TIP700: How to Invest during Fiscal Dominance w/ Lyn Alden
Feb 21, 2025
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Lyn Alden, a macro analyst and author of 'Broken Money,' dives into the concept of fiscal dominance and its significant effect on financial markets. She explains why the S&P 500 thrives despite high interest rates and discusses the outlook for big tech. Alden also reveals how the U.S. will manage large fiscal deficits and shares three major investment trends to watch. With insights on navigating investment strategies in this unique economic landscape, she emphasizes the importance of adaptability and diversification for investors.
Fiscal dominance marks a shift in monetary dynamics, where government fiscal deficits significantly influence financial markets and investment strategies.
The S&P 500's all-time highs demonstrate resilience despite higher interest rates, primarily driven by sustained government spending and liquidity conditions.
Investing during fiscal dominance requires diversifying portfolios with inflation-resistant assets and recognizing critical long-term trends like energy density and computational technology advancements.
Deep dives
Understanding Fiscal Dominance
Fiscal dominance represents a paradigm shift in how money is created within an economy, primarily emerging when annual government fiscal deficits exceed the sum of new bank loan creation. This inversion from the previous monetary dominance era indicates that traditional central banking tools may lose effectiveness as central banks attempt to control inflation. In the past, money supply growth largely stemmed from bank lending fueled by household credit demands, while today, monetized fiscal deficits play a more significant role. The consequence is a structural change where investors need to recognize that expansive fiscal policies can maintain inflationary pressure and create a confusing environment where typical market reactions may not apply.
High Stock Valuations Amidst Rising Rates
Despite higher interest rates and inflation, the S&P 500 has reached all-time highs, largely due to ongoing monetized fiscal deficits that mirror historical patterns seen in the 1940s rather than the 1970s. This era of fiscal dominance, characterized by substantial government spending, allows for the retention of investment in equities even as rates climb. Central banks are constrained in their capacity to raise interest rates significantly without exacerbating fiscal deficits, which maintains a supportive environment for stock prices. An absence of key shortages in the labor market and energy sector further stabilizes market conditions, enabling equities to flourish despite the inflationary backdrop.
The Impact of Liquidity on Asset Prices
Liquidity plays a crucial role in influencing asset prices, with findings indicating a strong correlation between global liquidity and performance across various asset classes. Currently, the U.S. Treasury's issuance of short-term debt is helping offset liquidity drains caused by Federal Reserve policies. As a result, liquidity conditions appear favorable leading into the upcoming election, with expectations of potential future easing by the Fed. However, factors such as tariffs and the strength of the dollar could still serve as wildcards that may affect liquidity dynamics, making ongoing assessment vital for investors.
Navigating Investment Strategies in Fiscal Dominance
Investing during a period of fiscal dominance requires a strategic approach that departs from traditional methods, as economic indicators may not behave as expected under prior monetary dominance regimes. Recognizing that fiscal policies can mitigate recessionary pressures, investors might consider increasing exposure to equities related to travel and consumer spending, especially as wealth within certain demographics rises. Diversifying portfolios to include inflation-resistant assets, such as energy producers and hard commodities, is essential to manage risks in an inflation-heavy environment. Additionally, the importance of recognizing dilution rates in asset holdings and adjusting portfolios to minimize exposure to dilutive assets will be critical to achieving long-term success.
Long-Term Structural Trends to Monitor
Three critical long-term structural trends include a focus on energy density, the expansion of computational technologies, and the preservation of network effects. Energy density remains essential for economic growth, while increases in computational capabilities potentially drive advancements across sectors. Investors should remain attuned to the implications of these structural trends, understanding that they will likely outperform in the long term despite potential fluctuations. Balancing investments across these themes while being cautious of overall market valuations can provide a roadmap for achieving sustained growth amid changing economic backdrops.
On today’s episode, Clay is joined by Lyn Alden to discuss fiscal dominance and its implications for investors. While many value investors claim that following the macro environment isn’t all that important, Lyn makes the compelling case that fiscal dominance has a considerable impact on financial markets overall.
IN THIS EPISODE YOU’LL LEARN:
00:00 - Intro
02:03 - What fiscal dominance is and why it matters.
08:39 - Why the S&P 500 is at all-time highs with the backdrop of higher interest rates.
11:36 - Whether Lyn expects US big tech to continue to outperform.
19:05 - How the US will continue to run large fiscal deficits.
28:55 - Why nothing stops the fiscal dominance train.
36:20 - Where we are at in the liquidity cycle.
41:08 - How to invest during a period of fiscal dominance.
55:19 - Lyn’s three major trends to never fade.
And so much more!
Disclaimer: Slight discrepancies in the timestamps may occur due to podcast platform differences.
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