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Market Update August 19: The Central Bank Boom Bust Cycle

Market Update August 19: The Central Bank Boom Bust Cycle

August 27, 2020
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We continue to move forward on the coronavirus timeline. Finally, economic activity is ascending from its deep hole, and industrial activity is also rebounding. Although COVID-19 continues to dominate the headlines, we are seeing a reduction in new cases. We estimate a couple of weeks out before seeing the drop in new cases; let’s see how that forecast plays out.

Our market is rapidly changing as the November election is approaching and the corona virus continues to dominate headlines.

If the 2016 election of President Trump and Brexit taught us anything, it’s that polls aren’t to be trusted. Instead, let’s focus our attention on the Electoral College map. We do not elect anyone to the presidency through polls, but through electors. 

 

Last week, we saw a retraction against GDP growth due to employment information. Initial claims for state unemployment benefits decreased by 228,000 to a seasonally adjusted 963,000 for the week ended Aug. 8. Firms that are laying people off at this stage clearly do not see any improvement in the near future.

Economics 101

Each week, we review fundamental building blocks of how the economy works to help bring clarity to our investment thesis. So far, we’ve covered marginal utility theory, the regression theorem, the stages of production and the production possibility frontier, and loanable funds.

This week, we’re focusing on the ramifications of money supply expansion. Excess resources suggest a greater pool of loanable funds, which drops the interest rate. Once that interest rate is lower, entrepreneurs see it as a way to borrow money. Now, they can pay back loans on projects that didn’t work out at higher interest rates. 

As economic development increases, so does capital production. The intent is to expand the production capacity of the overall economy, which will ultimately increase our production possibility frontier and standard of living. That’s how the market balances itself: the interest rate and consumption vs. excess resources work together to reach equilibrium.

 

 

Central Bank Business Style

Let’s revisit the Gross Domestic Product (GDP) equation we talked about, where GDP equals consumption plus investment plus government spending.

GDP = Consumption + Investment + Government Spending

If consumption and investment have gone up, it is likely economic activity has also increased, and government spending will typically follow suit. This is part of the boom/bust cycle through which the economy consistently oscillates.

Boom

Bust

An increase in the Money Supply will…

•       Reduce the interest rate…

•       Which will increase capital investment projects…

•       And increase in consumption…

•       Which will cause prices to rise (inflation)…

•       And the fed will increase rates by decreasing the money supply…

 

•       Capital projects will be mothballed reducing investment…

•       The higher interest rates will cause an increase in savings and a reduction in consumption.

Asset Class Weighting & Strategies

As the U.S. dollar has stabilized in the last couple of weeks, it’s no coincidence that gold has given back some of its recent gains. We’re also seeing a rotation away from technology, likely due to fear coming out of the market. The beneficiaries have been small and mid-cap as well as unloved stocks in the S&P 500. This means many of the stocks in the market have some runway here.

Follow GWS on YouTube

For the full video recap of the webinar on which this blog post is based, follow GWS on YouTube. (If a recent episode isn’t posted there yet, it’s still in compliance review). And be sure to tune in to our weekly Gatewood Wealth Solutions Market Webinar to hear updates on the current state of the market and economy. As always, we welcome you to share our broadcast links on social media or with your friends and family. They are more than welcome to listen in and learn our perspective on the market and the economy.

If you have any questions, please contact your Lead Advisor or any other member of our team.  We are here for you.

Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All investing involves risk including the possible loss of principal. No strategy assures success or protects against loss. Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.

 

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