Yahoo Finance’s Julie Hyman, Brian Sozzi and Myles Udland discuss the outlook for 2021 with Barons Knapp, Ironsides Macroeconomics Managing Partner.
Video transcription
MYLES ABROAD: Let’s discuss a little more about the impact this stimulus package could have on the economy with a view to 2021. Barry Knapp joins us for the discussion. He is managing partner at Ironsides Macroeconomics. Barry, always good to talk to you. Thank you for joining this morning. Let’s start with the stimulus and if it’s something you expected, you’ll eventually get through, if it changes at all how you think about it next year. It certainly helps to limit consumer balances, and we see how many benefits the economy has brought during the summer and fall.
BARRY BUTTON: Yes. We expected this to happen almost from the day after the election. We did not expect a fiscal agreement until 2021, but once we get the election result, which we did, which actually implies that we are going to get a split government – the Senate will probably remain Republican, although we will have to return little because it looks like President Trump has damaged Republican chances a bit. But we thought we would get an agreement in the crippled session, and that agreement would extend the unemployment benefits in 2021 until the first part of 2021. That was our expectation.
For us, the most important outcome or thing that changes through this is due to what we described in our note this week entitled Fiscal Follies. It appears that the Republicans’ chances in Georgia have been somewhat damaged. Betting markets fell by 5%. They were solid in the Republican camp. Call it 71% to 29% that Republicans will own the Senate. But the five-point hit is not insignificant, and it is the biggest risk for us.
Between now and at least when the Fed begins to normalize policy or slow the pace of change, presumably somewhere in the second quarter, we did not think there was room for a significant correction of around 10%. But if the Democrats achieve a shock victory on January 5, the risk of tax increases will increase significantly, and we will not be shocked by a 10% setback in the S&P. So you know, last week was not a great week for the market outlook.
JULIE HYMAN: At the same time, Barry … Hey, it’s July. At the same time, does the risk of more stimulus not increase, or does the chance of more stimulus increase if the Democrats actually achieve that victory? I mean, even if there were tax increases, one would have to think that they are not going to come for some time, given the state of the economy and the fact that we are still on a very fragile basis. So can you not imagine a scenario where you will get the more positive consequences? And if you are going to get the negative consequences for tax market increases in the market, is not this a way to go further?
BARRY BUTTON: July, we can call it the Goldman Sachs thesis, right? Because that was essentially their argument – that you will now get a lot of stimulus and that you will only get tax increases later. My problem with that is what could very well happen and is likely to happen is something along the lines of the 2009 U.S. Recovery and Reinvestment Act, where you get no Republican support for another fiscal stimulus plan, which means you have to use reconciliation . . The Democrats will have to use reconciliation to succeed.
Reconciliation would imply that it had to be paid for. The way to pay for it is to pull the tax increases forward. And so if we get the scenario and they have to pull the tax increases forward to pay extra incentives, you have to think about the multiplier effects of government spending in relation to the negative effects of tax increases. And from our perspective, government spending is always less efficient – it’s like the word of the year, right, efficiency – but it’s always less effective than the negative impact of increased taxes.
And so this is the scenario we are concerned about, that the Republicans do not support any additional stimulus. The Democrats are pushing it too far. Then they have to pull the tax increases forward. This is therefore the risk we think the market could focus on and cause a 10% setback.
This is not our official forecast. We do think the Republicans are going to hold the Senate. We’re going to have a mixed government. We think this is actually a very good result. This is a negative scenario. We think we have probably done enough by now to extend the unemployment benefits until April, and that will be enough to bridge us through the vaccine, and the economy will just come back nicely. Just like in August, we were not worried about getting off the fiscal cliff, and it really had no negative economic impact when we got off the fiscal cliff. So we think the prospects are good. I’m just a little worried that what happened last week will cause this scenario to increase the risk of tax increases.
BRIAN SOZZI: Barry, you’re looking for double-digit returns in 2021. Is it off the table if the Democrats do win in Georgia?
BARRY BUTTON: No. Listen, the most important factors here are in my opinion very much in place. It is that we are going to get a very strong recovery in the global manufacturing. We are experiencing a very strong recovery in global manufacturing and trade, not only because of the pandemic, but also because of the 19 month long trade war that took place before it. We have had the only period since China was integrated into global supply chains where growth in world trade was negative when world GDP was positive.
You could even see it last night in the Vietnamese export numbers, which were so strong. It was the first number we got for December. This will continue and be a big positive impetus at the beginning of the year. We think we are going to get a very strong recovery in capital spending. This could be somewhat detrimental if my tax scenario started to play out and that the tax rate on companies would rise significantly, but we still think the argument is for a very strong period of capital expenditure.
And the reflection story is intact, too. It was not the same shock of the financial sector as the global financial crisis. And so inflation is higher. Eventually it will be negative for markets, but in the early stages, reflection is positive. The forces we are thinking are therefore going to continue and will push markets higher, even if we have a policy shock sooner than we would expect. So you know we’re having a policy shock related to the Fed sometime around the middle of the year. We can get one sooner if the Democrats take both seats in the Republican Senate. However, I think this is a lower probability.
MYLES ABROAD: Barry, just finally, you know, the title of your newsletter, It’s never different this time, right? But I think the lack of a thesis about financial crisis that you just outlined really struck me in your letter because it is so different from what we saw in 2008-2009. And when you talk about policy shock, is there a risk that we’ll suddenly think of a Fed rate hike in 2022? Is this some kind of big election event? And it’s just two years away, right, the mid-cycle re-up. How do you think about that?
BARRY BUTTON: Yes. It is never different this time, but it does not only apply to the last business cycle, as you rightly noted. And when Reinhart and Rogoff released their book, and Carmen and Vince Reinhart released an abridged version of it in 2010, they talked about how financial crises are the most persistent economic effect is a decade of disinflation. It was not a financial crisis, was it?
The inflation outlook – the argument for higher inflation from a monetary perspective is quite compelling, from a cyclical perspective is compelling. And if you think about where the disinflationary pressure has come from over the last three decades, it came because of China and the Soviet bloc being integrated into the industrialized world and putting commodity prices down.
We’ll probably now go from just-in-time management of the supply chain to just-in case, right? And so you will not see the same persistent disinflation effect on the price of goods. So inflation is higher, and I think it will deliver some awkward moments at FOMC meetings, as soon as the middle of the year, where we start pushing through their inflation target. If they now look at inflation increases to 2%, they pat themselves on the back and say: give, we finally win. But I think there will even be a point this year where they start to get a little uneasy with the outlook for inflation. And so it will be a very different business cycle than the previous one, not different from all cycles, but different from the new normal period 2009 to 2014.
MYLES ABROAD: Good. Barry Knapp with Ironsides Macroeconomics. Barry, always great to get your mind. Thank you for joining the program this morning.
BARRY BUTTON: Thank you. Thank you for having me.