First Vaccine

“It’s always darkest before the dawn” was most recently uttered in pop culture by Florence and the Machine. With the coronavirus vaccine now approved and in initial distribution now at the same time as coronavirus infections and hospitalizations at an all time high in the US, it seems we have a “darkest before the dawn” situation now. How do you think the new vaccine will affect the US and World economies in 2021 and beyond? Without a doubt the effect will be good, but how good? And what does it mean for your financial goals?

For Fixed Income

If you agree that the vaccine will be a good thing and that economic output and metrics will improve as a result, that is not good for fixed income. Improved economic output likely means higher interest rates which means lower bond prices. Because the US Fed has indicated it will keep short-term interest rates low for likely the next 2 years, look for longer-term interest rates to rise and therefore look for the yield curve to steepen. With the 10-Year US Treasury rate currently at about 90 basis points, look for it to move to between 2% and 2.5% by 12 months from now. Are you busy now refinancing your house? Good idea, because mortgage rates should also be up by a similar 120 basis points or more in a year. Investment grade corporate bonds, currently in the low-2% range, should be in the high 3%’s, which isn’t a big stretch because that’s where they were during early 2019. My recommendation is to underweight fixed income and to stay short-term on what fixed income you do have. If you are a borrower (i.e. mortgate) then its a great idea to lock in now for the long term. If you are a lender (i.e. fixed income investor), then not such a good idea to lock in now.

For Alternatives

This to me is the biggest question mark. Will inflation return or not, and if so how much? While there is debate now as to whether or not Gold is an inflation hedge, historically it has been considered as such. If you buy that argument, then investors seem to be hedging their bets as to how inflationary the fiscal and especially the monetary policy reactions to the pandemic economy will turn out to be. Oil has been rallying for the past 2 months and copper and lumber have also been strong, all of which indicate stronger future economic activity and as well higher inflation. All that said, inflation hawks have been out there before and have been wrong in the past. I think a balanced portfolio should have some exposure to inflation-leveraged assets and an investor should slightly overweight their exposure in this area. Perhaps look at inflation-protected TIPS, or Google “Inflation ETF” and read about ETFs that are inflation-protected. If you own real estate, either in your home or through a rental property, then you may consider that you are already properly positioned against the inflation threat. Bitcoin? It has been very strong but I’m not sure Bitcoin’s strength has been a reaction to higher inflation or a reaction to a concern about the ability of world governments to survive and to continue to govern post-pandemic.

Equities

The vaccine is bullish for equities. However, has the run-up we have had in equities since late March 2020 already captured the upside reflective of the improved post-pandemic economy? Said another way, is the upside already priced in at current equity prices? I don’t believe so, and I do believe there is more upside to be had by being invested in equities. My reasoning is the TINA argument – there is no alternative. Because I see interest going up especially at the longer end and with mortgages and corporate bonds, I see investors moving out of the fixed income sector and increasing their exposure in the equities space. Corporate earnings, especially among the biggest companies and including the FAANG stocks, should be strong and should continue to improve. I believe investors should overweight equities. Though their returns may or may not be in the double-digits, they will likely exceed what they might earn in fixed income.

IMO

Even though the run-up in equities since March has been strong, I believe the rally has more legs. I also see longer term interest rates going up and therefore I believe investors should overweight equities. Look also to invest such that you might benefit from higher inflation. Refinance your mortgage now if you are looking to do so and haven’t already done so. With the coronavirus vaccine now at the very start of being administered, let’s hope that the vaccine rollout works, not just for our portfolios but for all of humanity.

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