When Goldman asked domestic and international portfolio managers, hedge funds, sovereign wealth funds, and corporate executives what they thought of the bank’s 2021 outlook for US equities, those who said 4,300 on the S&P is too bullish generally cited inflation risk.
“They argue that the vaccine-supported US economic recovery we anticipate will lead to rising prices for goods and services, inflationary concerns will then spark a backup in Treasury yields, and that in turn will translate into lower equity valuations and share prices,” the bank’s David Kostin said, in a late Friday note.
As a reminder, Goldman’s outlook for the US economy was considerably more bullish than consensus prior to the latest round of coast-to-coast COVID lockdowns. Some banks are now revising their outlooks, at least for Q1.
It’s somewhat amusing (to me anyway) that after all these years, a sizable contingent of professional investors are still concerned about a problematic rise in inflation.
How many of these PMs who expressed such concerns were old enough to be investing other people’s money during the last serious bout of inflation in the US? Some of them, maybe. But probably not the majority.
And bonds have been in a bull market for damn near four decades.
So, irrespective of whether it’s the “right” call this time, it’s been the wrong call every time historically for all practical purposes, something SocGen’s Albert Edwards will gleefully remind you if you ask him.
Goldman was diplomatic in a note answering those who cited inflation risk in suggesting their 2021 S&P forecast is too high.
“PCE inflation has two components: Services (74%) and Goods (26%). Health Care spans both categories, comprising 23% of measured PCE, and its growth is likely to stay below 2% for the next several years,” the bank’s Kostin wrote, flagging “bipartisan support… to restrain medical services inflation [and] the launch of Amazon Pharmacy [which] will allow customers to compare drug prices and should serve to keep pharma inflation below 1%.”
Beyond that, Goldman sees “slight” deflation for goods over the next two years, and an 8% drop in prices for video, audio, and computers. As far as housing goes, Kostin reminded folks that “publicly-traded apartment REITs noted in their Q3 results that occupancy has stabilized at the expense of lower rents [and] the suburbanization trend will also serve to restrain rental inflation during the next few years.”
That latter bit is key. I’ve spent quite a bit of time in these pages documenting the de-urbanization trend and what it’s meant for rents. “Of the 100 largest cities for which we have data, 41 have seen rents fall since the start of the pandemic in March,” the latest national report from Apartment List says.
Rents in major “superstar cities” have collapsed. For example, this time last year, a 2-bedroom apartment in San Francisco would have run you around $3,200. Now, the price is down to less than $2,500.
I find this difficult to believe, but according to Apartment List’s data, the median 2-bedroom in New York City now costs less than one-third of what I once paid years and years ago. I suppose it depends on what’s meant by “New York City.” That could capture any number of disparate locales.
“During the same months last year just five cities saw a drop in rent prices, and only two experienced a decline of more than one percent,” Apartment List went on to say, discussing the impact of the pandemic, and noting that “even in the cities where rent growth has been positive through the pandemic, it has still been sluggish [with] 63 of the 100 largest cities currently registering slower year-over-year rent growth than at this time last year.”
The trend in affordable midsize cities is the opposite. Places like Boise, Toledo, and Memphis have seen prices increase, but the national trend is clear. And frankly, I’m not convinced that enough people want to move to Boise and Memphis to make an impact on the aggregate national trend.
In any case, that tangent helps to contextualize Goldman’s comments about suburbanization restraining rental inflation in 2021. It seems (highly) unlikely, in my view, that the availability of a vaccine is going to prompt large numbers of people to suddenly go flooding back into major cities, especially to the extent new suburbanites bought rather than rented.
As for whether the Fed’s “new” (and the scare quotes are there for a reason) inflation framework is likely to lead to runaway price increases, the answer is probably not. Indeed, it’s hard to believe that anyone can suggest as much with a straight face.
The Fed has yet to explain, in precise terms, what exactly the American version of AIT even means, other than to simply reiterate the spirit of AIT as a concept (i.e., other than to repeat that policymakers will tolerate hypothetical overshoots to compensate for years of undershoots).
“Under the Fed’s average inflation targeting framework, the policy rate will remain at 0-25 bp through at least 2023, although our economists forecast the first hike will not occur until 2025,” Goldman’s Kostin said Friday, adding that “a funds rate near zero, even if inflation rises to the Fed’s target, suggests any increase in Treasury yields will be limited.”
And that’s to say nothing of WAM extension, which is now widely expected to come at the December FOMC meeting. Also consider that if the GOP holds the Senate, the size of fiscal stimulus will be constrained, which will hurt aggregate demand, serve as another factor weighing on bond yields and, ultimately, tamp down domestic inflation.
Forgive me, but if I were going to push back on Goldman’s year-end target for the S&P in 2021 (which, again, is 4,300) I’d be more inclined to cite the deflationary impact of scarring on the economy, structural damage to the labor market that could lead to permanently depressed demand, or the prospect of vaccine rollout taking longer than expected due to logistical challenges.
Time will tell, but I’m not sure “red-hot inflation” needs to be on anyone’s list of 2021 worries.