Roaring 20's or That 70's Show

 With the 50 basis point backup in 10-Year U.S. Treasury yields over the first two months of the year the stock market has reached a critical juncture. As readers of this blog know, I have been bullish on stock prices for over a year ago ( See: Shulmaven: The Fed Green Lights the Stock Market ) largely based on the fact that interest rates will stay lower for longer. That assumption is now under challenge as I believe the markets now rightly believe that inflation will not be as quiescent as it has been over the past decade. To be sure I wrote about asset price inflation leading to consumer price inflation in January (See: Shulmaven: "Is the Pandemic Hiding Future Inflation," UCLA Economic Letter, January 2021), but we are now witnessing dramatic price increases in copper, oil and lumber and across a spectrum of producer prices. 

Meanwhile the Biden Administration continues to push for its extravagant $1.9 trillion relief/stimulus program and the Fed continues to support 25% year-over-year M2 growth, more than twice the peak rate of the great financial crisis. This is a formula for higher inflation and yes, higher interest rates that could work to engender a low level 1970's style stagflation.

To be sure that is a risk, but my sense is that what the stock market has been telling us all year that it isn't only interest rates that have been driving stock prices. In my opinion, assuming the Biden Administration is successful with a major infrastructure program that will complement the coming corporate capital spending boom I envision, profits will soar. Indeed corporate spending will concentrate on the electrification of the economy, hardening the grid, insourcing of critical supplies to make the economy more resilient, and hardening the IT infrastructure. All of this will be going on concurrently with a suburban housing boom. Net net, it is my belief that the 20's will roar, at least in the early part.

As a result the demand for capital will be high, interest rates will rise faster than what the market now expects and concomitantly price-earnings multiples will contract. So instead of the 22-25 times earning multiples hypothesized, future multiples will be on the order of 18-21 times earnings. Not so bad, but the risk remains that later in the decade we will see the reemergence of a less than benign interest rate and inflation outlook.