Impulse Moderation

July 01, 2021
By Patrick V. Masso, CFA

Time for a confession…Chocolate is an enormous weakness of mine. Dark varieties particularly tickle my tastebuds. Toss in a tincture of salt, a decadent ribbon of caramel, and perhaps a few nuts to provide a crispy crunch to every bite and the endorphin waterfall floods my brain!

Despite dark chocolate reportedly being an amazing source of antioxidants and a factor in lowering the risk of heart disease, cacao connoisseurs must also beware of the potential downsides like elevated sugar content and the impact of caffeine on sleep quality. Best to practice impulse moderation!

As we move through the back half of 2021, the US economy will likely begin undergoing its own version of impulse moderation. The cratering of macroeconomic statistical artifacts at the start of the pandemic in 2020 created an easy bar to jump over the first half of this year.

Consider a small business that saw its revenue in Q2 2020 get cut in half from $1,000,000 to $500,000. Maybe the business has been able to start recovering and generated $750,000 of revenue in Q2 2021. Presto--a 50% year-over-year increase! It still may take a little more time to eclipse that $1,000,000 revenue number, however.

The trajectory of growth rates matters to prices of stocks, bonds, and other financial assets that trade across capital markets. The macroeconomic hurdles are likely to become naturally taller over the coming quarters. In other words, growth rates are probably going to decelerate.

The US real GDP growth that declined 9% year-over-year in Q2 2020 is expected to increase approximately 13% year-over-year in Q2 2021! The rate of growth is likely to decelerate meaningfully from this probable peak to about 7% year-over-year in Q3 and Q4 2021 (slower, but still fantastic!) and still further into 2022 until we approach more sustainable levels of growth around 2%.

Inflation fears have been all the rage and you are no doubt spending more at the grocery store (for that chocolate bar!) and gas station than you were last year for the same quantity of “fuel”. Indeed, inflation rates have accelerated dramatically, alongside real GDP, since probing 0% in Q2 2020. Headline inflation in Q2 2021 is likely to be north of 4% year-over-year – approximately double the rate of inflation pre-pandemic.

Much like the trajectory of real GDP growth, inflation statistics are expected to peak and roll lower as we progress through the remainder of the year and into 2022. However, given the supply chain bottlenecks currently being experienced across the globe, the potential for a bipartisan infrastructure bill ($1.2T spread over 8 years) to pass both houses of Congress, and the possibility of a large spending bill ($2-6T) being signed into law via the budget reconciliation process, the pace of deceleration may initially be less pronounced for inflation metrics.

Another form of impulse moderation is beginning to percolate inside the Federal Reserve. In response to the pandemic, the Fed’s balance sheet has essentially doubled from $4T to $8T over the course of just 16 months. Fed officials have recently begun discussing the appropriate time to start reducing (tapering) asset purchases from the current pace of $120B/month ($80B Treasuries and $40B mortgages). This would be the first step toward normalizing monetary policy.

Progress on the pandemic and economic recovery fronts have led the Fed to accelerate the timing of interest rate increases, with a few members forecasting two increases as appropriate, starting in 2023.

The upcoming economic weather forecast could pose choppier portfolio management conditions. Our investment philosophy and process are built with flexibility in mind at multiple levels of the total portfolio. In coming months, as we attempt to sidestep pockets of risk and capitalize on opportunities, we will remain nimble in positioning portfolios above and below their long-term strategic asset allocation targets.

Now, where did I put that chocolate bar…

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