Covid 19 Response Short and Long Run Implications

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Covid 19 Response – Short and Long Run Implications

June 26th, 2020

Proprietary & Confidential | ©2020 New England Asset Management, Inc. |

Agenda

• Covid 19 policy response in context

• Budget implications and other near term costs

• Will monetary and fiscal policy be inflationary?

• Capital market impact of Fed programs

• Long run implications

2

Covid 19 Policy Response-Go Big or Go Home


Policy Response – Firing the Big Guns

4

Photos of Mnuchin, Trump, Lagarde and Powell from Wikimedia Commons.


Policy Response – Monetary Policy – Interest Rates

5

0.25%

-0.50%

0.10%

-0.10%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

2006 2008 2010 2012 2014 2016 2018 2020

Fed Funds Rate ECB Deposit Rate BoE Base Rate BoJ Policy Rate

Source: Federal Reserve, European Central Bank, Bank of England, Bank of Japan, OANDA, NEAM


Policy Response – Monetary Policy - QE

6

Source: Federal Reserve, European Central Bank, NEAM

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0

Ja

pa

n %

US

,EU

,UK

%

Central Bank Balance Sheets as % of GDP

US Federal Reserve European Central Bank Bank of England Bank of Japan


Policy Response – Fiscal Policy

7

Global Financial Crisis

Covid Crisis Forecast

-16.0%

-14.0%

-12.0%

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

US Euro Area

% O

f G

DP

Source: Deutsche Bank, NEAM


U.S. Fiscal Response Roughly $3 Trillion (and Counting) in Rescue Funds

8

Sources: Congressional Budget Office, Committee for a Responsible Federal Budget

Where Nearly $3 Trillion in Stimulus Funds Will Go

$687BSmall business loans &

grants

$592BBig business local

government loans &

financial assistance

$395BTax cuts/

credits

$293BRecovery

rebates

$268BUnemploy-

ment

insurance

expansion

$252BHospital restitution,

veterans, Medicaid &

other healthcare

$45B FEMA

$161BState and local

stimulus funds

$160BOther

$61BSpecific

to airlines

$31BEducation

stabilization

$27BVaccines,

stockpiles

$25B Infrastructure$35B Food stamps


Source: CSM

Global Stimulus

9

Near Term Costs


-4,000

-3,500

-3,000

-2,500

-2,000

-1,500

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-500

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0

Bill

ion

s U

SD

U.S. Budget Deficit(in billions)

Source: Congressional Budget Office, NEAM

U.S Budget Deficit Estimated at $3.7 Trillion for 2020

11


Budget Deficits as Far as the Eye Can See

12

-4,000

-3,500

-3,000

-2,500

-2,000

-1,500

-1,000

-500

0

2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

Bill

ion

s U

SD

U.S Projected Budget Deficit (-) or Surplus

Source: Congressional Budget Office, NEAM


0

50

100

150

200

250

Deb

t/G

DP

%

Total Sovereign Debt vs. GDP

Source: Worldpopulationreview.com

Debt vs GDP by Country

13


Source: Congressional Budget Office

U.S. Debt to GDP

14

Will Enormous Policy Response Cause Inflation?


Answer…It Depends on What Kind of Inflation

• General Price Inflation (CPI)

• Short to intermediate term – NO

• Longer Term (3 years +) – Possible , more likely with “structural” changes

• Financial Asset Inflation

• Short to intermediate term – Absolutely

• Longer Term (3 years +) - Absolutely

16


Year Over Year Change in Consumer Price Index

• Average 1930-Current 3.1%

• 1960-1994 4.8%

• 1995-2008 2.7%

• 2009-2020 1.6%

• Fed Target 2.0% sustained

Source: Bureau of Labor Statistics

17


Drivers of Lower Inflation

• Demographics• Aging populations consume less

• High Debt Levels• Higher Debt levels “crowd out” other beneficial spending

• Globalization• For the last 25 years, globalization of supply chains and labor has driven down costs

• Income/Wealth Disparities• Each dollar of income and wealth has a lower economic “multiplier” as one moves up the

income spectrum

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Globalization

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-5

0

5

10

15

20

Ch

an

ge

in

CP

I% Y

oY

Price Inflation as Measured by CPI

Change in CPI Year over Year 5 Year Moving Average Average since 1940

World Trade

Organization

Is formed

China admitted

to WTO

NAFTA signed into law

Source: Bureau of Labor Statistics; NEAM

Globalization Has Exerted Downward Pressure On Consumer Prices

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The Pandemic Will Likely Disrupt the Status Quo

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Mind the Gap….Income and Wealth Metrics are Disinflationary

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Source: Pew Research Foundation

Wider Income Gaps Hurt Consumption and End Demand

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Source: Pew Research Foundation

Wealth Metrics Tell an Even More Extreme Story

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As Interest Rates Plummet, Savings Rates Rise

