@theMarket: The Virus Versus the Fed
Bulls and bears are in a tussle. Market averages reflect the battle that is moving stocks down, up, and then sideways throughout the week. It is a phase where investors are in a data-dependent mood and the data isn't all that good.
The bears are watching the COVID-19 cases climb higher every day, which threatens to trash their expectations for a "V" shaped recovery. The bulls, meanwhile, aren't too worried. They are banking on the Federal Reserve Bank's promises to keep pouring added stimulus support into the financial markets just in case the virus pushes the economy further toward the brink.
It did not have to be this way.
A few months ago, America had a chance to beat this pandemic. That was before the president decided to politicize the virus, pretend it wasn't serious, and then fumble the response when he realized it was. Now, with the number of new virus cases hitting the highest level since the onset of the pandemic in America, he chooses to simply ignore it.
We are left holding the bag. However, readers are also aware that the American people are not blameless. For weeks I have been warning that the general disregard for following medical guidelines among the public was likely to produce the present results. When our politicians encourage this behavior, and even support gun-toting radical groups to storm state houses, this is what you get.
Twenty-seven states (and counting) have witnessed an increase in COVID-19 cases. The worst hit among them followed the president's urgings to re-open, downplay the risks, and get the economy moving again before the election. New York Gov. Andrew Cuomo, who has paid his dues combatting the worst outbreak in any American state, said it best. "You played politics with this virus, and you lost."
So, what happens now? Most likely, we get a few more rounds of positive economic data points, such as stronger retail sales, higher manufacturing numbers, etc., but those are "rebound" numbers from a low, low base. After that, the data will look less rosy and may even decline, if the virus numbers increase and begin to spread outward from hotspots in the West and Southeast.
The economy, as we know by now, is not the stock market. The stratospheric levels of the indexes are all about Fed stimulus. The thinking here is that as long as the helicopter money is still raining down from a central bank sky, buy stocks. Fundamental news, such as the results of yesterday's stress test by the nation's large banks, which at one time would have been important, has little to do with what happens to their stock prices.
Speculation in the markets by new retail investors, stuck at home, and trying to make money day trading, adds another unpredictable element. It is their buying, for example, that is bidding up the stocks of bankrupt companies, like Hertz and GNC, or chasing unproven "story" stocks at a few cents a share to see them double or quadruple in a day, or a week. My advice is buyer beware if you are trying to play that game, because they almost always end badly.
June is almost over, and I expect there will likely be more turbulence early next week. There is some talk of a large end-of-quarter rebalancing among institutions from stocks to bonds, after the strong equity gains this past quarter. That could cause some additional selling, maybe another 100-point risk to the downside in the S&P 500 Index.
However, contrarian indicators, such as bearish investor sentiment, and high short interest on the S&P 500 Index, plus expectations of another massive fiscal stimulus bill next month, would indicate that stocks are still in a bullish phase. Last week's advice, therefore, to "buy the dips" remains in place.
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The Retired Investor: Corporate Debt & the U.S. government
The pandemic and its impact on the American economy required a drastic response from both the federal government and the Federal Reserve Bank. One of the most controversial, but necessary, steps taken by the Fed was to not only purchase private-sector debt, but implicitly guarantee that debt.
In addition, both fiscal and monetary stimulus has been pouring into the economy in an effort to defend jobs and stave off bankruptcy for thousands of small businesses. While some worry about the inflationary effects this may have down the road, the attitude of most economists is that we will worry about that later, if it becomes a problem.
In my last column, I explained that as far as Fed stimulus is concerned, central bank money is not necessarily inflationary, it simply swaps assets for central bank reserves within the financial system's balance sheet. Inflation rarely occurs, unless banks take some of their money and decide to lend it to you and me. That's called private money. The faster it circulates (called velocity) from one person or entity to the next, the higher the chances that inflation will rise.
