Covid-19 has wrought extraordinary damage on the global economy. Unemployment continues to soar to unprecedented levels. Companies continue to scramble for government support.
We are unquestionably facing an economic slump larger than any we’ve ever experienced. The only issue in question now is how rapid the recovery might be.
Everything about this crisis has been off the charts in terms of historic comparisons. And yet, it seems that the recovery in the stockmarket is falling into the same category.
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Why have markets rebounded so sharply? Because of all the money printing
According to Goldman Sachs, the current rally in the MSCI World Equity Index is one of the strongest in history, stretching back to 1970.
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It’s not the only surprising statistic. Here’s a couple more to give you an idea of how expensive-looking the US market is right now.
Firstly, as Bloomberg's Tracy Alloway tweeted this morning, via Bank of America, the biggest five shares in the S&P 500 now account for a far higher proportion of the overall index than they did at their previous high in 2000.
Secondly, as John Authers points out on Twitter this morning, prospective price/earnings ratios for the market as a whole “are their highest in 18 years for crying out loud”. In other words, share prices relative to expected earnings (and note, those expected earnings are probably too optimistic right now) are at their highest since just after the tech bubble burst.
In other words, there are signs that the market – in the US certainly – is not just valued highly but in fact, really rather overvalued, just a month after hitting its coronavirus lows.
What does this indicate to me?
You can talk about things like markets pricing in an “oil price dividend” (low oil prices might be bad for producers but consumers – once they start travelling and spending again – will love them). Or you can look at how maybe the coronavirus outbreak looks now to be peaking in most developed markets (hopefully), even the hardest-hit ones (like the UK).
But for me it's mostly a simple illustration of the power of money printing, and how markets have been conditioned to react to it over the last few decades.
You might be staggered that stocks are trading on such high p/e ratios and I definitely sympathise. But on the other hand, what are they meant to do when bond yields are this low?
If the risk-free rate (the money you can earn by investing in US government bonds) is negative in real terms (and not far off it in nominal terms) then the return from anything riskier doesn’t have to be all that high to be tempting.
And if the central bank has waded in and effectively got rid of bankruptcy risk, why wouldn’t you wade into markets, particularly the ones that are most obviously beneficiaries of this largesse?
Investors are even happy to acknowledge this. As Michael Mackenzie notes in his FT column, Rick Rieder of massive asset manager BlackRock recently wrote that the group plans to follow the actions of developed-market central banks “by purchasing what they’re purchasing, and assets that rhyme with those.”
I mean, you don’t get much clearer than that. BlackRock manages money for an awful lot of people. And it is openly making its asset allocation decisions based on what central banks are buying and (probably) on what it thinks central banks might buy next.
It makes total sense. It’s a logical move for any asset manager who doesn’t want to be exposed to rampant career risk. But it is also a parody of a free market. Capital allocation decisions are not being based on value, or earnings potential, or anything that might be described as a “fundamental”. They’re being based on: “who’s first in the queue for the printed money?"
The only way the Fed runs out of ammo
I am absolutely not saying: “Don’t fight the Fed”. The action taken by central banks now (on top of the actions taken in 2008, which came on top of over-reactions stretching back to the 1980s) will undermine our system yet further, and set up the conditions for a future blow-up which neither the Fed nor central government will be able to alleviate painlessly.
But I am suggesting that we need to be realistic about these things. Are you surprised that the most-desired stocks have rebounded so quickly, when faced with a genuine wall of cash flooding into markets? No fund manager will get fired for owning these stocks, so why wouldn’t they buy them?
The companies and institutions closest to the money-printing motherlode – the Federal Reserve – are the ones that have done the best during the post-2009 rally, and I reckon we’ll see the same thing now.
What does it mean for your investments?
Well, we can’t discount a further slide in markets. Maybe (although it looks increasingly less likely) they will retest their lows (or perhaps just some of the weaker markets will). Albert Edwards at Societe Generale still reckons that we might see another low, even for the S&P 500.
However, it’s worth noting that Edwards also points out that if this does happen, and the S&P goes below its 23 March low of 2,190, then chances are the Fed will look to do even more. And if it falls very much further than that, then “don’t be surprised when the Fed announces it will begin buying S&P 500 ETFs”.
I do rather think that this is the point. And I wonder if markets haven’t just decided that they might as well price this in right now. If you believe that the Fed really will do whatever it takes, then the only thing that can really stop the Fed from printing whatever it takes to keep asset prices propped up is the return of consumer price inflation.
That’s the only point at which the Fed runs out of ammo. Or rather, it’s the point at which allowing asset prices to fall becomes less painful than the alternative, which is to allow consumer prices to rise.
So there is no real choice. Markets might fear deflation but they also don’t mind it right now. Because as long as deflation remains the big concern, then there’s no chance of the Fed taking its foot off the money-printing accelerator.
The question is: what happens when the world finally re-opens for business? And that’s when we’ll see the real consequences of all of this activity.
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