President Biden signed into law a $1.9 trillion Coronavirus aid package last week. New spending of $1.1 trillion is expected this year, with the remaining $0.8 trillion spread out over the coming years. The spending is on top of last year’s $3 trillion fiscal support program, sets up 15% annual deficits for 2020 and 2021, and increases debt to 110% of GDP.  

Why should we care about such spending, especially when the economy is hobbled by COVID-19?

Indeed, the package will indeed help many. There are $670 billion in checks and enhanced unemployment benefit checks on the way to individuals and families. States will receive about $570 billion to add to their coffers and ease some burdens. $200 billion in child tax credits are popular. And $170 billion will be available for advancing healthcare programs.

But there are real and important questions about the necessity and timing of the stimulus. In the past, borrowing gets ramped up when the economy is weakening, and nervous investors are happy to buy newly-issued U.S. government Treasury bonds. In that situation, the strong demand for perceived safe-haven U.S. Treasuries usually more than offsets government bonds’ surging supply, leaving rates unchanged or lower. Today, the economy is not on the downswing, with Q1 GDP estimated to be near 8% annualized. Investors are also not eager to buy U.S. Treasuries, evidenced by weak showings at U.S. Treasury auctions. Thus, interest rates are not behaving as desired, they are rising.

Deficits: All About Spending

We think it is important to point out that spending is the driver of deficits today, not a lack of revenue. For example, a great deal has been made about the dire condition of state finances, but projected revenue shortfalls have not materialized as imagined a few months ago. A recent Bloomberg study showed total average state tax revenue down a meager -0.4% in 2020, for example. Similarly, Federal tax receipts are estimated to be just about the same level in 2020 as a year earlier. Thus, today’s deficits should rightly be seen as coming from the spending, not revenue (tax), side of government ledgers.

This brings us to the crux of the matter of why this should matter to you. Deficits must be financed through a combination of borrowing or taxation, both of which can affect your wallet and portfolio.

Borrow the Money?

In 2020, about $1.7 trillion in U.S. Treasury issuance took place to help finance the first round of COVID-19 stimulus. Last year, the Federal Reserve took onto its balance sheet $2.3 trillion of U.S. Treasury bonds through asset purchases, far more than the $1.7 trillion issuance. This year, according to Bank of America, a massive $2.8 trillion of new U.S. Treasury issuance is likely as the result of continued fiscal support measures. Yet, the Federal Reserve is on course to buy only $960 billion, leaving a sizable gap — a gap needing others to fill.

To fill the gap, private investors need to step up and buy U.S. Treasuries, but demand for “safe” U.S. Treasuries is lessened by prospects for improving growth. The fears and concerns that usually arise during a crisis or recession — and create robust U.S. Treasury demand — are simply not here now. This may be why recent U.S. Treasury auctions have gone off so poorly and may partly explain why rates have been on the rise. Fiscal stimulus, typically used counter-cyclically, is now being used pro-cyclically, creating new risks and uncertainties. Rising inflation, interest costs, and currency issues are a few of the risk factors produced under such practice.

Raise Taxes?

Another way to pay for spending is through taxes. President Biden’s tax plan has remained in the background recently, owing to ongoing worries over the pandemic. At some point, we expect the plan, which features higher taxes, to feature prominently as a means for funding spending. Since taxes are always less easy to sell than spending, the plan may be revised or offered piecemeal. At some point, expect elements of the plan to work their way to the House and Senate floors. For now, taxes will take a back seat to other more pleasant priorities.

More to Come?

The last reason why this new package is vital to think about is that it just might not be the last one. Recent talk about another big fiscal push later this year, potentially focused on infrastructure, climate change, and healthcare is being vetted. Any additional legislative push’s size and shape will depend on the path of recovery and intra-party politics. Democrats control Congress with the narrowest of majorities and face mid-term elections in 2022. Different opinions exist within the party on how/when/why to proceed with other spending bills. Time will tell whether such a plan is feasible or can gain enough support in the months ahead.

What to Do Now

Remember that credit cycles tend to dictate sustained periods of prosperity (boom) and contraction (bust). The last cycle, which culminated in the Great Financial Crisis of 2007-2009, exemplifies what can happen when borrowing becomes excessive, expectations exceed reality, and reality finally takes hold. Asset prices come under pressure, deflationary pressures mount, and the economy endures a slump. It is in this process, however, when the best opportunities are created, too! We are also reminded that the credit cycle which began after the financial crisis is still underway today, having not been interrupted by the pandemic. The addition of large amounts of new borrowings by governments extended the cycle, suspended foreclosures and repricing, and may now be creating distortions in some areas.

Conclusion

Newly enacted policy choices, whose timing and magnitude veer far from standard or conventional macroeconomics applications, may also create unintended risks alongside the intended benefits. Should policy choices create uncertainty, we should continue to seek out the highest quality companies at the best possible prices as a way to navigate whatever waters lie ahead. Dependable cash flow, low debt burden, and profitable assets are all features we find especially desirable — especially in a world of higher debt burdens, higher inflation, and/or higher interest rates.

Disclosures:

WCA Barometer – We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. Analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.

Standard & Poor’s 500 Index (S&P 500) is a capitalization-weighted index that is generally considered representative of the U.S. large capitalization market.

