Uncommon Sense

A Capital Markets Christmas Carol

“I will live in the past, the present, and the future. The spirits of all three shall strive within me.”

― Charles Dickens, A Christmas Carol

Michael Arone, CFA
Chief Investment Strategist, State Street Global Advisors

I Wear the Chain I Forge in Writing
My children are home. The stockings have been hung with care. The holidays are nearly here. You could cut the tension in my house with a butter knife. Bah, humbug! And here I sit wearing the chain I forge each month in writing Uncommon Sense -- word by word, sentence by sentence and paragraph after paragraph; I gird it on of my own free will, and of my own free will, I write it. After December, thankfully, there will be no more silly Uncommon Sense holiday lampoons. It’s back to serious investing business next month. For the fifth straight year, January’s article will identify three surprises for investors in the coming 12 months. But in the meantime, this Ebenezer Scrooge will playfully visit with the Christmas ghosts of markets past, present and future.

Shadows of the Inflation that Has Been
In Charles Dickens’ A Christmas Carol, the first spirit to visit Scrooge is the Ghost of Christmas Past. Together they visit Christmas scenes from his childhood. If I were playing the part of Scrooge today, the Ghost of Christmas Past would transport us back to my early childhood in the 70s - not the 1870s, wise-guy, the 1970s. The stock market was a catastrophe. Economic growth was weak and unemployment was rising, eventually reaching double-digits. The US Federal Reserve (Fed) responded with easy monetary policies that were designed to repair the labor market. Disastrously, by the early 1970s, accommodative monetary policy resulted in high rates of inflation. Multiple oil crises, powerful labor unions, and currency speculators added additional fuel to the inflation fire. Year-over-year inflation peaked in 1979, at more than 13%.

Perhaps former Fed Chairman Paul Volcker would be cast as the Ghost of Christmas Past in our capital markets Christmas tale. After all, those that don’t learn from the past are doomed to repeat it. Isn’t that the lesson that the spirit is trying to teach Scrooge? Immediately following his appointment as Fed Chairman in August 1979, Volcker aggressively raised rates to defeat inflation. The Fed funds rate reached a whopping 18% in 1980. For interest rate-sensitive industries such as housing and autos, rising rates were devastating. Many Americans simply could not afford new cars and homes. By 1982, inflation had been tamed and rates slowly began to stabilize. This paved the way for a lengthy economic expansion and bull market.

Many economists and market observers were fearful that today’s easy monetary policies would result in high rates of inflation, too – a 1970s repeat. So far, those fears seem wildly overestimated. Nearly all measures of inflation remain stubbornly and persistently below the Fed’s 2% target, providing ample room to keep rates low and financial conditions easy. This has undoubtedly supported financial asset prices.

America’s burgeoning energy independence and the waning influence of labor unions combined with structural headwinds, such as debt, demographics and technology, are likely to keep inflation dormant for a good while longer. However, an inflation scare in 2020 is possible. West Texas Intermediate (WTI) crude oil prices have climbed 34% year to date.1  Labor is capturing a growing share of business output in a tight jobs market. And the Fed has practically said it would welcome higher prices. A 1970s replay isn’t likely in the cards, but an inflation scare may spook investors into concluding that the Fed will begin raising rates again by the end of 2020, putting downward pressure on already lofty valuations.

There’s No Time Like the Present
The Ghost of Christmas Present would display visions of today’s ebullient markets for this Scrooge. Uncommon Sense readers know that I continue be frugal despite the markets’ abundant gifts this holiday season. The US government and the Fed have provided more presents to investors during this long-running bull market run than old Saint Nick himself. The Fed has cut interest rates three times in the last few months, purchased Treasury Bills and conducted supportive operations in the repurchase (repo) market. In fact, according to Strategas Research Partners, the Fed’s balance sheet has grown by 31% over the last three months.2 This is the greatest percentage increase since January 2014. As a result, the money supply has been growing at an annual rate of 10.4% while nominal GDP growth is just 3.5%. Where is all this good holiday cheer flowing? Into financial assets of course. It’s no coincidence that markets are at all-time highs.

