Goldilocks Economy: All-Clear or Perilous?

The global economy is in recovery, and a new economic cycle is underway. Human health and well-being, technological capability as a core competency, and sustainable solutions to global concerns drive and define this latest economic cycle with new winners and losers.

A global pandemic dismantled traditional ways of consuming and doing business. This event has led to a significant number of over-encumbered government balance sheets that were already less-than-solid. Leadership matters in this challenging economic cycle, as difficult decisions with far-reaching consequences will either support or undermine progress.

The financial markets recovered spectacularly after the significant drawdown in the first quarter of 2020.  Financial markets have started 2021 at levels that might be considered as good as possible.  We believe the slow, productivity-enhanced recovery has the potential to drive corporate earnings higher than expected with limited inflationary impact. While not purely a "Goldilocks" economy primarily due to potential government policy, it is also not an unstable economy (we do not see a systemic bubble currently building).

Below, we expand upon three themes that we view as most relevant to how 2021 unfolds for the financial markets. 

Theme #1: Lives Disrupted. Food and Housing too. The compromised U.S. sovereign balance sheet due to federal relief packages will linger.

The events of 2020 tested humanity's ability to address a global health crisis. It tested the economic fortitude of countries and companies, as well as the flexibility of leadership. Finally, 2020 tested the will of the citizens and leaders of the United States to ensure the survival of the very foundations of democracy.

2021 begins with a vaccine roll-out, better-than-expected earnings from corporate America, and a tug-of-war on how much is enough financial relief to bridge the pandemic-induced economic divide. The cost of monetary relief to support negatively- affected Americans is high in the short term but would be potentially even more costly in the future.  That said, the increasing public debt will tend to have a dampening effect on future economic growth and the strength of the United States balance sheet. We think the most likely scenario for the remainder of this decade is slow, approximate 2% real U.S. GDP growth, close to  potential growth (Chart 1). The current labor surplus will tend to dampen inflation with low interest rates over the near-term. Longer-term, we would expect interest rates to move upward with the risk of more inflation as the unemployment rate declines and the economy recovers.

Chart 1:  Real Potential Gross Domestic Product

Source: Federal Reserve

Theme #2: Economies Must Evolve to Thrive

The chaos, uncertainty, disruption, and pain due to the pandemic in 2020 has given way to a transformative path toward economic recovery. The economic recovery underway is defined by unprecedented federal relief, corporations with digital competitive advantages gaining market share at increasingly profitable margins, and the potential for private cost-effective solutions to public challenges. Just as the evolution of the Internet had stages toward widespread deployment, 2021 is witnessing the increasing requirement for digital capacity for survival. One example of increasing value in digital are cryptocurrencies. They have been evolving as an alternative payment system. Now, Bitcoin, specifically, is rapidly taking on the potential to be an alternative store of value. Bitcoin's dual utility significantly broadens its appeal. The inflection has occurred at a time when U.S. public debt has ballooned beyond 100% debt-to-GDP (Chart 2).

Chart 2: U.S. Public Debt as a Percent of GDP

Source: Federal Reserve

Theme #3: Global Issues Local Impact

We are all in this together, quite literally. This pandemic has highlighted the global connections. Digital economies enhance worldwide commerce and have the capacity to cross over borders for better or worse.  Systems must work with resiliency to unforeseen events. Consumers have experienced the negative effects of manufacturing systems and supply chain disruption over this last year. Aging populations, national and personal security, water, energy, healthcare, and economic stability are global concerns. Technology-based innovations and solutions to international questions can scale growth rapidly and profitably.

We need not look beyond Oregon to see global issues coming to the fore. As a 2013 Council of Economic Advisors report on grid resiliency* determined, severe weather is the leading cause of power outages in the United States (Chart 3). The Oregon Office of Economics concludes “the personal and economic impacts today of electricity disruption are more about grid resiliency and being without electricity for days rather than electrical generation**.” The loss of electricity impacts broadband access that is increasingly important to society. The pandemic demonstrated the importance of flexibility in work locations. That flexibility was enabled by broadband access.

Chart 3: Weather-Related Outages

The most recent power outages offer opportunities to rethink investment spending. With just the two regions of Portland and Salem accounting for 58% of the state’s population, 63% of personal income, and 67% of GDP, any upside or downside to economic growth statewide is impacted. While Oregon is one example of what grid resiliency can mean for economic resiliency and flexibility, this is a global issue in which we see significant financial opportunity in.

Conclusion:

We are cautiously optimistic about stocks. We believe bonds bring meaningful diversification with some income to a portfolio. We are neutral on longer-term bonds.

2021 will be a year of successes and failures as the world moves beyond COVID-19 limitations in the economy.  We anticipate a dramatically changed economy, yet one that is necessary for humanity in these times.