S&P Global (SPGI) is a leading American provider of financial information, analytics, and credit ratings, headquartered in New York, NY. It operates major divisions including S&P Global Ratings, S&P Global Market Intelligence, S&P Global Commodity Insights, S&P Global Mobility, and S&P Dow Jones Indices.

The ICE BofA U.S. High Yield Index is an unmanaged index that tracks the performance of U.S. dollar denominated, below investment-grade rated corporate debt publicly issued in the U.S. domestic market.

The S&P 500 Growth measures constituents from the S&P 500 that are classified as growth stocks based on three factors: sales growth, the ratio of earnings change to price, and momentum.

The S&P 500 Value Index measures constituents from the S&P 500 that are classified as value stocks based on three factors: the ratios of book value, earnings and sales to price.

The S&P 500 Equal Weight Index is the equal-weight version of the widely regarded Standard & Poor’s 500 Index, which is generally considered representative of the U.S. large capitalization market. The index has the same constituents as the capitalization-weighted S&P 500, but each company in the index is allocated a fixed weight of 0.20% at each quarterly rebalancing.

The WCA Rising Dividend Custom Benchmark is a rules-based benchmark constructed by Washington Crossing Advisors to represent a universe of large capitalization U.S. companies that meet certain quality and dividend growth criteria, including proprietary screens for profitability, earnings consistency, and balance sheet strength, along with minimum market capitalization and dividend growth requirements. The benchmark is reconstituted and rebalanced quarterly and is intended to serve as a style-appropriate benchmark for the WCA Rising Dividend strategy.

The Washington Crossing Advisors’ High Quality Index and Low Quality Index are objective, quantitative measures designed to identify quality in the top 1,000 U.S. companies. Ranked by fundamental factors, WCA grades companies from “A” (top quintile) to “F” (bottom quintile). Factors include debt relative to equity, asset profitability, and consistency in performance. Companies with lower debt, higher profitability, and greater consistency earn higher grades. These indices are reconstituted annually and rebalanced daily. For informational purposes only, and WCA Quality Grade indices do not reflect the performance of any WCA investment strategy.

The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage that is often obtainable in commodity trading can work against you as well as for you. The use of leverage can lead to large losses as well as gains.

The information contained herein has been prepared from sources believed to be reliable but is not guaranteed by us and is not a complete summary or statement of all available data, nor is it considered an offer to buy or sell any securities referred to herein. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. There is no guarantee that the figures or opinions forecast in this report will be realized or achieved. Employees of Stifel, Nicolaus & Company, Incorporated or its affiliates may, at times, release written or oral commentary, technical analysis, or trading strategies that differ from the opinions expressed within. Past performance is no guarantee of future results. Indices are unmanaged, and you cannot invest directly in an index.

Asset allocation and diversification do not ensure a profit and may not protect against loss. There are special considerations associated with international investing, including the risk of currency fluctuations and political and economic events. Changes in market conditions or a company’s financial condition may impact a company’s ability to continue to pay dividends, and companies may also choose to discontinue dividend payments. Investing in emerging markets may involve greater risk and volatility than investing in more developed countries. Due to their narrow focus, sector-based investments typically exhibit greater volatility. Small-company stocks are typically more volatile and carry additional risks since smaller companies generally are not as well established as larger companies. Property values can fall due to environmental, economic, or other reasons, and changes in interest rates can negatively impact the performance of real estate companies. When investing in bonds, it is important to note that as interest rates rise, bond prices will fall. High-yield bonds have greater credit risk than higher-quality bonds. Bond laddering does not assure a profit or protect against loss in a declining market. The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage that is often obtainable in commodity trading can work against you as well as for you. The use of leverage can lead to large losses as well as gains. Changes in market conditions or a company’s financial condition may impact a company’s ability to continue to pay dividends, and companies may also choose to discontinue dividend payments.

All investments involve risk, including loss of principal, and there is no guarantee that investment objectives will be met. It is important to review your investment objectives, risk tolerance, and liquidity needs before choosing an investment style or manager. Equity investments are subject generally to market, market sector, market liquidity, issuer, and investment style risks, among other factors to varying degrees. Fixed Income investments are subject to market, market liquidity, issuer, investment style, interest rate, credit quality, and call risks, among other factors to varying degrees.

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio relative to the market as a whole. A beta of one is considered as risky as the benchmark and is therefore likely to provide expected returns approximate to those of the benchmark during both up and down periods. A portfolio with a beta of two would move approximately twice as much as the benchmark.

Standard deviation is a measure of the volatility of a security’s or portfolio’s returns in relation to the mean return. The larger the standard deviation, the greater the volatility of return in relation to the mean return.

Changes in market conditions or a company’s financial condition may impact a company’s ability to continue to pay dividends, and companies may also choose to discontinue dividend payments

This commentary often expresses opinions about the direction of market, investment sector, and other trends. The opinions should not be considered predictions of future results. The information contained in this report is based on sources believed to be reliable, but is not guaranteed and not necessarily complete.

The securities discussed in this material were selected due to recent changes in the strategies. This selection criterion is not based on any measurement of performance of the underlying security.

Washington Crossing Advisors, LLC is a wholly-owned subsidiary and affiliated SEC Registered Investment Adviser of Stifel Financial Corp (NYSE: SF). Registration with the SEC implies no level of sophistication in investment management.