InSight

Market InSights:

There Is Too Much Money

You read that right, there is simply too much cash in the capital markets to not see a handful of effects that could impact your investments and plan. The supply of money floating around is massive right now. There is a lot of risk, COVID has us concerned about the economics of the coming year, but it’s getting harder and harder to ignore how much cash has been made available.

Even relative to itself, it’s a volume of cash in the money supply that will take at least a decade to settle into long term investments, or be recaptured by the Fed. At the beginning of the year there was roughly $15T in circulation held in cash and cash equivalents. We are in December and the number is closer to $19T of more highly liquid cash in the world. This $4T expansion in only 12 months is remarkable.

Here’s some history on money supply. It took until 1997 to reach the first $4T in circulation, the decade from 2009 to 2019 saw that supply double from $8T to almost $16T (the fastest doubling ever), resulting in a major part of the expansion of the stock market for that decade. Now, in twelve months we have seen a flood of almost 27% more money in the supply than there was at the beginning of the COVID-19 pandemic. 

One of the best leading indicators for where capital markets are headed, can be found in how much money, especially highly liquid money like cash, is available in the system. This is a reflection of how big the pie is. Usually in investments we are focused on cash flow, and a companies market share – or how effective a company is at capturing cash flow from a given size of market. That’s becoming less relevant as the sheer volume of cash has exploded. The pie is so big right now that there will have to be a a few notable adjustments to make:

Inflation – While I have heard that Jerome Powell has not registered an increase in inflation yet, it is hard to believe that as the newly introduced money will not have an expansive effect on the costs of goods and services. Many mark the inflation rate off the CPI, grievances with that benchmark aside, it would be irresponsible to assume that the basket of securities they mark to market does not see an above average increase as more money finds its way into the same number of consumer goods. Additionally, elements like rents will see a disproportionate increase in the coming decade because while supply of say consumer goods will increase quickly to capture this cash, construction of rental properties is a less reactive market and a slower roll out to correct the market. In the meantime expect rental costs and revenues to see above average inflation figures. 

Interest Rates – Permanently impaired. As I write this the current observation, the 10 year US Treasury is paying 0.9%, a third of where it was even 2 years ago. It is heard to believe that such a robust introduction of cash doesn’t become a permanent downward pressure on fixed income assets for the foreseeable future. Unless there is a formal and aggressive contraction of the money supply, it will take decades for the amount of cash in circulation to let up that downward pressure on bonds. Interest rates in short term assets will be particularly affected as the demand has become less appetizing in contrast to long term debt, and the supply of cash is chasing too small of demand. 

Equities – The real benefactor here. It is hard not to believe that over the course of the coming decade, this cash infusion doesn’t trickle its way up and into the stock market and other asset values. Generally the most “risky” part of the market is the historically the benefactor of excesses in cash. Companies will do what they do best and capture this supply of cash through normal operations, this will expand their revenues and ultimately the bottom line. Additionally, the compressed borrowing costs from low interest rates will lower their operating costs. Compound the poor risk reward ratio in bonds and you will see more of those investments seek out stocks, real estate, and other capital assets. This sector will see a virtuous combination of more revenue, and more demand for shares. Expect permanently elevated P/E reads for the time being. 

 

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USA’s Credit Rating Downgraded – What it Means for the Economy and Lessons from the Past

USA’s Credit Rating Downgraded – What it Means for the Economy and Lessons from the Past The U.S. has had its 2nd downgrade in 12 years Equity and debt markets and the broader economy are highly correlated to the strength of U.S. Creditworthiness Politics and Debt Debates are wearing on credit agencies’ willingness to underwrite poor behavior and political infighting In a surprising turn of events, the credit rating of the United States has been downgraded to AA+ from AAA, a rating the U.S. has held at Fitch since 1994, signaling a potential cause for concern in the country’s financial stability. The downgrade comes as a result of several key factors that have raised worries among investors and financial experts. Expected Fiscal Deterioration: The downgrade reflects concerns about the future financial situation of the US over the next three years. Experts fear that the government’s ability to manage its finances may deteriorate, potentially leading to a higher risk of defaulting on its debt. Growing Debt Burden: Another significant issue is the increasing debt burden that the US has been facing. The government has been accumulating more debt, which raises questions about its ability to repay the money it has borrowed. Erosion of Governance: Over the past two decades, there has been a steady decline in the quality of governance in the US. This is evident in the way the government has repeatedly struggled to reach agreements on the debt limit, leading to last-minute resolutions. Such instability erodes confidence in the government’s fiscal management. The consequences of this downgrade could be far-reaching, impacting various aspects of the economy. One potential concern is that it might lead to a lack of confidence in US bonds, which are essential for the government to borrow money. If investors become skeptical about the government’s ability to pay back its debts, they may demand higher interest rates on US bonds, making it costlier for the government to borrow money. The US government’s deficit, which is the amount by which government spending exceeds its income, is expected to increase. In 2023, it is predicted to reach 6.3% of the country’s total economic output (GDP), which is quite high compared to previous years. By 2025, it might even widen further to 6.9% of GDP. Moreover, the level of debt compared to the size of the economy is projected to rise over the forecast period, reaching 118.4% of GDP by 2025. This level of debt is significantly higher than what is considered safe for countries with strong financial standings. One potential consequence of the downgrade is the risk of a mild recession in the US economy. Tighter credit conditions, weakening business investment, and slower consumption could lead to economic growth slowing down. This, in turn, may impact job opportunities and the overall well-being of the population. To address these issues, the US Federal Reserve has been raising interest rates. While this can help control inflation, it may also make borrowing money more expensive for businesses and consumers. The Federal Reserve faces the challenge of balancing economic growth with the need to manage inflation. It is important for the US government to take swift and effective action to address these financial challenges. Failure to do so could lead to more difficulties in the future and potentially impact the financial stability of the nation. Despite the downgrade, the US still possesses some strengths that support its financial standing. Its large, advanced, and diversified economy, coupled with the US dollar’s status as the world’s primary reserve currency, provides the government with exceptional financing flexibility. In August 2011, a similar event occurred when Standard & Poor’s (S&P) downgraded the credit rating of the United States from AAA to AA+. This had significant effects on financial markets and the overall economy: Market Turmoil: The downgrade triggered widespread market turmoil. Stock markets experienced sharp declines, and investors panicked as they worried about the stability of the US economy and its ability to repay its debts. Increased Volatility: Financial markets became more volatile in the wake of the downgrade. Investors became uncertain about the future, leading to wild swings in asset prices and increased risk aversion. Higher Borrowing Costs: The downgrade led to increased borrowing costs for the US government. As investors perceived the risk of holding US government debt to be higher, they demanded higher yields on US Treasury bonds. This, in turn, increased the interest payments that the government had to make on its debt, putting additional strain on the budget. Impact on Consumer Confidence: The downgrade had a negative impact on consumer confidence. When people see negative news about the economy, they become more cautious about their spending and saving habits, potentially leading to decreased consumer spending, which is a significant driver of economic growth. Weakened Dollar: The US dollar, which had long been considered a safe-haven currency, faced pressure due to the downgrade. As investors sought safer alternatives, the value of the dollar depreciated against other currencies. Impact on Global Markets: The downgrade had ripple effects on global financial markets. Many countries and institutions around the world hold US Treasury bonds as part of their investment portfolios, and the downgrade caused concern about the stability of these holdings. Political Fallout: The downgrade also led to political fallout within the US. 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Can manufactured homes can be considered like-kind property for tax purposes under IRC Section 1031

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Saving Automation 101: Routine, habitual, saving

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