative impact on economic activity, perhaps significantly at first, with governments looking to offset huge increases in government debt with monetary and fiscal policy pivots.

How Big A Risk Is Inflation Really?

Once a large share of the population is vaccinated and people are feeling safer, consumer confidence will return with “revenge spending” on consumer-facing services, such as restaurants, theaters, airlines, and hotels, which were hardest hit from the pandemic induced shutdowns last year. If businesses are not prepared for a wave of increased demand, however, the result could be a temporary surge in inflation. If you’ve been out recently, you may already be feeling the pinch to your wallet, most notably with the recent rise in gas prices as a result of rising oil prices, a loss of refining capacity and the transition to summer gasoline. The price of airline seats this summer is also expected to spike as newly vaccinated Americans head out for long-delayed travel.

The consensus among the Federal Reserve (the Fed) and economists is that there will absolutely be a spike in inflation in the short-term caused primarily from temporary supply shortages and a sharp increase in demand as economies fully reopen, but the Fed is more concerned with the longer-term averages for inflation with its target at or just above 2 percent. A key concern for investors about inflation is that it will ultimately lead to rising interest rates when the Fed decides it needs to slow growth to curb inflation, hurting stock prices. But in the most recent statement, the Fed did not change its messaging around its intention to keep rates low through 2023, even if we see a short period of transitory inflation. However, stronger and longer-lasting inflation could complicate the interest rate outlook for the markets.

Brighter Days Ahead

The COVID-19 pandemic has been an economic and human catastrophe, and it is unfortunately far from over. But with vaccines being rolled out and more Americans eligible to receive the shot, it is possible to be cautiously optimistic that the next normal will emerge this year or next. We believe that, in some ways, that normal could be better. With good leadership and innovation from both business and governments, changes in productivity, green growth, medical innovation, and resiliency could provide an enduring foundation for the long term.

Until we speak again, I hope you can begin to enjoy the warmer weather and you are able to experience renewed contact with loved ones and good friends.

Sincerely,

Steven LePage