As Americans brace for a week of horror, the stock market is having a very good run so far. Why?
We don’t think it’s that complicated:
There’s a lot of money out there.
The government is pumping trillions of dollars into the economy, and wants to spend trillions more. And unlike the 2008 Great Recession, when Republicans were inclined to say “whoa” to massive stimulus, they seem fine with it now.
So Democrats want to print and spend money because they always do, Trump wants to print and spend money because he always does. And Republicans, who were extremely sensitive to the nation taking on a lot of debt when there was a Democratic President (or even when George W. Bush was President for that matter), seem perfectly content to go along for the ride. Another quarter trillion semi-promised to small businesses. Great if it keeps them afloat and people employed. Adds to the debt though.
This is not potentially without “benefit” to Republicans also (which may be why they’re not really putting up a fight other than they want to get re-elected, and for whatever reason, they want Trump re-elected): the massive amounts of debt America is already taking on at this time to the tune of trillions of dollars, will almost surely mean cutbacks in Medicare and Social Security down the road, when taxpayers have to start paying back for this stuff in the future, even if the economy is much better. And you can be sure corporate America won’t get stuck with the bill.
Another reason: big investors right now can borrow money basically for zero. So why not? Part of the reason the Federal Reserve lowered interest rates to zero almost a month ago, was to encourage financial institutions to do just that. And so that could be a lot of the money we see going out into the market.
Because even at zero interest, banks aren’t going to take money if they don’t see places to put it where they can earn more than zero return on that money. That is, they’re not going to put even “free money” on their books unless they’re going to turn a profit. But there are still few attractive places to do that right now. Banks typically let extra money sit in Treasury bills and bonds, but there’s no benefit to that at all at the moment since those are paying zero. Well, there actually is one benefit: safety. So they might do it to preserve capital, but they wouldn’t take on any new money—even if it’s free—to return nothing, no matter how safe it is.
Now, the Fed wants those financial institutions to lend that free money to people and small businesses that need it. But that’s too risky for their taste right now, and that part of the market’s still frozen up. Even in places where the government’s gone out of its way to remove a lot of the risk for banks.
Just ask a friend with a mortgage and maybe a second mortgage if banks are eagerly approaching them to refinance since interest rates are so low. Especially if they just lost their job or their income for who knows how long.
Or even ask restaurant and casino mogul Tilman Fertitta, who is trying to put a deal together to save his business, which would involve him paying 15% interest on a $250-million loan. Meaning financial institutions could be getting the money they’re lending him for zero interest, and they’d make $37.5-million a year, assuming he pays it back (this is a slight oversimplification). Now, banks always charge more for loans than it costs them to make, but this—according to Bloomberg—would be a record
So why would he be willing to pay so much for the same money the Fed is handing out for free? Risk. Plain and simple. If the cash can carry him over, and the pandemic subsides, and people start going back to restaurants and casinos, the lenders will score big. That doesn’t happen, and everybody’s deeper in the hole.
So they’re requiring a very high premium, and they’re not really benefiting the “little guy” yet, but banks do seem to be starting to at least see opportunity. And maybe that’s leading to some optimism.
And big businesses—many carrying far less risk than Fertitta, are tapping into all kinds of lines of credit, which potentially means big profits for banks and other financial institutions. So that may also be part of what’s got the market fired up.
So big question: are they maybe getting a little too fired up?
Because the rally looks a little too enthusiastic, at least to us. Especially if you look at history. Because we look at it from this perspective: the stock market now is still nowhere close to the lows it hit during the last Recession. In fact, the S&P 500 today closed about 23% higher than its lowest point in the last month, and 21% higher than where it had recovered to when Trump took office. Which—despite what Trump says—was pretty good. And get this: even with big down days triggered by the Coronavirus, the S&P 500 is still up 300% from the last Recession.
Meaning there have got to be a lot of investors out there thinking the economic impact of the pandemic will be a brutal but quick hit, not long period of dragged out systemic malaise. We’re not sure about that. But could they be right?
Let’s follow that path for a minute and see where it takes us. The stock market is a leading indicator, meaning it reflects not where the economy is now, but where investors think it will be a bit down the road. And while almost everybody’s predicting a Recession, maybe that’s already been “baked in” as they say. And if the US and other industrialized countries seem to be reaching their near-term peaks of cases and deaths, or getting close to it, investors may start feeling they finally see the “light at the end of the Coronavirus tunnel”. The biggest problem for business in all of this (and part of what’s led to so many people getting laid off), is a feeling of utter helplessness: a complete lack of visibility as to when this might end. So now businesses might feel they’re beginning to see a glimmer.
We don’t want to be negative, but if that’s the reason the market is up and not just because there’s a ton of money out there that no one actually wants to lend to people who then will have to pay it back in uncertain circumstances, and stocks are one of the only places they can park it where they might make a profit, then we think it’s shortsighted.
For a few very simple reasons:
• There’s no cure, vaccine, or even proven therapy yet effective enough in treating if not curing and preventing COVID-19 to the point where people really don’t have to worry about it so much.
• Even if COVID-19 drops off in May and June, it could come back. These types of diseases tend to do that.
• There’s still no visibility about what workplaces are going to look like and how much the value of things has been impacted from restaurants to retail to real estate, basically because everything’s been frozen in place.
• And finally, seeing hope right now in stock prices presupposes—even if everything else falls into place in the best way possible—Trump won’t manage to screw it up. Maybe through petty grievances that turn into huge personal vendettas, or refusing to do the work with global partners that will be required to get everybody back on their feet. (The Federal Reserve can remedy some of that on its own, but not all.
On the other hand, Trump will always want to spend more and more money—debt be damned—and it’ll take a lot before Wall Street’s tired of that repast.