Over the last decade, lending institutions, generally, have been loath to lend to the private sector because they feared that borrowers would not be able to pay back their loans. But what happens if that lending risk were to disappear? That is what may be happening in today's markets under the government's new loan programs. By purchasing or promising to purchase, corporate debt, bad or otherwise, within the U.S. financial system, banks are now presented with a no-risk, win/win proposition of lending.
Why not lend as long as the government is willing to pick up the tab if things go bad? So, what if a company can't repay its loans? It wouldn't necessarily need to declare bankruptcy. The government could simply extend payments, lower interest rates, or do whatever it takes to keep the debtor in business. Right now, for example, much of the payroll protection loans will be forgiven if the guidelines are followed. Why not extend the same terms for other causes?
Would that ultimately mean the amount of private and public debt grows even larger than it already is in this country? Well, yes, but according to Modern Monetary Theory (MMT) that's OK, too. MMT argues that as long as a country can continue to control and print its own currency, there is no chance that a country can go bankrupt.
In fact, the more a country spends, the better off it will be, according to MMT theorists. If inflation were to result, all the central bank would need to do is hike interest rates. Therefore, there would be no need to adhere to traditional economic theory.
Think of it — politicians would have a field day. All their political popular causes would suddenly be possible — refinancing, reconstruction, environmental, even equality loans — all guaranteed by the government. A version of this concept (another $1 trillion in fiscal stimulus) is expected to be passed by Congress next month.
Traditional economic theory would argue that all that borrowing would create a ballooning deficit and out of control deficits would require a reduction in spending and/or an increase in taxes. Otherwise, inflation would explode, interest rates would skyrocket, the economy would tank, and the government's debt payments would go through the roof.
Both theories, however, have an Achilles heel when it comes to inflation. The last four years have revealed to us just how much influence politics have on what we thought was our independent central bank. Imagine the outrage from every political corner if the Fed were to raise rates, no matter the reason.
In addition, the government's announced plans to provide a backstop to corporate debt, should result in an uptick in bank lending. It won't be much at first, since banks will need to feel their way into renewed lending before expanding on the practice. But there is a lot of cash just looking for a home right now. Between $4 and $5 trillion is sitting in money market funds, according to Refinitiv Lipper, as of last month. There is also another $2 trillion in cash parked within the banking system.
If I am right, over the remainder of this year, and into next, I expect to see loans increase substantially, unleashing first a trickle and then an avalanche of money, which should flow into the real economy. That is what the central bank, the federal government and everyone else is hoping for. My concern is that we may see the velocity of money take off as well. If it does, and inflation does begin to rise, will we be prepared for the outcome?
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The Retired Investor: Inflation, a Factor to Forget?
It has been a long time since we have seen a rise in the inflation rate of any magnitude. As a result, most investors have largely dismissed inflation as a near-term concern. But that doesn't mean we have vanquished this troublesome variable from the financial equation forever.
There is a reason that inflation fears have subsided. Ever since the Financial Crisis, when central banks and governments dumped trillions of dollars into the world's economies, investors feared that all this money would re-ignite the inflation fire. It didn't happen. Instead, the inflation rate moderated, and in some countries began to drop. Rather than worry about inflation, investors and central bankers began to worry about the opposite — deflation.
You see, inflation, as any economists will tell you, is caused by an increase in the velocity of money. Simply put, velocity is a measurement of the rate that money is exchanged. It is the number of times that money moves from one entity to another.
Let's say I borrow $100 from my local bank. I spend $10 of it at McDonald's, another $20 at the movies, and spend the rest taking my wife out to dinner. If any of these three use that money to pay their suppliers, workers, or whatever, the money I spent is passed on to others. If they, in turn, take that money and buy items of their own with it, then the velocity of money continues higher. Over time, if this continues, the velocity of that same $100 will be so great that too much of this money will be chasing too few goods. In which case, inflation takes off.
