Recently on the Big Mike Fund podcast, Mike had the honor of speaking with Frances Newton Stacy, Director of Portfolio Strategy at Optimal Capital. Frances has appeared on many major networks such Fox Business, Yahoo, CBS, and Bloomberg sharing her financial expertise. Frances shared her thoughts with Mike on the financial outlook post-election, and what impact she speculates the political changes will have in 2021.
We are now post-election and in this pandemic world, and the market seems to be pretty happy and is almost at historic highs.
According to Frances Newton Stacy, this could be because the market is happier with the idea of a divided government—our country is moving towards the two extremes in both directions. When you talk about pricing in super far left or super far right terms, markets get disruption and uncertainty. Markets like certainty, i.e. having middle ground, having balance on both sides.
Along with installing a new administration in Washington, what is yet to come fiscally in 2021?
- Fiscal stimulus coming; estimated around 2 Trillion
- Republican controlled Senate (potentially); makes it harder for Biden to raise taxes
- New vaccines and the reopening of business as usual
- Possible bump in capital gains rate up to the income rate, which is 39 to 40% for people in the top bracket– change depends on whether we have a split government
- Possible increase in the corporate tax rate from 21% back up to 28%, tough on small businesses
If the runoffs change and the Democrats get control of the Senate, then Democrats would have control of the House, the Senate and the Presidency. If this happens, initially markets would trade up on that news, given that there would be more stimulus, but taxation and different tax policies would start getting priced in pretty quickly. These policies and more will start being determined in January 2021.
We have record amounts of debt in our financial systems.
Why hasn’t the ‘Trickle down’ effect of fiscal stimulus been stimulating the economy during this pandemic era?
The Republican ideology around supply side economics is the trickle-down effect– and that’s not occurring right now because of the record amount of debt in the system. The money’s coming in and creating an asset bubble, but it’s just not trickling down into the lower echelons of the economy.
Currently, the influx of stimulus money is splitting the middle class, and most of that split is going into the lower classes. In other words, it’s deleting the lower-class, it’s killing the small businesses, it’s killing the lower end, which is requiring stimulus to hold that end up while it’s making the top end of it.
The cost of living is going up, and inflation is stagnant—A difficult paradox
The other thing in our financial system that’s putting a lot of pressure on it is the fact that even though we don’t see core inflation moving higher, which is what the FED follows, it does not include gas and food prices.
For the people in the middle class who didn’t get crushed by the pandemic, they may get crushed by the change in the cost of living because they don’t have the cushion that the upper end of the spectrum has to afford the cost of living.
What is the ‘Big Lag’ in debt service and forbearance?
When balance sheets, corporations, governments, and everybody starts taking on more debt, which we’ve done during the pandemic, that debt service has actually passed on to consumers in many cases through price increases, but not right away. Therefore, there’s a lagging effect. But looking forward, we’re expecting inflation, and the existing debt that we had in the system and the existing stimulus that was in the system pre-pandemic.
The only thing that will make that untenable is if we have problems in the credit markets, because we have many loans that are in forbearance and we just don’t really have any idea what percentage of those loans will actually default. If we have a hundred million loans in forbearance and 2% default, we’ll sail right through that. If we have high default rates, you take that money out of circulation and it is deflationary.
Debt Forgiveness and Default in the Credit Markets both Deflate the Economy.
When you forgive debt, you write it off the books, which means it comes out of circulation. So, if you put 2 trillion in with stimulus, and then you forgive 1.7 trillion in debt, you change the debt service for the individual borrower, but systemically you reduce the money supply coordinately and then that’s also a deflationary pressure.
There have been talks about removing partial debt payments. The people who have student loan debt are the people who are not winning in the scenario where things are being very divergent right now. Therefore, it makes sense to help those debtors and not have them default. But if you write it off, it’s the same as if they default mechanically for the money coming out of the system. So that’s one thing that economists are going to have to pay close attention to.
Forebearance numbers haven’t changed a ton, maybe 8+% of the mortgage market is in forbearance, about 100 million loans. If you take all those hundred million loans, and then even 20% or 25% of those default, that’s going to be pretty scary for the credit markets.
If you take the statistics now for how many loans are coming in and out of forbearance, and then you move past December with no new fiscal stimulus, how many of those people that were on unemployment benefits that didn’t go into forbearance or were keeping up with their rent are now going to get evicted or go into forbearance? If forbearance isn’t available, then loans become defaults.
Are interest rates going to stay low indefinitely?
In the near term, it does look like the yield curve is steepening and that rates are going up.
Eventually if rates go up too high, the FED will lower them again, because of yield curve control, i.e. where they target asset purchases somewhere along the curve to try and depress that part of the curve with the purchases.
The problem is on the one hand you would like to see interest rates go up because it signals recovery and then you get loans moving. But on the other hand, because we have a record amount of debt in pretty much every sector of the economy, if interest rates go up too far, too fast, that’s going to create a wave of default.
We’re not going to be able to service all of that debt if interest rates are moving higher. And that’s the reason that the FED would come in with yield curve control– they would foresee the deflationary challenge coming from default.
The FED will most likely leave interest rates alone until they start seeing pressure on liquidity, and then they’ll come in and constrain them again. Although we have a record amount of liquidity that was dumped into the system because of the pandemic, debt service removes liquidity from the system.
Looking forward, debt service becomes the real problem
When you’re looking for things like inflation to ‘inflate’ your way out of the debt, but yet you want to keep interest rates really low, that’s a really tough dichotomy to navigate.
Ray Dalio released a book titled “A Template for Understanding Big Debt Crises” Ray goes through 48 debt crises and he uses total debt to GDP. About 365% debt to GDP is really when a country starts having some problems and looks like it could be headed for restructuring. We’re at 362%, and we’re not quite there on public debt to GDP.
It’s really in that total debt to GDP number that we’re hitting the danger zone. The challenge that policymakers are going to have is that:
- You want to have more stimulus come in
- You want to fix the economy
- You want to look at the wealth gap
- You want to look at taxation
We do need stimulus and, in the immediate term, for people who are suffering, it’s more important than these debt considerations, but once we kind of fill the gap from the pandemic and do everything that we possibly can to help those and get the country reopened, then we’re really going to have to look at those debt to GDP ratios because they’re important.
COVID-19 Era and Beyond
The thing about this COVID-19 pandemic era is that we’ve added to the debt, but we’ve also contracted the GDP quite dramatically. The third quarter numbers coming out here shortly are going to be huge, but it’s coming off of a really bad quarter. It’s really the year over year debt to GDP ratio number we need to look at.
When you make the GDP figure smaller of course it exacerbates that ratio on both sides, and that’s the thing that we’re contending with. And that’s the thing that the Biden administration is going to contend with.
We are at a disadvantage of too much national debt, which creates a heavy load to keep pulling us lower. Unfortunately, there’s not much we can do until we go to the restructuring.
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Warmest wishes in this Holiday Season….
CEO, TF Management Group LLC
This newsletter and its contents are not an attempt to sell securities, nor to sell anything at all, nor provide legal, nor tax accounting, nor any other advice. The presenter is a private lending and real estate fund management business, and the information represented herein are purely for educational purposes and represents the opinions of the presented. Prior to making any investment or legal decision you should seek professional opinions from a licensed attorney, and a financial advisor.
TF Management Group LLC (TFMG) is an investment fund management company that specializes in both short-term debt financing for real estate “fix and flip” projects, and long-term “value-add” equity deals.