Bored gamblers sitting at home without sports to bet on have started a new day trading frenzy comparable to 1999. They obviously love call options and it has been easier than picking winners on tracks, fields, and courts. Bankrupt companies are being bid up though the stocks are worthless. Short covering is extreme as well. Institutions feel compelled to chase stocks, convincing themselves that returns will certainly be better than what can be achieved from high grade bonds. That is likely not the case over the long-term.
The economy is turned upside down too. Thoughts of paying those enjoying free money to go back to work are making the rounds. Are you kidding me? That is as silly as the recent bail out of fat cats and Wall Street. It is all quite clownish, but these sorts of ploys become mistaken for enlightened thinking these days among those desperately tied to the system and numb to the meaning of what is taking place. It is a circus.
The mood of the country and trading in the markets is extremely narrative-driven. Pandemic fears have turned into social unrest narratives. The data being released is noisy enough that positive tales can be spun, while companies are mostly keeping as much negative information as they can close to the vest. Clearly some of the data is being “massaged” for re-election purposes. The latest monthly employment data was released with known “mistakes” in it that just happened to drive the unemployment rate down a few percent. The BLS refused to correct it. Please.
Most importantly, with so much cash flowing out of the Treasury and the resulting debt sucked up by the Fed, you cannot tell how the economy is really doing because of $3 trillion of artificial support. Many of the unemployed are making more money than they did from their jobs and many of those with jobs got nice checks as well. Regardless, the economy is shrinking at an over a 30% annual rate this quarter. Our best guess is that unemployment is at a record 15-30% depending how you measure it.
The new fix is the same old fix. Create massive amounts of debt. All of this new debt is now sitting on balance sheets as individuals and companies fight for survival as a bankruptcy wave hits the economy. This is providing liquidity that will make more entities ultimately insolvent even if they survive a while longer.
We do not completely believe the Fed when it says negative rate policy will not be tried here. It will likely be tempted to do so if only because Europe and Japan both gave it a go. The PhD’s might not be able to stand foregoing it if things do not improve. However, the Fed is in bed with the banks to an incredible degree and they do not like the idea. It has been a horrible failure in Japan and Europe and crushed bank earnings. Additional measures like yield curve control may be tried too, but rates are already below 1% across most of the curve so that does not seem like a meaningful option.
U.S. stocks were priced for perfection before the pandemic and ensuing economic collapse. The narrative is that the economy was doing well before the virus caused disruption, but growth was already slowing. The Fed had already begun a QE program late last year because the fixed-income markets were seizing up.
The Fed is hellbent on proving its critics wrong by doing even more of the shortsighted and idiotic things that got us into trouble in the first place. That only proves those critics correct and paints the U.S. as one more place on the map where the markets are just as corrupt and manipulated as those of nations that many of us used to disparage regularly and term “uninvestable.”
The Fed got caught with its pants down again and it was not a pretty sight. It never could escape from the ultra-easy policies of the last decade that were supposed to be temporary. It never returned to anything like the pre-2008 normal. It has no ability to loosen control or the largely insolvent system it fostered will crater. The liquidity it provides does not fix solvency issues at companies, nations, states, or municipalities. It does not spur growth.
One highly deplorable aspect of the Fed’s plan is knowingly goading naïve investors into chasing stocks at incredibly expensive levels. The level of the S&P 500 is a matter of official policy more than employment or inflation. Meanwhile, savers are penalized by rates kept well below the level of inflation.
The Fed has not learned or refuses to acknowledge that it’s policies thwart growth in many ways, but the most obvious is the inability of savers to earn fair market returns from fixed-income assets or bank deposits because rates are set by the authority of the FOMC at levels well below inflation. That hurts spending. The propensity to spend by those more invested in stock markets has never overcome this flaw. The top 1% hold the assets the Fed protects, while those depending on employment to pay the bills are in a world of hurt as jobs are lost. Small business closures are skyrocketing.
In highly unusual fashion, one major brokerage firm used the term fake to describe U.S. markets. Other mainstream participants are using similar terms. The pricing mechanism is broken, and markets are very fragile. We now see so many signs of extreme bullishness that we have lost count. Meanwhile, GAAP earnings for the S&P 500 are now expected to be below $100 for 2020 and uncertainty over the back half of the year is through the roof. The fallout from the shutdowns has not even flowed through income statements and balance sheets yet, but bullish investors want to take positions anyway at valuations that have remained well above those seen at prior downturns that were less severe.
We might be more optimistic than some about a return to growth. However, that might remove some future Fed activity from the equation. That could unsettle markets. It already seems as those corporate bond investors are disappointed by the Fed failing to back up the truck in that market. At the same time, one has to wonder how long the federal government will provide free money if the economic data gets better with the deficit already skyrocketing.
Stocks were priced for perfection before the pandemic. One can now sell them near those same prices, though the world has shown itself to be far from perfect. We urge U.S. investors to consider that Europe and Japan have tried heavy-handed central bank intervention for years without stocks becoming as expensive in those places. The current fascination in the U.S. might wear off fast because stocks are already at nosebleed levels and corporate buybacks are fading. Maybe it is as simple as day traders returning to betting on the ponies and investors realizing that equities offer returns close to zero over an investment horizon. That’s not a smart bet.
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.