The Stock Markets are soaring, making the wise who had advised caution look foolish, even prompting a CNBC headline ‘The Stock Market vs. The Experts’, by their very bright, capable, and well informed commentator Ms. Kelly Evans of CNBC; and an opinion piece in the Canadian Financial Post, ‘Maybe the Stock Market Isn’t So Crazy After All For Flying So High Amid the Worst Economic Dip in 90 Years’, by Pierre Chaigneau, an Associate Professor of Finance and Commerce at the Smith School of Business, Queens University.
It has been no secret that some of the most experienced and successful investors of all time, like Warren Buffett and Ray Dalio, and others equally famous and successful, had been predicting prolonged economic pain, with little to no-chance of a ‘V-shaped’ recovery, and significant additional downsides to the Stock Markets going forward due to the overall and ongoing damage by the pandemic.
Now as the economies take the first baby steps towards the earliest stages of ‘reopening’, with the most recent and surprisingly great ‘Jobs Recovery Numbers’ (there is a caveat, but more on that later), the Stock Markets have soared, with the accompanying sense of euphoria from market observers and commentators. And now the talk has decidedly turned to how wrong the ‘experts’ were, what with Markets soaring and the economy looking like its bouncing back rapidly in the widely predicted, highly anticipated ‘V-shaped’ recovery, the popular deductions are, the Markets are right and the experts have been proven wrong.
Even Trump jumped in, exulting that Buffett has been right all his life but this time he was wrong in selling the Airlines. Trump making that statement makes us even more sceptical of the rightness of the Stock Markets and the wrongness of experts, as Buffett is seldom wrong in money matters and Markets, but Trump too often is.
Currently, the overwhelming sentiment is, one cannot argue with Stock Markets. They are the ultimate truth. After all one cannot argue with ‘Mr. Market’ can one?!
Well, matter of fact one can. Warren Buffett has made fortunes in his lifetime, betting that at times Mr. Market is dead wrong. In fact capitalizing on stocks, and Stock Markets, at times being wrong where valuations and prices are concerned has been his secret to success. And Ray Dalio built a legendary hedge fund ‘Bridgewater Associates’ (2019 assets under management $160 Billion), by being more right than not about financial markets and economies. This is just an example of two ‘experts’ that the Markets seem to be proving wrong, currently. But there are certainly many more experts that believe that the recovery will be slow and prolonged, and the Stock Markets pose additional risks.
So what gives?
Well, Ms. Evans puts forth the argument that the most unexpectedly positive recent Jobs Report – the US economy adding 2.5 million jobs last month, versus the 7.5 million decline that the economists expected, and the unemployment rate falling a point-and-a-half to 13.3%, instead of the expected rise to 19% to 26%, may seem an unexpected outcome – ‘except it’s not’ - she states. She goes on to argue that the rebound of the Stock Market (from its March lows?) was indicating a fast rebounding economy from the effects of the pandemic. But, instead of, ‘being cheered by the market rebound, people decried “the gap between Wall Street and Main Street”, and focused instead on the gloomy forecasts about how much of this job loss researchers think will be permanent and how we’re already in another Great Depression’.
Ms. Evans’ contention is that the Stock Market is the ‘one source of information that doesn’t hail from the group-think halls of academia and think tanks’, thank God, and is therefore the obviously more accurate information as it often delivers (and we paraphrase) - ‘inconvenient verdicts against the professional class and is more often than not the target of their ire’. We will admit that at times her accusation may be accurate - at times.
Ms. Evans goes on to inform that ‘since the darkest days of the pandemic’, it’s the ‘mom and pop retail investors’ that kept their heads and did not sell stocks, ‘Everyday Americans were buying’ while Wall Street was panicking and selling. She concluded that in this instance the ordinary folks were right to expect a quick rebound in the economy, as borne out by the buoyant Stock Markets propelled upwards by their buying, and the experts were wrong in predicting a slow and tortured recovery, and their selling of the Markets. We find her argument wanting.
It is a market cliché that experts sell to the retail ‘mom-and-pop’ investors during market tops, and generally ‘Smart money’ stays out of Markets when there is trouble brewing, and ‘Retail (dumb) money’ goes all in. So we find her argument for the soaring Stock Markets, retail money buying, a confirmation that all may not be well with the Stock Markets going forward. But, these are truly extraordinary times, and there is another overwhelming and dominant influence to take into consideration when talking about the US, Canada’s, and all the other major international Markets, without which any discussion of market movements are naïve, and missing the main influencer.
Neither Kelly Evans nor Professor Pierre Chagneau mention or acknowledge the overwhelming influence of the Federal Reserve and the other Central Banks on the current financial markets. In their respective analysis of the driving forces behind the soaring Markets, which seem to be defying the reality of the devastated economies and the general consensus of experts, they both fail to acknowledge, or even mention, the massive intervention of the Federal Reserve and the Central Banks and governments that arrested the free-fall of the Stock Markets, and put unprecedented support under the COVID-19 virus pandemic crushed economies, making possible any later rebounds.
We submit, that it is safe to say - but for the unprecedented and almost continuous stimulus efforts of the Federal Reserve and the other Central Banks, there wouldn’t have been much of viable financial markets globally, after the 2008 crash, as it had threatened to crash the entire global financial system.
It is also equally safe to say – but for the additional and extraordinarily exceptional, and immediate, multi-Trillion dollar injections of liquidity into the financial markets in the current crisis, there would not be much of a Market today.