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Sa

vin

gs R

ate

%

Interest Rates vs Savings Rate

Savings Rate as % of Disposable Income 5 Yr. UST Yield

Source: Bloomberg; NEAM

25

Covid 19 Rescue -Capital Markets Impact


0.00

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Hig

h Y

ield

(P

oin

ts)

Inve

stm

en

t G

rad

e S

pre

ad

(P

oin

ts)

U.S. Fixed Income SpreadsYTD 2020

Corporates Aggregate (L1) Autos (L1) Credit Cards (L1) Tax Exempt Municipals (Yield) (L1) AAA CMBS (L1) High Yield (R1)

Source: Bloomberg Barclays Indices; NEAM

U.S. Fixed Income Credit Spreads

27


Source: Bloomberg; NEAM

Long Rates are Rising, Curve is SteepeningInflation Breakevens Back Above 1%

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0.00

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6/3/2019 7/3/2019 8/3/2019 9/3/2019 10/3/2019 11/3/2019 12/3/2019 1/3/2020 2/3/2020 3/3/2020 4/3/2020 5/3/2020 6/3/2020

U.S. Treasury Curve SteepeningInflation Breakevens Rebounding

.2VS30 U Index - Last Price (R1) USGGBE10 Index - Last Price (L1)UST 2 yr. vs. 30 yr. 10 year inflation breakeven


3.0

3.5

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7.5

2,000

2,200

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5/3/2019 6/3/2019 7/3/2019 8/3/2019 9/3/2019 10/3/2019 11/3/2019 12/3/2019 1/3/2020 2/3/2020 3/3/2020 4/3/2020 5/3/2020

Fe

d B

ala

nce

Sh

ee

t (T

rilli

on

s U

SD

)

S&

P 5

00

Federal Reserve Balance Sheetand S&P 500

S&P 500 US Federal Reserve BS

Source: U.S. Federal Reserve; Standard & Poors; NEAM

Fed Balance Sheet Has ExplodedStock Investors Riding the Wave, But Will The Rally Be Durable?

29


0

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Ma

r-3

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r-1

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No

v-1

7

Ma

r-1

9

Ra

tio

S&P 500 P/E

401K’s

inception

Fed begins using

Quantitative Easing

Source: Haver Analytics; NEAM

S&P 500 Price to Earnings

30


0%

20%

40%

60%

80%

100%

120%

140%

S&P 500 Market Capitalization Relative to U.S. Nominal GDP

QE Starts Here…

Source: Bureau of Economic Analysis; Bloomberg; NEAM

Bottom Fishing No Longer AllowedSigned, the Fed

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27.0%

62.8%

185.1%

0.0%

50.0%

100.0%

150.0%

200.0%

250.0%

0.0%

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20.0%

30.0%

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50.0%

60.0%

70.0%

Ja

pa

n

U.S

. A

nd

Eu

rop

e

Total Central Bank Assets as a Percentage of Equity Market Capitalization

Federal Reserve Assets as % of S&P 500 Mkt Cap. ECB Assets as % of MSCI Europe Idx Mkt. Cap Bank of Japan Assets as % of Nikkei 225 Mkt Cap. (RHS)

Source: U.S. Federal Reserve; European Central Bank; BoJ; Bloomberg; NEAM

QE Infinity – There’s No Way Out

32


Source: Bloomberg; S&P; NEAM

Are Equity Markets Too Optimistic?History Implies the Answer is Probably “Yes” BUT if a PE of 20X is the New 15X, then the Answer Might be NO

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What’s Next?


• Bankruptcies

• Restructurings

• Mergers

• Spin offs

• Roll ups

• Divestitures

Defaults and Bankruptcies Are Rising

35


Source: Bloomberg, NEAM

Interest Rates Will Remain Exceptionally Low

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-0.20

0.00

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0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

0 5 10 15 20 25 30 35

Tre

asu

ry R

ate

s

U.S. Treasury Rate Forecast Year End 2020

Current NEAM Low NEAM High


Tax Rates Likely to Rise in the FutureBudget Deficits Will Need to Be Paid for Eventually

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

Sta

uto

ry C

orp

ora

te T

ax R

ate

Statutory Corporate Tax RatesSelect OECD Countries

Source: Organization for Economic Cooperation and Development (OECD)

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Longer Term Considerations for Investors

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• Potential for Higher Savings Rates vis a vis Consumption

• Larger Fiscal Deficits/ Sovereign Debt Levels• Weaker U.S. Dollar could spark inflation in the longer term

• Higher Tax Rates• Corporations have been massive beneficiaries of Fed’s credit programs

• Supply Chain Re-ordering / Peak Globalization

• “Not-So-Free Markets” Featuring Low Interest Rates and Tight Credit Spreads • Central bankers with their thumbs on the scale

• Changes in Consumer and Company Behavior

Thank You

Covid 19 Response Short and Long Run Implications

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