Mark Lazar’s September 2020 Newsletter
Monetary policy does not work like a scalpel, but more like a sledgehammer. Liaquat Ahamed
After peaking in February, the stock market correctly anticipated some of the worst forthcoming economic data (in such a short period) in US history, including a record plunge in retail sales, employment, and growth. Consequently, the S&P 500 dropped nearly 35% top-to-bottom.
|Dow Jones Ind Avg
|S&P 500 Index
|Emerging Market Index
|2020 Federal Budget Deficit
|US Q3 GDP Forecast
*All data as of 9/4/2020
But after bottoming March 23rd, something remarkable happened; the market again correctly forecast that while the impending economic data would be bad, it would be less bad than predicted—a lot less. Over the coming months, both the S&P and Nasdaq went on to hit record highs. This left a lot of market experts scratching their collective heads. Yes, we know the stock market is forward-looking, but let’s be frank; things weren’t (and still aren’t) exactly rosy, with some sectors of the economy (i.e. airlines, hotels, cruise lines, theme parks, sporting events, concert venues, casinos, etc.) limping along, at best. Let’s look at some of the factors that are driving the market, which may explain such a swift market rebound.
Markets are Forward-Looking
As previously mentioned, markets don’t care what happened yesterday. Rather, they’re attempting to divine what’s going to happen tomorrow; specifically, 6–9 months in the future. Mr. Market clearly believes tomorrow is a better day.
Unprecedented Fiscal Stimulus
Uncle Sam has been throwing everything, including the kitchen sink, at the economy to prevent a temporary contraction in consumption and spending from becoming something much worse. With a (current) price tag of over $2 trillion, the CARES Act was unprecedented in size and scope. This included programs like the Paycheck Protection Program (PPP), stimulus checks ($2,400 per couple, $500 per eligible child), copious unemployment benefits, bailouts for affected industries, etc.
TINA: There Is No Alternative
As referenced in the May 2020 commentary, post-selloff, the stock market has been the prettiest ugly girl in the room. Compared to other asset classes (bonds, real estate, cash, alternatives, etc.), stocks appeared relatively attractive.
I believe the biggest driver of the stock market post-COVID has been monetary policy. There’s a reason for the old saying, don’t fight the Fed; when the Federal Reserve is accommodative (i.e. lowering interest rates, increasing the money supply, expanding credit, etc.), it’s bullish for risk asset prices. In other words, loose monetary policy boosts stock prices, bond prices, real estate, gold, commodities, etc. In other words, there’s an inverse relationship between interest rates and asset prices.
The chart below illustrates just how aggressively the Fed has been printing money:
The 10-year Treasury yield hit a record low of .32% earlier this year. Considering most pension plans have an assumed rate of return of 7%, it’s evident that number can’t be achieved by purchasing bonds. What’s a pension plan to do in a record-low interest rate environment? TINA; move up the risk/reward spectrum and buy stocks and other risky assets that can at least potentially hit their target return.
Furthermore, with the 10-year break even (expected) inflation rate of 1.70%, Treasury yields currently have a negative real return. In other words, with a current yield of about .70%, the ten-year note provides investors with a negative return of 1% annually for the next decade. Conversely, stocks have historically been a good hedge against inflation.
It could be argued that central bankers have become contemporary alchemists, turning lead into gold, effectively sprinkling monetary stimulus fairy dust on risk assets and, voila! Everything is worth more. I believe this to be at least partially true, however, I learned long ago that that when investors fight the Fed, they’re almost always regretful.
Mark Lazar, MBA
Certified Financial Planner™