What the US’ latest stimulus bill means for investors in the new year

The short-term nature of the stimulus package underscores the need for the new Congress to provide further relief
The long-term costs are also worth watching, as we hopefully approach the end of the pandemic and look towards a broad economic rally

Chaoping Zhu

Published: 3:30am, 2 Jan 2021

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After a long wait, US President Donald Trump finally signed the second pandemic relief and government funding bill into law on December 27.

The focus of this massive US$2.3 trillion bill is a US$900 billion stimulus package, which includes a US$600 direct payment to each eligible adult under certain income levels and children under certain ages. It will also bring various unemployment benefits to workers and financial support to enterprises.

In addition, language has been added to the bill forcing the Federal Reserve to close four lending facilities and return unused funds from these programmes to the Treasury, and prohibiting the Fed from restarting these programmes without new legislation from Congress.

Had Trump not signed the bill, not only would unemployment benefits and stimulus cheques have been in limbo, funding for vaccine distribution would also have been further delayed and it could have prompted a US government shutdown.

For the US economy, this package provides some overdue relief. The resurgent pandemic has caused an economic slowdown, which is becoming evident from short-term indicators such as unemployment claims, airline travel and restaurant reservations. While fourth-quarter real GDP growth could still be as strong as 5 per cent annualised, growth in the first quarter of 2021 could slip to 1 per cent or below.

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As a result, the bill is critical to helping some workers and businesses get through the hardship before the mass distribution of Covid-19 vaccines and a full economic recovery. However, the short-term nature of this stimulus package underscores the need for the new Congress to provide further relief after it begins its duties later this month.

The long-term costs of these fiscal and monetary measures are also worth paying close attention to, as we hopefully approach the end of the pandemic and look to expectations of economic recovery and growth in the long term.

For the federal government, the new relief package will add to the deficit. In September, the Congressional Budget Office estimated a deficit of US$1.8 trillion for 2021. This package, along with another relief package in the new Congress and an infrastructure bill, could boost the deficit to between US$2.5 trillion and US$3 trillion, raising the national debt to close to 110 per cent of GDP.

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For the Fed, in theory, the new language in this bill barring it from reopening credit facilities should not diminish its ability to combat financial shocks. After all, a simple act of Congress could provide new authorisation.

However, the history of the 2007-2008 global financial crisis suggests that Congress might not be particularly wise or responsive in dealing with financial issues in a politically charged atmosphere.

For the market and investors, the passage of this bill brings some needed aid that will lessen economic hardship over the winter, as direct stimulus payments go out to households and small businesses get help from the extension of the Paycheck Protection Program.

However, a combination of big deficits and low interest rates during the pandemic could set the stage for higher taxes and interest rates when the economy fully recovers. And expectations for strong earnings growth and low inflation might already have been fully priced into parts of US equity and fixed-income markets.

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The reality is that after a surprisingly good year for portfolio returns, asset prices look stretched. The forward price-to-earnings ratio of the S&P 500 as of December 19 was 22.1 times – 33 per cent higher than the 25-year average of 16.5.

The real yield on 10-year Treasury bonds, using year-on-year core consumer price inflation, was minus 0.70 per cent. Because they are already so expensive, these valuations suggest very modest future returns on basic balanced portfolios in 2021 and the years that follow.

Unquestionably, the US economy will eventually recover, as it always does. However, this broad economic rally will not change the fact the pandemic has left many individuals impoverished and many small businesses closed forever.

In a similar way, a broad economic recovery provides no guarantee of further gains in financial markets in the year ahead. In fact, a starting point of big deficits, low interest rates and high valuations could make this a very challenging year for traditional diversified portfolios.

To ride out the winter and prosper in brighter days, investors may need to look for better value within particular pockets of US equity markets, while ensuring a greater exposure to international equities and alternatives.

Chaoping Zhu is a Shanghai-based global market strategist at JP Morgan Asset Management

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