How much inflation can the country afford before we’re in trouble?

Let’s discuss.

First, let’s get on the same page about some basics.

If you’ve noticed the price of a thing increasing over time (say, your favorite candy bar or the cost of college tuition), that’s inflation in action.

Economists use the broad increase (or decrease) in prices of goods and services across the country as a measure of economic health.

When inflation is stable and predictable, it’s a sign of a basically healthy, growing economy.

But, high inflation can quickly eat away at the purchasing power of your dollars, indicating that the economy might be overheated.

Deflation, or a decline in prices, can be a warning sign of a shrinking economy.

Recent data highlighted a surprise spike in inflation, indicating that prices increased faster than economists expected last month.1

Could this be a worrisome sign that the economy is overheated? Could $50 burgers be in our future?

Maybe.

On the other hand, could it be a temporary blip caused by the economy emerging from the pandemic-driven slowdown, complicated by supply chain issues?

Very possible.

Are the headlines catastrophizing?

They usually are.

Let’s look at the data.

The Consumer Price Index (CPI), one of the major indexes economists use to track inflation, showed a surprising spike in April, igniting fears of runaway inflation.

Core CPI (which excludes the highly volatile categories of energy and food) showed a 0.9% increase in April month-over-month and 3.0% year-over-year. That’s much higher than the expected 0.3% and 2.3%, respectively.1

However, digging a bit deeper, we see that just two categories of goods (used cars and transportation services) accounted for the vast majority of the surge.2

That suggests things like flights and train travel suddenly became more expensive after a year of rock-bottom prices.

Is that runaway inflation or the normalization of prices as the world reopens?

We can't tell from a single data point, but it's not unusual to see prices increase in sectors that experienced a severe slowdown last year.

And the jump in used car prices? Well, many folks are turning to the second-hand market right now, in part because new cars are caught up in global supply chain bottlenecks for things like semiconductors and raw materials.3

Inflation is something to keep an eye on, especially in a year when so many of the usual variables have been thrown into flux. An ongoing surge in prices could hurt our wallets as our dollars buy less over time.

However, a single monthly spike following a very weird period for the economy is not cause for alarm yet; we should prepare ourselves for more odd numbers coming out of different parts of the economy in the weeks and months to come.

Shortages of everything from ketchup to gasoline could lead to price increases and fluctuations as supply chains attempt to disentangle from pandemic disruptions.4

Should we expect markets to react to inflation (and other) headlines?

A negative market reaction is not surprising after weeks of strong performance. We should expect volatility ahead as we (and the economy) adjust to a post-pandemic world.

Bottom line: Expect the unexpected in 2021.

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So, the next (final?) round of stimulus was signed into law by President Biden.

Let’s dive in.

The $1.9 trillion bill called the American Rescue Plan Act of 2021 includes stimulus checks, child tax credits, jobless help, vaccine-distribution money, healthcare subsidies, and aid for struggling restaurants. What’s not inside? A higher minimum wage. 

Here's a quick visual of how it compares to prior rounds of stimulus.

Here are some immediate takeaways: 

More stimulus checks are coming: $1,400 checks could be hitting bank accounts and mailboxes this month, going out to adults, children, and adult dependents such as college students and elders. These adult dependents did not qualify for previous payments, so that’s good news for many.1

Who gets paid? Individual filers who earn as much as $75,000 (or joint filers making $150,000), plus their household members, qualify for the full $1,400 per person.1

Folks filing as a head of household can earn up to $112,500 and still qualify for the full payment. Phaseouts kick in quickly this round, and an individual with an income of $80,000 or a couple earning $160,000 get nothing.1

Not sure if you qualify? The Washington Post put out a handy calculator to help you figure it out. (Accuracy not assured, etc., etc.)

If you’ve filed your 2020 taxes, your check would be based on that income. If not, it would be based on your 2019 tax filing. If you’re waiting for a missed payment, individual tax returns have an extra line called “recovery rebate credit” to claim your stimulus payment. 

Enhanced unemployment benefits are extended through Sept. 6: Folks claiming jobless benefits will receive $300/week on top of what they already get from their state through the fall.2

Some unemployment income is now tax-free: Individuals who earned less than $150,000 in 2020 can shield up to $10,200 in unemployment benefits from taxes. For married couples filing jointly who both received unemployment, the tax-free amount goes up to $20,400, but the $150,000 income cap still applies. Unfortunately, if you earn over $150,000, it currently appears that all of the unemployment benefits become taxable with no phaseout.3

If this applies to you or someone you love, my advice is to wait to file or update your tax return until the IRS issues guidance on what to do.

