2021- The Gradual Return of Moral Hazard
There are a variety of market forces that make 2021 predictions an indulgent moral hazard. That said, we do see a few things as being more likely than not.
- We do see a synchronized global economic boom once various vaccines are broadly distributed
- Max stimulus – A powerful combination of policy, consumer liquidity, and a gating factor
- Money supply growth and changes in the rate of growth are very important
- Talk of bubbles becomes rather loud in 2021 as the year marches onwards
Good day, this is Brian Barish, President, and CIO of Cambiar Investors. Thank you for tuning into our 2020 Market Review & 2021 Outlook. We hope you are doing well in these unprecedented times.
THE GRADUAL RETURN OF MORAL HAZARD
One of the upshots of the pandemic and the need to lockdown and distance is that certain activities and policies that contain elements of moral hazard having to give it a free pass. These go from very benign, but understandable, such as wearing sweat pants while attending important work meetings and Zoom calls, to quite devastating but still understandable, such as preventing restaurants from serving customers indoors or closing movie theaters and schools. Small businesses are dying with each passing day, and school-aged children are not learning what they’re supposed to be learning. At the big macro level, the lack of moral hazard extends to budget deficits only seen in the second world war, gigantic Fed balance sheet expansion, and the suppression of normal price discovery mechanisms in credit.
Moral hazards tend to lead to outright hazards down the road.
All of it is understandable, and probably necessary, but moral hazards tend to lead to outright hazards down the road. The massive monetary stimulus and suppression of credit pricing no doubt fed it to stock market’s frenetic rise in 2020. The US stock market ended the year at all-time highs on practically every financial metric.
So what’s our forecast? Well after a year like 2020, the very thought of making broad forecasts as though we really could know the future seems like an indulgent moral hazard. The current forces at play: a pandemic and lockdowns, vaccines, huge pent-up consumer and industrial demand, immense consumer liquidity, stimulus beyond anything we’ve seen in our lifetimes, and the pervasive adoption of numerous disruptive technologies. There’s a lot coming together and we just don’t know how this confluence could be predictable. We’ve had some views about the coming year a year ago, and they did not include a pandemic. That forecast was shot 60 days into the year.
Deep in the pandemic, I’d surmised that given the severity of the bear market, a full economic and stock market recovery might take years. Wrong again. Fortunately, we kept buying stocks as they came to us, otherwise we would not have had such a good year. So, any forecasting now about markets and world events comes with a very heavy dose of humility. We will keep buying stocks in 2021 as they come to us and selling them if they become too hard to rationalize.
That said, we do see a few things as being more likely than not. First, we do see a synchronized global economic boom once various vaccines are broadly distributed, which we estimate will be in the second quarter for most adults. This could mean GDP figures of seven to eight percent in the US for all 2021, which are the highest numbers on record since the early 1950s. Other developed countries will see similarly outsized growth numbers off of low-based comparisons, and these will happen largely all at the same time. This means an intense burst of demand for pent up consumption, production, vacations, medical procedures, supply chain, inventory restocking. You name it, it’s being under-produced and under-consumed relative to sustainable demand.
Second, on the public policy side, you do have max stim. Governments and central banks are pushing money to businesses and individuals, easy money through the financial system, and all largely at the exact same time. It’s a powerful combination of policy, consumer liquidity, and a gating factor on putting all of that to use that none of us has really ever seen before.
Third, we do continue to think that money supply growth and changes in the rate of growth are very important to watch. High money supply growth is a critical factor in the stock market’s valuation expansion, and this will slow down later in 2021, and down a good deal more in 2022 as the economy reopens and the fed tapers down on its open-ended bond buying program.
Fourth, given the valuation expansion that we’ve seen in the last 12 months and the prolific speculation in stock markets, we imagine that the talk of bubbles becomes rather loud in 2021 as the year marches onwards. This begs the question, what is a financial bubble exactly? Well, there are a few popular definitions. One is a situation in which asset prices rise and appear to be based on implausible or inconsistent views about the future. Number two, a protracted period of low-risk premiums. Number three, a period of time in which asset prices reach levels that are strongly in excess of intrinsic value and rise rapidly to these levels. More cynically, herd behavior that asset managers get fired for not owning. And fifth, all of the above, but still economists claim they cannot see them. Sarcasm aside, let’s just say that items number one and number two look very plausible right now. Are there any telltale precursors of bubbles that we can spot with the naked eye?
The fuel for asset bubbles is much less controversial. There are usually three key ingredients. First, easy money and excess liquidity. Check. Second, the suspension of disbelief by market participants. I would say also a check. Third, some kind of paradigm shift or new technology that precipitates this. Well, there are definitely some paradigm shifts abounding in individual sectors. It would take a long, long time to go through them all. Maybe there’s a larger paradigm shift fantasy that inhabits investor minds today on the very concept of easy money itself. Investors expect the world’s central banks to keep trying and keep failing to generate durable inflation, justifying paying exorbitant prices for intriguing growth stories.
The situation is reminiscent of the turn of the millennium, when stock valuations were not cheap, but not terribly demanding either for older and stodgier companies. A smaller group of market darlings possessed hyper normal valuations and implausible business cases. We see something awfully similar in 2021. And as moral hazard gradually creeps back into our vocabulary, there may be some reckoning to be had.
The reopening that we are all usually waiting for may very well be the reckoning. Given the challenges of turning on so many supply and demand chains to full steam all at once, we envision shortages of many products and some potential for aggressive pricing to clear markets. It seems likely, and maybe highly likely, that the world may see a bout of cyclical inflation in 2021. Markets would not be very surprised, and at some level it would be welcome. Sticking the landing.
Do they have a plan? That’s one way of looking at it. And we may be at least one year too early on this, but it’s at least worth pondering. What if we get inflation and rates rise and the asset bubble pops? Asset bubble pops tend to be deflationary. Or alternatively, what if we don’t get much inflation after all in the next stim, after the next monetary accommodation, after all the truly unprecedented pent-up supply and demand issues? It would be as though developed countries are turning into Japan, liquidity trap and all. Either way, the case is strong for maintaining balance in stock portfolios, and some care as to valuation and the underlying assumptions behind each stock. In other words, be careful. Don’t assume moral hazard is gone forever.
Thank you for listening to the 2020 Market Review and 2021 Outlook, we appreciate your continued support of Cambiar Investors
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