One of the principles of economic theory is that in order for inflation to catch hold, all the money that central banks dumped into the global economic system over the last decade had to somehow find its way into the hands of consumers, who will spend it and pass it on. That didn't happen either. Instead, the world's banks and other financial institutions, stashed all that central bank cash in their electronic vaults, but didn't lend it out. There were two reasons for this.
The first one was fear. Banks were not about to lend this money to consumers, or corporations, given the aftermath of the crisis. Lending (in the form of mortgage money), was a big risk for banks, given what happened to the housing markets during 2008-2009. At the same time, unless you were one of the bluest of blue-chip companies, banks were charging an arm and a leg for corporate borrowers. Besides, the corporate appetite to borrow money was tepid at best. Given that the economy was sluggish, and the future uncertain, who really wanted to invest?
The growth rate of the economy continued to justify that attitude. The economy remained anemic throughout the Obama years and beyond. Companies argued that there just wasn't enough incentive to invest. Taxes were too high and regulations too onerous.
The Trump administration, as we know, thought they had provided the solution. They cut regulations and gave businesses a massive tax cut, expecting that at long last corporations would hire workers, raise wages, and grow the economy. Instead, all companies did was buy back their stock, pay out larger dividends, or acquire other companies with the money. The only inflation we experienced was in the stock market as prices of financial assets soared.
Fast-forward to today, worldwide, both governments and their central banks have upped the ante on additional monetary and fiscal stimulus, thanks to the pandemic. They feel they can do so with impunity, knowing consumers worldwide will not be spending much of that money until the all-clear is sounded on the pandemic side. They are confident that despite the fact that while monetary and fiscal stimulus is at historical highs and still growing, inflation will remain subdued.
As long as all that new stimulus money remains in the banks and does not fall into the hands of the consumer or into business investment, the velocity of money should remain tame. However, in my next column, I will point out that in this new round of stimulus, the Federal Reserve Bank has changed the rules of the game dramatically.
At the same time, more and more politicians, and some economists, are arguing that Modern Monetary Theory (MMT), by necessity, should be the natural direction the world takes in combating the fallout from the pandemic. Why is that important?
I believe by force of circumstances, both the Fed and proponents of MMT may be rubbing a lamp that could lead over time to releasing that genie of inflation back into the world once again. I'll explain why in my next column.
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@theMarket: Markets Fear New Virus Surge
Thursday happened to be one of the worst days for the market all year. Stock indexes dropped between 5-6 percent in the blink of the eye as the number of COVID-19 cases spiked higher in several states. Was that simply an excuse to sell, or should we be worried about a second surge?
As far as a second surge is concerned, I don't know what Wall Street is talking about. We are still in the initial phase of the pandemic. All that has happened is that a number of states are playing catch up with ground zero states like New York, New Jersey and California. Of course, it doesn't help that most states, like Florida, Texas, Arizona, Mississippi, Alabama, etc., have all but ignored the medical guidelines for re-opening their economies. This flouting of the best medical advice in favor of political partisanship has contributed to the sudden spike in cases since Memorial Day.
If investors spent a little more time listening to the epidemiologists, instead of bidding up airlines and cruise ship stocks, they would have realized that new cases would start to show up by the second week in June. And, like clockwork, that is just what is happening. But I believe this so-called "second surge" was simply the excuse traders needed to take profits in a market that had become way too frothy.
In my column last week, I wrote:
"Can we go even higher? I expect so. Look for the S&P 500 to hit 3,220-3,250 next week before pausing to catch its breath." The S&P 500 Index touched 3,232 on Monday before profit-taking set in. Thursday, that same index fell to the level I discussed with you two weeks ago, the 200 Day Moving Average at 3,002, and that is where it bounced on Friday.
Is it a coincidence that the new virus numbers coincided with the technical levels that I have been watching? You might think so, but I believe otherwise. As such, we should see some further correction next week after this bounce has played itself out. I am guessing we possibly break back down below the 200 DMA on the S&P 500 Index, depending on the virus news.