The child tax credit is larger: The bill increases the child tax credit for one year to $3,600 for kids under 6, and $3,000 for kids between 6 and 17 (the current credit is a flat $2,000 per child under 17). 50% of the credit would be available as advance monthly payments that the IRS will start sending to families in July 2021.4

Unfortunately, not all families will qualify. Phaseouts begin at $75,000 for single filers, $112,500 for heads of households, and $150,000 for joint filers. However, families who earn less than $200,000 ($400,000 for joint filers) could still claim the regular $2,000 credit.4

Health insurance costs could drop on health exchanges/marketplaces: The bill removes the income cap on insurance premium tax credits for folks who purchase insurance on the federal health exchange or state marketplace (for two years). That means the amount you would pay for health insurance would be limited to 8.5% of your income as calculated by the exchange.5

Final thoughts

A lot of rules have changed in the last year, throwing an already complex tax season into a bit of confusion.

If your AGI is over the thresholds above, there are still ways you can lower your AGI retroactively for 2020 and potentially qualify for the stimulus. Consult with your financial planner to see what options are available to you.

Could there be more stimulus passed this year? It seems unlikely if the U.S. economy continues to expand.

According to a fresh estimate, our economy will expand nearly twice as fast as originally expected, growing at an estimated 6.5% in 2021 versus the 3.2% projected in December.6

Obviously, these projections rest on a lot of assumptions about vaccination rates, reopening, and consumer spending.

Let’s hope we stay on track.

P.S. Markets have hit new highs as fears of out-of-control inflation faded and hopes about the recovery surged. The usual caveats apply: we're in a roaring bull market and any time stocks reach new highs, pullbacks and corrections are possible. Keep calm, cool, and focused. I'm here for questions.7

1https://www.washingtonpost.com/business/how-can-i-qualify-for-that-1400-stimulus-check/2021/03/10/419fa7bc-81e2-11eb-be22-32d331d87530_story.html

2https://www.cnet.com/personal-finance/weekly-300-unemployment-benefits-what-happens-now-with-new-stimulus-bill/

3https://www.cnbc.com/2021/03/09/covid-bill-waives-taxes-on-20400-of-unemployment-pay-for-couples.html

4https://www.kiplinger.com/taxes/602378/congress-passes-3000-child-tax-credit-for-2021

5https://www.cnbc.com/2021/03/10/health-insurance-costs-to-drop-for-millions-under-covid-relief-bill.html

6https://www.nytimes.com/2021/03/09/business/oecd-doubles-us-growth-forecast.html

7https://www.cnbc.com/2021/03/10/stock-market-open-to-close-news.html

Chart source: https://www.wsj.com/articles/whats-new-in-the-third-covid-19-stimulus-bill-11615285802

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This material is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. The content is developed from sources believed to be providing accurate information; no warranty, expressed or implied, is made regarding accuracy, adequacy, completeness, legality, reliability or usefulness of any information. Consult your financial professional before making any investment decision. For illustrative use only.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific situation with a qualified tax professional.

2020 Global Market Commentary

2020: A Tale of Two Markets

2020 can be summarized by the famous Charles Dickens line from A Tale of Two Cities:

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of light, it was the season of darkness, it was the spring of hope, it was the winter of despair.”

Stock markets in the U.S. and around the globe turned in a very good year, despite two formidable headwinds that swirled around the economy and markets all year. COVID-19 and the elections of 2020 seemed to either slam markets with hurricane-like force or provide a steady wind in the market’s sails pushing markets to new record highs. There really were not many calm days.

In a nutshell, 2020 saw markets crest new highs at the beginning of the year, followed by a couple of corrections, the end of the longest bull market in history, a legitimate recession, a V-shaped recovery, and newer market highs. And along the way, we saw unemployment hit 50-year lows and then hit depression-era levels, multiple government stimulus programs, the best and worst quarterly GDP numbers of all time, a very active and aggressive Federal Reserve, social unrest throughout the country, negative oil prices, a frothy housing market and a major shift in Washington power. It was the best of times and the worst of times – in a single year.

But first, let’s do the numbers:

• The DJIA rose 7.3% in 2020;

• The S&P 500 rose 16.3% in 2020;

• The Russell 2000 Index rose 19.9% in 2020; and

• NASDAQ rose 43.6% in 2020.

Sector Returns in 2020

The overall trend for sector performance for each of the four quarters in 2020 and each of the 12 months was good, but the performance leaders and laggards did rotate all year. For example:

• Q1 ended with every one of the 11 S&P 500 sectors turning in negative numbers;

• Q2 ended with every one of the 11 sectors turning in positive numbers;

• Q3 ended with 10 of the 11 positive; and

• Q4 ended with all 11 sectors positive.

