The Last Rally Of This Decade
0Recommendation: Based on the data presented below, I am giving a buy rating for the U.S. equity market, represented by the SP 500 index. My expectations for the growth to persist are supported by the continuation of extremely accommodative Fed monetary policy (despite the recent tapering decision), rebound in economic activity, and the strong corporate performance that has followed. Even the recent inflation release, which was well above the Fed’s target, does not pose a risk to the continuation of the rally because market participants are expecting prices to be elevated for the years ahead. If the projections described in the article below are realized, equity prices will continue to grow into the first part of 2022. They will then peak ahead of the change in the Fed’s monetary policy, which is underway and will experience a significant shift in the middle of 2022. Overview The previous two years were unprecedented in many financial and economic aspects. These can easily be observed from equity markets in free fall to Indexes recently reaching all-time highs, from record high unemployment to businesses struggling to hire additional staff, and from the risks of deflationary depression to the appearance of out-of-control inflation. Though volatility is still high, it is possible to state that things are gradually getting back to normal. Thus, an assessment of the underlying economic conditions and direction will be prudent to conduct. In this article, I will look back to the beginning of the pandemic and how the economy operated during the lockdown, as well as how things currently stand. Also, I will assess the prospects for the economy over the next 10 years and how this may affect equity prices. Retrospective The pandemic-related lockdown led to mass business closures and bankruptcies, which led to layoffs across all industries and ultimately resulted in unemployment reaching levels not seen in decades. Wages are the main component of personal income in any country. It is especially important in the consumer-oriented U.S. economy, where households comprise 70% of the aggregate demand in the economy and generate the performance of the corporate sector. Together, these factors comprise 86% of the U.S. GDP and determine the level of economic growth that the government targets with its fiscal and monetary policies. At the beginning of the pandemic, the government’s standpoint was that the situation was critical and required sharp actions. These actions would be necessary to stop the domino effect starting with households not getting incomes due to high unemployment, thereby causing them to reduce their expenses. This would leave firms unable to collect their revenues, cutting on the CAPEX, and further reducing employment. Altogether, great harm to the aggregate demand and prices would result. To keep household income stable, the government launched stimulus checks that targeted consumers regardless of employment status. Along with this, credit lines were provided to businesses from all industries so that firms would not cut their expenses or employees. From the monetary policy side, the Fed cut rates to record lows and established QE with a monthly pace of $80 billion in Treasuries and $40 billion MBSs. The chart below shows the total securities holdings rising from $3.8 trillion in February 2020 to $8.0 trillion at the end of October 2021. Actions were designed to fund the government, support incentives, and keep up demand in the housing market, which is systemically important and generates consumption in different related industries. Another indirect result from the QE program can be seen in equity prices. The equity market represented by the broad index Willshire 5000 soared, along with the Fed’s balance sheet. This was due to the P/E multiples expansion amid depressed corporate earnings. The growth created the well-known wealth effect of widely invested households boosting their earnings and stimulating consumption. It worked! Followed by the unprecedented fiscal and monetary stimulus and improvements in economic reopening, things started to work out. Under the above circumstances, the market power was able to fix the problem on its own due to the following two reasons: The record drop in households and corporate spending led to a drop in prices in the economy. The chart below shows a rapid drop in the participation rate and civilian labor force. At the bottom, the participation rate dropped from 63.6% to 60.2 %, and the civilian labor force was reduced by eight million people. The drop was driven by the significant rise in unemployment compared to the number of available jobs on the market. People just quit the labor market. Assessing the failure of the rate to recover to pre-pandemic levels, it's either the employee who is looking for a job but struggling to find one and becoming a discouraged wor