By Michael St. Michael
5 minute read
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Most everyone will breathe a sigh of relief at the departure of 2021. Overall, though, 2020 ended up being a good year for investors. It was easy to make money in the stock market. The S&P 500 produced over 17 percent total return and the DJI up 6.84%. However, beyond the markets, there are plenty of reasons why people are concerned with the economy in 2021.
Unemployment remains extremely high in the US. In November, the real unemployment rate was 12%, much higher than the official unemployment rate the government releases, which stood at 6.1%. As many know, the unemployment rate the US government uses as the official benchmark does not include underemployed workers, or workers who have given up their job search and who are thus not counted. The workforce situation in the country therefore remains dire, despite the injection of trillions of USD of stimulus funds into the economy.
Speaking of stimulus funds, government money presses are on fire. The US debt now stands at $27 trillion, a number which means that every American owes about $70,000 for their share of the national credit card. If we add to this the roughly $91,000 in consumer debt each American owes, it is not difficult to argue that that America has a teeny debt problem. Critics of balanced budgets and those who pooh pooh the importance of national debt, mostly by arguing that any nation can simply print more money and inflate their way out of it, barely deserve the respect of a reply, but I will give one.
It is true that sovereign nations have fiscal autonomy for the most part. ‘For the most part’ is important to stress because there are powerful cultural and market forces in play when it comes to the USD. The currency’s status as a world safe-haven currency (along with the Yen, Euro, and Swiss Franc) means that culturally investors are conditioned to flee to the dollar when world events create financial uncertainty. However, the place of the dollar is far from assured in this regard. Runaway inflation would mean replacement of the USD by one or more of the other safe-haven currencies, with a whole series of negative consequences for the US and its economy. Obviously, the inflated dollar means that selling US debt will become increasingly more difficult, especially in light of the poor interest rate environment, which favors borrowing but not saving.
Borrowing and not saving are major weights on US households. Most families are deeply in debt and, despite the outward appearance of affluence, many middle-class families live paycheck to paycheck. $1.5 trillion in student loans and $16 trillion in mortgages represent mild debt toxicity, their costs drive down individual spending power; the former is an especially heavy anchor on the household economy, people who invest in SLABS (Student Loan Asset Backed Securities) excepted. The middle class has been failed by US policymakers for decades, and 2021 is unlikely to bring positive change. A case in point: the most recent stimulus handed $600 to many American adults is insufficient to be helpful but expensive enough to cause more fiscal headache, raise debt levels, and further erode global confidence in the USD. Because of the virus and the accompany lack of fiscal intake as well as stimulus output, American debt is now at the highest level in history.
In addition to continuing high unemployment, a weakening dollar that will drive up consumer prices in many areas, 2021 will witness the folding of small businesses, a cascade from 2020 that will rush into the new year. All these factors will negatively affect consumer sentiment which is already depressed. Consumer confidence, pegged in December 2020 around 80 by the benchmark Michigan Consumer Sentiment, remains far off its previous five-year low.
2021 will also likely usher in a financial crisis. A squeeze on banks is inevitable. Till now, rounds of stimulus have insulated businesses and banks from some real Covid-induced hardship, subsidizing mortgage and rent deferrals. Assuming there is a third round of stimulus under a Democrat controlled Congress and President Biden, the full impact of delinquencies and mortgage defaults should only hit in the second half of 2021. With only about a quarter of businesses able to pay their rent, commercial real estate will be hammered with the double whammy of declining revenues and a subsequent loss in valuation. Commercial retail spaces are running ahead of most of this sector: malls have suffered from the death of major retail outlets and lower-tier malls will consequently close in droves, weakening an already destabilized brick-and-mortar market. We will likely witness the demise of a dozen more national retail shops this year.
The current toxic mix of unemployment and debt will lead to a wave of millions of bankruptcies in the commercial and private sectors in 2021, which banks must absorb. Businesses, especially small business continue to suffer and these have received little to no relief from the stimulus packages.
Certain sectors hit especially hard. The oil and gas industries have been walloped by low prices and rising costs of credit; as their credit worthiness decreases, so their borrowing costs escalate. In 2020, oil/gas concerns and retail companies led by percentage in having their bond ratings rendered Junk. Without a robust recovery in oil prices, a wave of oil and gas defaults and bankruptcies is inevitable, and it is doubtful that $60 oil will save many. Bear in mind the failures in the petroleum industry will have severe aftereffects in the US economy, as the sector provides numerous (159,000 on the extraction side alone) high paying jobs. Low prices for the first half of 2021 could spell the death knell of many.
Business and personal bankruptcies will wash over the banking industry in the second half of 2021. Write downs by financial institutions will lead to further job losses in the financial sector and have knock on effects and likely lead to a fourth injection of cash from the federal government, putting the strength of the USD and the stability of the markets further at risk.
Given the influx of cash the government is pushing into the economy like a tidal wave, 2021 is a good year to bet against the USD. Can we really have inflation, you ask, when consumer spending power remains so weak? Why, yes, kids, we absolutely can, and do! Nigeria is a current posterchild for this. It is a great day for the US economy to be included in any meaningful sense in the same sentence with Nigeria.
In order to hedge against inflation, people will inevitably continue to plow their money into the equities markets, which some analysts view as already overvalued. Stocks offer some hedge against inflation, but your one share of Bazoomba you paid $100 looks like a great deal inflated to $120, except you still own one share and that $120 will buy less gas, less food, and less of that furniture you wanted. Real, sustained growth based on underlying business will be harder to come by. While more unforgiving financial instruments like stocks account for inflation, bond markets are less adaptable since they are tied to government interest rate.
So what can individuals do to ride out what looks to be a difficult year for the US and probably the global economy? Obvious options are sticking to a budget, downsizing, and taking advantage of low interest rates to consolidate more expensive debt. On the investment side, gold, silver and other precious metals can help offset the decline of the dollar in inflationary periods, and 2021 appears to be shaping up as a big year for these. Commodities and other real goods, like land property, are other ways to trim the pain induced by our inflation/weak consuming power year ahead.