Ed Yardeni – The S&P is Going to 4,500

His market forecast was based on a view of a robust economic recovery.

We’ve never had as severe a recession that lasted only two months, he said, and the depth and duration were due to the lockdown. That hurt demand, which was amplified by job losses in the service sector. But even those people who lost jobs didn’t spend the subsidies they were given.

Real GDP is back to where it was before the pandemic, according to Yardeni, but not the labor market.

“Overall,” he said, “the economy revived much better than most anticipated.”

Treasury Secretary Yellen and Fed Chair Powell want to step on the accelerator to get to broad-based and inclusive maximum employment, he said. That is supported by $120 billion per month of quantitative easing (QE) and low interest rates.

Once the Fed starts to taper its QE, he said, it may be months before it raises rates.

The risks to the recovery are another round of the virus, which he said was unlikely given vaccines. More worrisome is a credit crunch, but that is hard to imagine given the liquidity still in the economy. That liquidity is supported by the $4 trillion growth in the money supply.

The stock market is at record highs and performance is no longer concentrated among a few technology stocks, he said. It is more broadly based in areas like computer hardware and videoconferencing software.

Is the market overvalued? Valuations are stretched, he said, “but not insanely so.”

We will get an increase in inflation, Yardeni said, but to a large extent it will be transient. But it will not be “as short a pop as the Fed expects.” The CPI could hit 3% in the second half this year, but it will recede to 2.5% at the beginning of 2022.

We could have a 1970s stagflation environment again, but there are differences, according to Yardeni. Productivity is making a huge comeback. We are in the early stages of a productivity boom, he said. Productivity is a “magic variable” that offsets cost and wage pressures and allows profit margins to stay high.

Productivity is evident in the technologies we are developing that boost physical and mental strain. He said they augment and do not replace workers.

Some of those gains are from increased capital spending, which he said is mostly in the technology sector. That accounts for 50% of all cap-ex, which is an all-time high. Every company should be viewed as a technology company – a user or producer, Yardeni said. “Everyone else will go out of business.” That justifies the high valuation and, indeed, many companies that use technology deserve higher valuations.

Will that gain in productivity lead to deflation? We are more likely to resemble Japan and its “lost decade” than the hyperinflation of the Weimar Republic, according to Yardeni. Our demography is deflationary, he said, and the U.S. labor force growing at only 0.5% annually.

Japan is a poster child for the industrial world because of its rapidly aging population. In 2011, more of its citizens died than were born, shrinking its population. Globally, excluding India and Africa, fertility rates are below replacement, according to Yardeni.

China and Japan have been employing modern monetary theory (MMT) through their infrastructure spending, according to Yardeni. He said that China’s bank loan debt has grown from $5 trillion in 2008 to $25 now, mostly because of unproductive spending and “bridges to nowhere.”

“China is a big version of Japan,” he said, although its demographics are not quite as bad.

Japan responded to its demographic weakening with MMT, but its interest rates and inflation still zero. That, according to Yardeni, has a message for investors who are worried about MMT in the U.S.

As for asset allocation, investors should be diversified globally but should overweight the U.S., according to Yardeni.

Bonds are not the place to be. A temporary inflation would not benefit bonds enough to help investors. If yields go to 2.5% to 3%, as he predicted, they won’t go higher if inflation is transient.

“It’s hard to imagine yields much higher than 3%,” he said, “because the economy can’t handle it. Our fiscal debt has made bond vigilantes more powerful than ever.”

We must recognize there is a possibility of a regime change, Yardeni said. The last such regime change was in the 1980s, when Paul Volcker broke inflation with tight monetary policy and Ronald Reagan broke the power of unions with his actions against air-traffic controllers. Now there is pressure to restore the power of workers through a federal minimum wage, he said, and the inflation situation is risky. But the boom in productivity will overpower any incipient inflation.

Investors should not worry about whether the U.S. can finance its entitlements. The day of reckoning may come with unchecked deficit spending, Yardeni said, and we are “robbing future generations of the flexibility to address those problems.” But for now, he said, our monetary and fiscal policies are working.

Robert Huebscher is the founder and publisher of Advisor Perspectives.

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