Here are the sector returns through the end of December 31, 2020:

Reviewing the sector returns for 2020, we saw that:

• 7 of the 11 sectors were painted green for the year;

• The Financials sector had a wonderful final quarter, helped by the Federal Reserve’s stance of keeping rates low through 2023, although it was not enough to push the sector into positive territory for the year;

• While the Energy sector also turned in a terrific fourth quarter, it was nowhere near enough to override its annual loss of more than 37%; and

• On an annual basis, the difference between the best and worst-performing sectors is dramatic, as the Information Technology sector is up over 42% YTD and Energy is down a whopping 37%+.

Markets Around the World Performed Well

Strong performance in 2020 was not confined to the U.S., however, as most global markets also turned in a positive year. In fact, of the 35 of the developed markets tracked by MSCI, every single one was positive for 2020.

But that was not the case for developing markets, however, as 24 of the 40 developing markets tracked by MSCI turned in negative numbers for 2020 and the range between the best- and worst-performer was significant. To underscore the range, consider that the MSCI EM Europe Index lost 15.94% and MSCI Asia APEX 50 Index gained 31.32%. The following shows the range of 2020 returns from markets around the world:

Asset Class & Style Performance

2020 was positive for many investors, but asset class and style played a huge role in determining total performance returns for investors.

For the year, Growth (+34.2%) outpaced Value (-0.4%) significantly and the smaller-cap names trailed their larger-cap counterparts for most of the year, although the differences between the two were mostly erased towards year-end.

Similarly, the larger emerging markets performed well, as evidenced by MSCI EM (+18.7) whereas the smaller emerging markets more often than not turned in negative numbers for the year. And Commodities and Global REITs struggled most of the year as well, eventually ending in the red.

The Federal Reserve Was in Overdrive

In dramatic and emergency actions to support the U.S. economy during the coronavirus pandemic, the Federal Reserve announced it would cut its target interest rate to near zero. And it announced its second rate cut on a Sunday no less.

The unexpected and faster-than-expected rate cut was on the heels of the Fed’s emergency 50 basis points rate cut just 12 days before – and that cut was the first time since October 2008 that our central bank decided to go ahead with a cut in between scheduled policy meetings.

Further, the Fed pledged its support to an aggressive quantitative easing program, suggesting that there was no limit on its purchases of Treasuries and agency mortgage-backed securities as well as purchasing investment-grade corporate bonds. The Fed also announced it would help maintain the flow of credit to municipalities around the country and establish a lending program for small businesses.

On top of all of that, the Fed also brokered a deal with other global central banks to lower their rates on currency swaps to bring normalcy to markets. The other central banks include the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank. And it appears that the Fed’s “zero-interest-rate-policy” will be in place through 2022 and maybe even through 2023.

Worst GDP Decline in History in 2Q

On September 30th, the Commerce Department reported that its “Third Estimate” of 2Q2020 GDP improved marginally to a decline of 31.4%. But saying it improved marginally seems disingenuous on its face because this 30%+ decline is on the heels of the 5% decline in the first quarter. And whether the number is 31.4% or 32.9% (from the second estimate), it’s still the worst quarterly decline in history – by a long shot.

Best GDP Growth in History in 3Q

Then three days before Christmas, the U.S. Department of Commerce released the “third” estimate of real gross domestic product for the third quarter and the “third” estimate was revised upwards from 33.1% to 33.4%. This is of course on the heels of the 31.4% decrease in the second quarter.

According to the Bureau of Economic Analysis (within the Department of Commerce):

“The increase in real GDP reflected increases in PCE, private inventory investment, exports, nonresidential fixed investment, and residential fixed investment that were partly offset by decreases in federal government spending (reflecting fewer fees paid to administer the Paycheck Protection Program loans) and state and local government spending. Imports, which are a subtraction in the calculation of GDP, increased.

Wall Street Climbed a Wall of Worry

While the first quarter of 2020 was pockmarked with unprecedented and immediate stoppage of economic activity as businesses shut down and people stayed at home, every month of the second quarter of 2020 saw businesses slowly start to reopen, albeit not as fast as they shut down. The third-quarter was an extension of the third quarter, although results of the shutdowns started to show more prominently in corporate earnings reports. And the fourth quarter saw much of the same, but more negative news started to creep into various economic data sets, including housing.

While many are happy to see 2020 in the rear-view mirror, the performance for 2020 for the major U.S. indices and most of the developed, international markets was nothing short of impressive, especially given the headwinds of COVID-19 and the drama surrounding the 2020 elections. And as we enter a New Year, those headwinds have not evaporated completely, but they are beginning to diminish.

Let’s hope that 2021 is “the best of times, the age of wisdom, the epoch of belief, the season of light, and the spring of hope.”

Sources: msci.com; fidelity.com;nasdaq.com; wsj.com; morningstar.com