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Berman Capital Q2 Financial Reports Marion County Hospital District July 2021 July 9, 2021 BCA 2Q2021 Investment Review and Outlook With the first half of 2021 behind us and U.S. equity markets having the strongest start since 1998, it begs the question of how the second half of the year will play out. All eyes were on the Federal Reserve during the quarter as investors looked for changes in their response to stimulus with every new piece of economic data that was released. Their official response has been to keep monetary policy accommodative until substantially higher and broader employment gains are achieved. However, various Fed Presidents across the 12 regions have expressed their opinion in contrast to the official policy, believing that an earlier withdrawal of fiscal support is warranted. The members of the Federal Open Market Committee no doubt have a litany of items they review on a continual basis that shape their opinion of the economy, but in this Outlook we seek to hone in on the most important aspects of the economy we believe the Fed is paying particular attention to. Where we stand with COVID-19 Sixteen months have passed since the World Health Organization declared COVID-19 a global pandemic. Since then, there have been over 182 million cases across the world and close to four million deaths (the actual number is expected to be higher given the difficulty in getting accurate counts). The United States, India and Brazil have been hit particularly hard and account for over 45% of all global cases. While many developed and emerging markets continue to be ravaged by this virus due to policy missteps, lack of access to effective vaccines or general vaccine hesitancy, the U.S. has turned the corner and is seemingly past the worst waves as the seven-day average cases are at 11,500 as of quarter end. President Biden set a goal of 70% of all adults receiving a vaccine before the Fourth of July holiday. Unfortunately, we were shy of that number as only 66% of adults have received at least one dose and 57% are fully vaccinated. While progress has been made globally, risks abound as the Delta variant spreads across the world and into the U.S. This variant has been shown to be more contagious than previous strains and is expected to be the dominant strain in the U.S. in the next few weeks. In fact, the Centers for Disease Control recently reported that the number of COVID-19 cases has risen 10% in the last week of June and the Delta variant now accounts for a quarter of all new cases detected. While the current numbers are nowhere near the peaks we saw in January, it makes medical experts nervous, and potentially the Fed, as it brings back memories of extended lockdowns and unemployment that would be detrimental to the progress already made. Risks of another wave of cases and new lockdowns, while unlikely, are still on the minds of investors, medical researchers, and Fed presidents. Is inflation temporary? With the headline Consumer Price Index well above economists’ estimates for the month of April and May, investors began to question whether the Fed’s easy money polices were the beginning of an era of hyperinflation. The Federal Reserve Chair Jerome Powell took to the offensive during the quarter and attributed most of the recent inflation surge to factors tied to the economy reopening. From what we are seeing in the underlying numbers, the Fed may be correct. Consumers saw higher prices for many of their purchases, but particularly for big-ticket items such as vehicles. Prices for used cars and trucks jumped 7.3% from April, contributing almost one-third of the rise in the overall 1 index. The indexes for furniture, airline fares and apparel also rose sharply in May. It is believed that the price increases in areas such as these are unsustainable and will temper as the economy continues to normalize. Taking cues from debt markets, investors are in agreement with the Fed that the pricing pressure we are seeing will be temporary. The 10-year Treasury yield had little reaction to the inflation news and has been trading in a shallow range, indicating that bond investors are not anticipating higher inflation on the horizon. 10-year Breakeven Inflation Rates have been trending down as well and ended the quarter at 2.32%. Overall, it is our belief that it is too early to call whether high inflation will be sustained or not. Year-over-year inflation numbers are distorted given this time last year we were in the height of lockdowns across the country and prices were falling. We continue to see conflicting signals in input prices across the globe (e.g., lumber prices have rolled off from their peak in early May, at $1700/bft, as sawmill capacity comes on-line, to $721/bft at quarter end while computer chip lead times have increased from 13 weeks at year end to 18 weeks at the end of May, indicating that chipmakers continue to struggle to keep up with demand). But the current evidence suggests the price spikes we are seeing are unlikely to continue and the market believes inflation will be at a manageable level on a go forward basis. The employment situation The Fed Chair reiterates that the labor market is a priority and has significant influence on their policy decisions. Substantial progress needs to be made not just in employment in general, but it must be broader in scope across different wage earners and demographics. While progress has been made since the low of 2020, it has not been at the pace necessary to remove policy accommodation. As of the time of this writing, the U.S. job market is still below its pre-pandemic employment level by 6.76 million people. This has created somewhat of a conundrum for policy makers as many industries continue to display signs of labor shortages citing a mismatch of skills, continued employee health concerns, and lack of childcare or government support as reasons for the lack of interested labor. However, in contrast to April and May when nonfarm payroll numbers missed expectations, June payrolls increased by 850,000, beating median estimates by a wide margin. Payrolls gained the most in 10 months, suggesting firms are starting to have success in recruiting workers to keep pace with economic demand. As a potential boost to future payroll numbers, June payrolls did not reflect the removal of the additional unemployment insurance payments that many states enacted during the month. Along with this and continued vaccinations around the world as well as schools reopening, we believe the outlook for employment is on a positive trajectory. What ties employment to inflation are employee wages. Normal economic theory suggests that as companies struggle to find employees, they must raise wages in order to entice workers. We are currently seeing this in the market as many retail businesses are offering hourly wages well above the federal minimum and/or additional signing bouses. While an appropriate level of wage growth is healthy for an economy, it stokes fear in policymakers’ minds if it gets out of control and causes wage-push inflation (i.e., after raising wages, corporations are compelled to raise prices for their 2 goods and services to maintain their profit margins. Consumers see prices rise for these goods and require higher wages to compensate, thus creating a vicious cycle). While we have seen wage growth spike in some industries such as leisure and hospitality, these numbers have been distorted due to the pandemic and have disproportionally affected these lower paying jobs. Other wage measures that are less distorted by the pandemic have shown stable growth across the country. Participation rates increase as people reenter the workforce and wage pressures will ease. Reliance on the consumer Higher global equity returns have come on the back of robust earnings and earnings have come from consumer spending. What will keep the economy growing for the latter half of the year and beyond is the consumer. As the economy transitions from stimulus-led growth to consumer-led growth, the Fed will be watching for any signs that consumer spending and sentiment are turning. Fortunately, this is not the case. Personal income for employees is now 5.1% above pre-pandemic levels and personal savings rates remain at an elevated level of 12.4% through May 2021, equating to an additional $1 trillion worth of savings since the start of 2020. Consumer confidence remains optimistic as well. Recent consumer survey data published by the Conference Board showed significant improvement in June and is now at its highest level since the onset of the pandemic. Confidence strengthened across income groups as well. Households making between $25k -$35k increased the most (+14.7 pts) while those making $125k+ increased 4.7 pts. Consumers’ short-term optimism increased based on their expectations that business conditions and their own financial outlook will continue to improve in the months ahead. The proportion of consumers planning to purchase homes, automobiles, and major appliances all rose; a strong sign that consumer spending will continue to support economic growth in the short-term. A continuation of government spending via fiscal policy With the coronavirus hitting different regions of the world at different times and vaccine rollout programs being enacted country-by-country, it’s easy to see how government policy responses across the world have differed. However, much of the developed world is investing billions at the same time in an effort to boost their post-pandemic economies.
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