World Awash with Liquidity
Global monetary bodies and government stimulus programs have added trillions to global liquidity that has not been used by the real economy. This excess liquidity has boosted risk assets while at the same time adding trillions to deposits as well as lowering consumer debt. Corporations and individuals are simply not borrowing on a net basis. Major banks reported that deposits were up, on average, 30% with tepid loan demand. Banks are now overcapitalized. We see substantial pent-up consumer demand ahead. At the same time, corporations will keep tight reigns on spending, thereby generating excess cash flow as the economic recovery escalates next year. This remains our forecast. Manufacturing needs to pick up meaningfully to build inventory levels back to normal levels. We expect the supply of funds will continue to exceed the demand for funds for many years forcing investors to stay out on the risk curve.
We realize that coronavirus cases will go up as the weather cools, and businesses who rely on working outdoors will slow. Still, we remain optimistic that economic growth will accelerate as we move through 2021 into 2022 supported by the Fed, several huge stimulus bills, accelerated opening as rapid response tests are rolled out worldwide, vaccines readily available next summer, and inventory levels are built. August manufacturing sales rose 0.6% while inventories increased 0.3%, which means that the I/S continued to move to further record lows, which supports our view that manufacturing will pick up meaningfully in excess of demand such that inventories return back to more normal ratios.
The IMF lifted its economic forecasts for 2020-2022 due in part to a faster than expected recovery in China. World trade volumes are likely to increase by 8.3% in 2021 and more in 2022. Unfortunately, the World Bank predicted that over 100 million people would be thrown into poverty due to coronavirus. This goes to the heart of our belief that corporations will not bring back their employees furloughed/laid off nor increase hires much having learned to do more with less. This supports our view that corporate operating margins/profits will be much stronger than the consensus believes today.
Most of this excess liquidity will remain in the financial system for the next two years keeping downward pressure on rates, but we still see a steepening yield curve as economic growth improves. While large productivity gains will hold down overall inflation, we still see meaningful producer/industrial price hikes as capacity utilization rates rise meaningfully as little new capacity comes on stream. While we continue to see an undervalued overall market, we continue to increase our exposure to more economic sensitivity favoring industrials, commodities, and transportation while continuing to reduce technology. Wall Street does not appreciate the positive leverage ahead and the potential for outsized cash generation, which will be used to hike dividends, increase buybacks, and make anti-dilutive acquisitions. Since Boeing received approval to begin flying the Max 737 in Europe, the United States should not be far behind. This alone should add at least 0.2% to GNP, favoring their industrial suppliers.
We had some good and bad news on potential therapeutics and vaccines. Lilly and J&J temporarily paused their phase 3 testing as there were incidents that needed to be investigated before proceeding. No one knows yet if the issues occurred on those taking the placebo or therapeutics/vaccines. Short pauses are not unusual, and we expect them to restart testing shortly. On the other hand, Pfizer came out yesterday and said that it hopes to present its data to the FDA before the end of November. By the way, we agree with Gilead that its antibody cocktail is effective in reducing death rates meaningfully. We expect more favorable news on therapeutics and vaccines. We remain confident that at least one vaccine will be approved near year-end for those most in need. Several, more efficacious, easier delivery system vaccines will be available in volume by mid-2021. Finally, rapid response tests are now readily available everywhere, which should permit an acceleration in opening just as we move indoors. This is good and supports a more robust economy as we move through 2021.
While we support a meaningful stimulus plan now, the economy has lots of momentum as we enter the fall. From the major banks’ heads, we heard that consumer spending accelerated meaningfully in October after a powerful September, up 1.9%. Consumer sentiment is very strong, so we look for a tremendous holiday spending season as the money/demand is there. Nevertheless, the stimulus plan is needed for those most in need, including individuals (still over 11 million unemployed), small/medium-size businesses, and industries hurt most by the pandemic like the airlines. States and hospitals need added support too. Regardless of a stimulus deal now, we expect many extensive stimulus programs next year, in the multi trillions, including ones for growth like infrastructure bills. Biden would outspend a Trump administration next year, and he would hold off on tax hikes until later in 2022 after the economy is above pre-pandemic levels. Expect significant fiscal stimulus boosting economic growth in 2021 and 2022.
We heard last week from the BOJ, Bank of China, Bank of England, ECB, and many Fed governors that they will remain all-in. They will let economies run hot, permitting inflation to increase above past threshold levels where actions were previously taken to slow growth. Here we are with trillions of excess liquidity sloshing around in the global financial system with much more to come in 2021 and 2022. The implications for economic growth, interest rates, and financial markets are all clear cut: growth will accelerate, interest rates will remain low, and stock markets will rise.
We are at the cusp of an acceleration in sustainable economic growth, which will lead to record corporate profits and cash flow in 2021 and 2022 as we get our arms around the coronavirus along with aggressive support from the Fed and government. Record levels of excess liquidity will drive risk asset prices higher.
We see the biggest positive earnings surprises in industrials, commodities, and transportation as operating margins increase meaningfully, as pricing improves, and costs are tightly controlled. These companies will generate record free cash flow as capital spending is held steady at 2020 levels. The excess cash generation will be used to boost dividends, reinstate buybacks, and make non-dilutive medium-sized acquisitions.
We have funded the additional purchases by further reducing our technology holding. While we still favor the industry longer term, relative earnings gains will narrow, which will lead to relative underperformance over the next two years. We have maintained our holding in retailers that are beneficiaries of the new normal utilizing their online and rapid delivery expertise. We continue to recommend the sale of all bonds as the yield curve steepens, albeit slowly, as global growth improves in 2021 and 2022.
Our investment webinar will be held on Monday, October 19th, at 8:30 AM EST. You can join the webinar by entering https://zoom.us/j/9179217852 into your browser or dialing +646 558 8656 and entering the password 9179217852.
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Paix et Prospérité LLC