Mid-Year Market Note

July 8, 2020 | The Corbenic Advisory Team

“We are committed to using our full range of tools to support the economy and to help assure that the recovery from this difficult period will be as robust as possible.”

– Jerome Powell, Chairman of the Federal Reserve

The Markets Year to Date

So just to bring everyone up to speed, a new strain of the Corona Virus spread throughout the world.  Everyone decided it would be a good idea to shut down the global economy (except Sweden, they did their own thing) and tell everyone to stay home and hoard toilet paper.  Then after inflicting a level of self-induced economic pain not seen since the Great Depression, we told everyone it was okay to start things back up as long as they wore a mask and maintained a distance of six feet.  Did we miss anything? 

Oh wait, we forgot, we still don’t have a vaccine, every day medical experts contradict whatever guidance was provided from the day before, the country is divided racially, politically, economically, and to whether the virus is even a thing or just an overreaction designed to tear down western society and life as we know it.  Seriously, you can’t make this stuff up.

And of course, during all this, the stock market basically did a round trip.  After falling 33% in 33 calendar days, it rose nearly 40% in 100 calendar days.  By the end of the Quarter, the S&P 500 Index was down 4.19% for the year, the equal weighted S&P was negative 12.06%, while the QQQ’s, or the top 100 stocks in the NASDAQ, was positive 16.46%.

Why the disparity of returns in the major indexes? The S&P and the NASDAQ are capital weighted indexes which means the largest companies have the greatest influence on returns.  Who are these titans of industry that skew the results?  Apple, Microsoft, Amazon, Facebook, and Google.  All who happen to be up strongly year to date as investors flocked to companies that would continue to grow even during a pandemic.

To provide a little perspective, there were five similar occurrences of similar volatility.  Three were during the Great Depression and the most recent was in the Spring of 2009. What do they all have in common? Unprecedented monetary policy by central bankers to address a severe collapse in economic and market conditions.

“So, we’ve been here before?” Absolutely! In fact, the recent history of the Federal Reserve and their response to adverse conditions have remained remarkably predictable.

The Implications of Monetary Policy

Since 1987 and at each subsequent financial crisis, and I use the term crisis loosely, the response has been more stimulus, lower rates, and greater assurances that the Federal Reserve would be there to save the day or at least give it their best shot.

You can’t blame them, no one wants to sit idly in the midst of a crisis. The natural tendency is to do something, anything, rather than be accused of fiddling while Rome burned or in this case Wall Street.  Unfortunately, sometimes, however painful, doing nothing is the better alternative.

In their defense, central bankers have an incomplete set of tools to address the barrage of economic and financial problems that come their way.  Their mistake is in thinking that despite this handicap they can effectively act regardless of the situation. They also have a mindset that says, first we’ll fix what (we) broke and then we’ll worry about all the things we broke trying to fix the first thing that broke. 

This takes a special kind of hubris or maybe they just hope they will be retired and on the lecture circuit before anyone notices. But the reality is, in an effort to fix things, central bankers create a series of unintended consequences, which if left to their own devices, will cause more damage than if they had all stayed home.

Unintended Consequences

With investors having become accustomed to extraordinary monetary intervention, central banks have found it increasingly difficult to normalize their policies. In other words, we have become addicted to accommodative monetary policy, especially in the financial markets.

The unintended consequence is a market rife with speculation, increasing volatility, and a lack of price discovery which leads to investors taking on additional risk without fully contemplating the consequences if or when policy reverses. It’s great while it lasts, but it doesn’t last.

But the risks are not confined to the financial markets. The increasing wealth gap across all major economies has been further exacerbated by monetary policy. The rich get richer, the poor stay poor, the middle class gets squeezed. 

The historical response to these periods of wealth inequality has been to modify the tax code in an effort to redistribute wealth. 

Speculation and the Fear of Missing Out

In recent weeks we saw novice investors chasing stocks into bankruptcy, giving credence to the rantings of a sports bettor offering stock recommendations, and a complete disregard for fundamentals or common sense. Unfortunately these investors are the ones that can ill afford the losses should they be left holding the bag at some point.  The smart money is already on the sidelines. But here’s the kicker, this can last much longer than you expect. 

Given the level of monetary policy that was brought to bear on the markets and the economy in general, the markets could very well continue to rise and at some point even eclipse their former highs though perhaps with a few bumps along the way. The Federal Reserve has indicated they will actively support the corporate bond market, the high-yield (junk) bond markets, municipal bonds, in fact wide swaths of the credit markets. They also stand ready to provide additional stimulus if things deteriorate. The Fed put is still in play.

And though we are focused on monetary policy, let’s not forget fiscal policy.  Since the unfolding of the crisis, Congress has authorized trillions of dollars in stimulus in an attempt to offset the implications of shutting down the economy. To date we have seen stimulus checks, enhanced unemployment benefits, PPP loans, and the Main Street Lending Program with ongoing discussions in Washington of extending these programs when they lapse at the end of July.

The initial flood of stimulus combined with accommodative monetary policy provided a foundation for the rally off the bottom.  A second round of stimulus could provide further support to the markets and without it, investors may not be willing to wait.

The Next Act

Investors have focused their hopes on the economy recovering by 2021 and corporate profits by 2022. There is lot that can happen between now and then, which we will address in the weeks and months to come such as the election, the ongoing economic implications of the virus, and possible changes to fiscal and monetary policy, but in the interim we would suggest the market has had quite a run off the bottom. There will continue to be opportunities in the markets, but it will require patience and an appreciation of the risks to be successful.

We wrote a cautionary market note in September of 1999, as we would come to learn, the markets didn’t rollover until March of the following year.  If you were out of the market during that period you felt like you were missing a great party, but at the end of the day it all worked out.  Sometimes it is better to be early than to be late and well gone before the police show up.

This is not the first time investors have encountered social, political, and economic risk, nor will it be the last.  We don’t have a crystal ball, just a healthy regard for risk and a desire to protect and grow our client’s wealth.

Opinion piece, please see Important Disclosure