The New Socialist Pricing Regime

It is the early days of the new socialist pricing regime on Wall Street and the free money handouts from Congress.  The deciders are trying to prevent markets from pricing in reality.  We still feel compelled to let events play out for a time.  We expect better opportunities in relatively short order.  We think investors are making and will make big mistakes as they feel compelled to play along even though current prices reflect perfection.  Taking solace in current economic data is silly because it speaks more to how much free money has been given out as opposed to the underlying reality

The powers that be under-reacted to the coronavirus back in January and February. Then they over-reacted in March, April, and May. They are now under-reacting because it suits them.  The Fed, as always, has over-reacted throughout the crisis and before it.  It has now created its biggest bubble ever in the process.

With the Fed now taking control of capital markets, one could argue that it will never let risks be priced into any assets.  It has gone too far as it went into full panic mode just like the various governments did with their extended lockdowns.  However, we think that the Fed put concept has limits as not all losses will prove preventable unless the Fed bans bankruptcies and poor corporate earnings.

Because of the incredible uncertainty about the future performance of most companies during the pandemic, you would normally have the makings for lower P-E’s.  Instead, valuations are off the charts.  Most other risky assets should never be trading at current prices either.  This is creating volatility because most investors realize that there is a big difference between where securities would trade without the Fed’s forceful hand and where they trade under the illusion that the Fed can and will control all markets. It is obvious that equities never got close to the sort of valuations of past recessions even though the current downdraft is of historic magnitude.

Many investors are optimistic that the economy will improve from here.  So are we.  The key difference is that equities reflect an earnings outlook that will likely prove almost impossible to achieve.  It is difficult to find stocks to buy that do not require more guts than common sense. Investors are choosing to forget that most of the earnings growth for the S&P 500 came from five or six stocks in the last five years.  Much was due to now fading buybacks.

Against this landscape, the economic data and corporate performance numbers in coming weeks will look quite good in comparison to March and April.  Trading systems and narrative construction on Wall Street are set up to respond to positive comparisons with outsized moves.  That said, from an overall economic performance standpoint, very tough times are still ahead, just not as bad as we saw in the last couple months.

The virus may fade in importance or it may shut down large chunks of the economy.  Governments cannot force people to leave their houses or spend money even if lockdowns are lifted.  That is why the nutty idea of the government handing out debit cards loaded with cash that must be spent by a certain date is making the rounds.

Meanwhile, the Fed has now decided that it wants to go with the forecast that the economy will be quite weak for the next couple of years.  That gives it room to keep rates at zero and buy an incredible $120 billion of bonds each month in coming years.

The Fed’s recent entrance into the corporate bond market has crossed an important divide between free markets and socialized markets.  The Fed has no business establishing what yields should be available for corporate bonds.  Suffice it to say that markets are much less free than they were when 2020 commenced.  We do not like it, but it is a fact.  We do think it is operating as more of a backstop in corporate bonds and less as an active participant for now, but it was clearly another power grab left unchecked because few openly question the Fed’s activities.  The Fed has turned the investment world upside down as risk is being mispriced across a broad spectrum of assets.