The government response to the pandemic has created extremely distorted asset pricing and a free money mentality for the overall economy. Investors are behaving like they have a gun to their heads as the Fed seemingly forces them to choose between horrible choice 1, low bond yields, and horrible choice 2, low earnings yields. We’d rather lean short and wait for better opportunities.
It seems the trading of the entire range of assets rests on the notion of extremely low treasury yields and a moratorium on authentic price discovery in credit markets by order of the Fed. Investors putting cash to work are doing so under the most bizarre set of circumstances in market history at prices that are tough to justify.
If the S&P 500’s $87 GAAP EPS projection is hit for this year, it would mean that the index is trading at a mind-blowing 39 times that number and almost 25 times cycle peak earnings from 2019 in the middle of a dismal economic environment. The maddening crowd sees no problem with that. With the deck stacked against us on the long side, we would rather not play the game as designed by the authorities.
A combined $7 trillion of monetary and fiscal support has gone a long way. Call it the pandemic boom. Many of the unemployed have seen their incomes go up by a lot with the transfer payments received from Uncle Sam. Personal income grew at an amazing 33% annual pace during the second quarter collapse even as employee compensation fell by 25%. That is a stunning level of government largesse. Much of that cash ended up funding purchases of discretionary items and stocks no doubt. However, it is now a thing of the past and it’s unclear what will support a still struggling economy going forward.
The economy appears stronger than it really is because the data reflects the performance relative to a horrible March and April and many of the unemployed are simply being left out of the official count. Close to 30 million people are out of work if you combine state and federal unemployment benefits data. That is not the stuff of bull markets. Companies were able to furlough workers to bring down operating costs dramatically in the second quarter. Revenues fell 30% in many cases even with top lines being helped by overly generous jobless benefits and other government handouts.
The very sloppily constructed money giveaway was much more than what was needed to fill the income gap. Many fully employed people got checks for $1,200. We would much rather help those who really need it. However, layoffs are becoming more permanent in nature and the eviction moratoriums will not last forever. Bankruptcies are climbing and small businesses are shutting down. The whole economic charade depends on even more government spending and the powers that be are struggling to agree to additional relief. This is a risk markets ignore for now.
The Fed has turned again to selling investors on the notion that it will allow inflation to run higher for a spell if it begins to rise. We are all supposed to be brain dead and perceive this as earth shattering news. We have been through this narrative before. It is not new. The Fed has shown no ability to raise inflation for a decade and we remain at a loss as to why the PhD’s get away with the notion that it would be good for Main Street anyway. Prices for most things are too high for most consumers already. It is a slap in the face, especially when one realizes that the whole narrative is simply meant to enable the implementation of policies that aim to keep stock prices high for upper income folks.
A major change has taken place this year. Congress has virtually taken control of the Fed, at least for now. Congress spends what it wants and expects the Fed to buy up the debt. The Fed is a dutiful servant. This could lead to higher inflation if money velocity (pace of money transactions and activity) were to increase. The recent spike in precious metals is mostly signaling that faith in the dollar and the Fed are waning in a major way, but they could also be sniffing out higher inflation expectations.
A spike in interest rates based on the approval of a vaccine or improving virus news may prove unsettling for many highly favored positions in the market. However, over the longer term, we also think it is likely that even in a less quarantined environment in future quarters it will become clear that most companies are still struggling, and many have disappeared for good. The virus issues will not go away quickly or completely regardless of vaccines or treatment breakthroughs.
We suspect that the dollar and gold may be indicating that the central bankers do not have as much room to operate reckless fiscal and monetary schemes going forward, but the jury is still out on whether higher inflation is in the cards. The biggest risk for markets is that no one has any idea what the real underlying economy looks like given the extent of government spending and Fed involvement and everything is priced into the stratosphere.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.