My reasoning: the surge in COVID-19 cases will continue into next week and beyond. That won't change. That should cap the market's upside, but not the downside. I believe investors will be jumpy until we determine the extent of the new virus surge.
A countervailing bull trend would be the argument that the medical community is now far better prepared to handle an uptick in virus cases, so further isolation tactics are not necessary, and we can expect fewer deaths. At the same time, both the Trump Administration and businesses are determined to re-open the economy. They are on the record stating that there will be no further economic shut-downs. That should support the stock market, at least temporarily, in my opinion, if things get out of hand (virus-wise) across the nation, than all bets are off.
Of course, both the bulls and the bears are avoiding a very ugly truth hiding underneath of all this financial, medical, and economic story-telling. The fact is that American lives are at stake. We are way beyond the worst-case estimate of 100,000 deaths and over 2 million virus cases and we are still counting. For our elderly community, this pandemic is a death warrant just waiting to happen.
The greatest tragedy of all is that most Americans, through their willful and selfish decision to ignore the rules as a matter of national political and economic policy, have made the decision that "the lives of the elderly don't matter." I can only say shame on us.
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The Retired Investor: The Virus & the Stock Market
Once upon a time, the world suffered from a pandemic. The global stock markets collapsed. The world's labor force disappeared, and the economies in every corner of the world plunged. All seemed lost until one day, the virus mysteriously disappeared, and every one lived happily ever after. If you liked that fairy tale, I also have a bridge I can sell you.
Don't say we were not warned. Every epidemiologist that wasn't on the government's payroll has been sounding the alert to prepare for a second wave of the COVID-19 virus. So why didn't we listen? There are a number of reasons.
Number one, it is an election year. If the economy doesn't show signs of new life between now and November the chances are less than even that our own orange-haired fairy will get re-elected. It is why, from the outset of the virus, President Trump attempted to downplay the seriousness of the epidemic. He still is.
Then there is the business community and its relationship to the federal government. I like to think of this country as one in transformation. It is no longer a democracy, in my opinion, but a welfare state that places the needs of the corporation first. We, the people, have been reclassified as "workers" first, and individuals with rights a distant second.
Both the government and Corporate America, for different reasons, have determined that the economy needs to re-open, despite the risks. Corporations fear that they will go bankrupt, lose market share as well as profits, if the shutdown continues any longer. And if that happens, the employment rate will fall even further. The present government, if it wants a second term in the White House, cannot afford to let that happen. As the U.S. Treasury Secretary, Steven Mnuchin, said today on CNBC, "We can't shut down the economy again."
Finally, some element of blame must fall on our shoulders, if we do experience a resurgence of COVID-19 cases and deaths. Few states paid attention to the non-binding guidelines of safe re-opening issued by medical authorities. That is because Americans, for the most part, had had enough medical advice anyway. After three months of lock-down, many of us simply found it too difficult, or too uncomfortable, to stick with the program. After all, if the president and some governors were saying it was okay, then why not me?
We used politics to demand the re-opening of many communities before an "all clear" was sounded. States such as Texas, Montana, Utah, Arizona and California have seen virus cases spike at least 35 percent since Memorial Day weekend. We used politics again, in the side-by-side demonstrations of the last three weeks as well, and justified our stance in the name of "black lives matter."
Here in Massachusetts, where until recently, most residents were pretty good at adhering to the guidelines, things started to break down on Memorial Day weekend, as well. I passed countless outdoor parties, BBQs, and the like where throngs of people simply ignored safe distancing. At the lake, pontoon boats were packed with people, as were picnic areas.
While we won't know for another week or so if the number of states with an upsurge in new cases expands dramatically, it is a time to at least expect more bad news on the virus front. As such, investors may see some of those outsized gains that everyone has accumulated since March disappear rather rapidly.
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