Not to be outdone, or should I say, outspent, the US House of Representatives just passed with bipartisan support a $1.4 trillion government spending deal on December 17. The Senate is expected to pass the legislation soon and President Trump has signaled his intent to sign it. The spending deal provides for an increase of nearly $50 billion compared to last year. This comes on the heels of the $738 billion National Defense Authorization Act (NDAA).3 The NDAA, which authorizes spending and lays out guidelines for the Pentagon, includes 12 weeks of paid parental leave for federal employees in exchange for creating Trump’s “Space Force,” the sixth branch of the US military. This quid pro quo between Republicans and Democrats has fiscal conservatives howling at the NDAA’s price tag.

Finally, it wasn’t all that long ago that the Tax Cuts and Jobs Act lowered taxes for corporations and individuals, temporarily boosting economic growth, corporate earnings and consumer incomes. In addition to the Fed, the US government is doing its part to support the economy and markets, creating a powerful one-two combination for financial assets.


They Sought to Interfere, for Good, in Human Matters, and had Lost the Power Forever
The third and final spirit that visits with Scrooge is the Ghost of Christmas Future. Curiously, in the various retold versions of A Christmas Carol, the ghosts of Christmas Past and Christmas Present take on many different representations, but the Ghost of Christmas Future always closely resembles the Grim Reaper. The scary and silent figure forces Scrooge to reluctantly face the lonely consequences of his lifelong pursuit of money.

Will the Ghost of Christmas Future visit with investors this holiday season? Has feasting on benign inflation, ultra-low interest rates and fiscal policy satisfied our greed? In the aftermath of the global financial crisis, many smart folks continually warned that today’s fiscal and monetary policy solutions would result in higher interest rates, rampant inflation, and mounting debt and deficits that would finally matter to the economy and markets. And, yet, they have not mattered! This further inflates politicians’ and central bankers’ considerable egos. The nation is on the verge of a presidential election, and neither Republicans nor Democrats are discussing sensible policy solutions to address a trillion dollar deficit and growing piles of debt. This represents a major and recent shift in American politics. Instead of addressing the deficit, both sides are recklessly promising to spend even more. Potential voters are eating it up, relieved to hear that painful austerity measures are off the table.

Scrooge eventually succumbed to the Ghost of Christmas Future’s warnings — will investors? As a little Christmas magic would have it, as I was writing this article, I received an email from a dear friend and mentor. Not knowing the theme for this month’s note, he wondered if the capital market system would break if the Fed stopped funding trillion dollar deficits through low rates and balance sheet expansion. Yet, if they keep the monetary policy spigots on full blast, inflationary pressures will eventually build and force them to raise rates, potentially ending the long economic expansion. If something cannot go on forever, it will stop.

I Will Honor Christmas in My Heart, and Try to Keep It All the Year
Of course, in A Christmas Carol, Scrooge awakens on Christmas morning a changed man. The ghosts of Christmas Past, Present and Future are able to successfully rehabilitate the miserly old man. From that day forward Scrooge treats everyone with kindness, generosity and compassion, embodying the spirit of Christmas.

If only it were that easy. Investors, politicians and central bankers have been gorging themselves on generous fiscal and monetary policies for at least the last decade. And, with Christmas coming the capital markets goose has definitely gotten fat. But, the underlying risks are not stable. In fact, lurking beneath the surface, like the ever-present Ghost of Christmas Future, the potential consequences are growing, not shrinking. So far, these dangerous policies have only bolstered financial assets and kept the economy chugging along. Wildly, this just encourages more risk-taking, spending and greed. Investors should enjoy the mild inflation, low rates and government spending goodies this holiday season. At some future Christmas, something has got to give, doesn’t it? Maybe I should be less like Scrooge and more like Pollyanna in 2020.


1 Bloomberg Finance, L.P. December 2109.

2 Strategas Research Partners, Investment Strategy Report, November 22, 2019

3 Andrew Duehren, “House Approves Spending Bills, in Effort to Avoid Shutdown,” The Wall Street Journal, December 17, 2019.


Gross Domestic Product (GDP)

The total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period. As a broad measure of overall domestic production, it functions as a comprehensive scorecard of the country’s economic health.


The views expressed in this material are the views of Michael Arone through the period ended December 19, 2019 and are subject to change based on market and other conditions. This document contains certain statements that
may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

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