A Smaller Package Yesterday, Fed Today. Are We Seeing Less Risk?

Macro Perspectives: Wed 16 Dec 2020

Stocks were up yesterday as it looks like Congress will agree on a stimulus package that strips state and local government aid (better known as bailouts for the fiscally irresponsible). If that's a go, the number is said to be around $700 billion.

That's a fraction of Pelosi's $3+ trillion dollar initial proposal. For the democrats to agree on a much smaller and very targeted package (to aid small businesses and extend the federal unemployment subsidy) they must be confident they can get another package done early next year (to address the Green New Deal agenda), which would indicate they are confident that Biden will be inaugurated AND they will get the Georgia senate seats.

Clearly, getting aid into the hands of people and small businesses removes a huge risk to the economic recovery. Despite the ramped up restrictions in certain states, Q4 is running a lot hotter than economists have expected.

As you can see in the chart below, the Atlanta Fed is projecting 11.2% annualized growth in Q4, with just a couple of weeks left in the quarter.

Accelerating the bounceback in economic activity is most stimulating for small cap stocks. In recessions, small cap value has a deeper decline than large cap stocks, but that tends to be followed by an explosive bounce back, and a persistent outperformance over the next ten years (compared to large caps). If we look at performance from the lows of this year, the Dow is up 62%, the Russell 2000 is up near 97%.

On a final note, the Fed will decide on monetary policy today. This comes a week after the ECB announced another $600 billion in QE. With that, if they are confident that a U.S. fiscal package is getting done, and foresee the prospects of another package early next year, I suspect they will begin setting expectations for upside risks to inflation. That would get market interest rates moving UP.