Unfortunately, today’s Stock Markets are an artificial construct (a bubble) of the Federal Reserve and the Central Banks, and are by no means the ‘free’ markets’ of independent buyers and sellers, with true price discovery of the assets being exchanged, that there were once supposed to be. And considering the extraordinary and perpetual ‘support’ (in other words direct purchase of assets) in the financial markets, by the Federal Reserve, Bank of China, Bank of Japan, the European Central Bank, and others in their respective Markets, the Stock Markets would be in a very different place today, and that certainly would not be heading back towards their previous highs, or as in the case of the NASDAQ, reaching new highs. It takes more than ‘mom-and-pop’ retail money to achieve that, and more than the factors listed by the Professor below. And while the Federal Reserve and Central Bank direct infusion of cash, and participation as a buyer of last resort of stressed assets, is deemed necessary in the Markets to prop them up, and as a result prop up the underlying economies, yet one can hardly pretend that there is any true ‘price discovery’ left in the Markets, or that the valuations quoted are by any means true or accurate.
Nevertheless, the Stock Markets are today what they are - more of political score cards for incumbent governments, held up by their respective Central Banks, than autonomous places of capital and asset exchange, as Free Markets.
Professor Pierre Chaigneaue credits the current buoyant markets (he is talking primarily of the Canadian Stock Market, which is of course heavily interlinked with the US Markets) in the face of ‘the worst economic dip in 90 years’, to:
a) Us knowing more about the COVID-19 virus than two months ago;
b) Much lower interest rates, which he contends have resulted in a lower discount rate in calculating stock values, and thus higher valuations;
c) The lower interest rates shift focus from the devastated short-term earnings to potentially profitable long-term earnings, and therefore ‘increases the disconnect between forward looking Stock Markets and the prevailing economic conditions’;
d) He also contends that a flood of possible bankruptcies would only increase profitability of those fewer companies that managed to survive in the wake of their weaker competitors, which didn’t survive, with the resultant diminishing of competition and greater demand for those that did;
e) A lot of the corporations have been well capitalized after 2008, and will weather the storm better; and finally,
f) The Stock Markets hate uncertainty, and now there is less uncertainty about the COVID-19 virus, its effects on infected individuals, and its fatality rate, which is proving to be less deadly than initially thought.
The professor has some valid points, but to a very limited point. Like Kelly Evans’ analysis of the rise of the Stock Market being attributable to the ‘moms-and-pops of America’ getting it right about the quick recovery of the economy, and the steady buying of stocks when the experts ‘were losing their heads’ (to paraphrase Rudyard Kipling) and selling, the professor also missed the ‘800lb gorilla’ in the Markets, namely the Federal Reserve and the other major Central Banks, including Canada. This is in addition to the Trillions being put out in fiscal support policies by all major governments to support the economy at large (so TWO 800 lbs Gorillas??).
So, in our view, it is the multi-Trillions in support from the Federal Reserve, Central Banks and governments, that is the primary cause of this rebound in Stock Markets, coupled with all the rest, the mom-and-pops, the traders, hedge funds, low interest rates and the reopening, etc. But the ‘support’ from Central Banks and governments is limited in its capabilities, and the ‘whatever it takes’ efforts of the Bank of Japan and the European Central Bank have proved that over the past years. They threw the ‘kitchen sink’ at their economies, with negative interest rates and massive repeat stimulus, and they still had a hard time fostering any sustainable growth in their economies, under much less stressful conditions than the pandemic.
Now the US Federal Reserve is talking of doing ‘whatever it takes’ (except for negative rates – for now) in its monetary policy, and will probably get similar results as Japan and Europe got, a struggling economy.
The massive daily stimulus and support packages, by the Federal Reserve, Central Banks and governments, have arrested the free-fall of the Stock Markets and the economies and provided the chance of rebounds. And, because the injection of liquidity into the financial markets through bond buying has a direct impact in boosting the Stock Markets, THAT, coupled with optimism about imminent vaccines, drugs, falling infection rates (in most developed countries at least), and the slow reopening of economies have boosted the Stock Markets now. BUT, this is by no means over yet. And therefore, by no means a return to the former good times is imminent.
Truly, ‘this is not even the beginning of the end, in fact it may be just the end of the beginning’ (to paraphrase and borrow from Winston Churchill). To reiterate once again, there would be no recovery, whatsoever, and certainly no soaring Stock Market(s) if it wasn’t for the daily billions being pushed into the Markets by the Federal Reserve and the Central Banks, along with all the ‘positives’ listed above, both by Kelly Evans and by professor Chaigneaue. But then were the experts wrong, and are the Stock Markets right? Not at all!
At least we don’t think so. The Markets may fly on Federal Reserve and Central Banks’ wings for now – but the economies have a long way to go before they can resemble any aspect of their pre-pandemic selves, if they ever get back to their former selves. By the way, the ‘unreal’ Jobs Report that put a rocket into the Stock Markets, may just turn out to be unreal after all - as the Bureau of Labour Statistics are flagging an error in their last Jobs Report - and think it may actually be above 16% rather than the 13.3% stated in their report.
It seems clear, at least to us and the ‘Experts’, that there will be no ‘V-shaped’ recovery coming out of this economic disaster. It took only three weeks to have the damage done to the economies that in the Great Depression took over three years. So there is no recovery in weeks and months from such damage, it will take years. And most experts agree on that. Plus, just the nature of the crisis, it being medical, will determine the economic recovery to be in fits and starts over time, dependent on the availability of proven, effective drugs and vaccines, in adequate numbers for the entire World.
For, as long as there are COVID-19 virus hot spots in the World, re-infections are possible (do not forget there are enough people in America, and the World, who will not take vaccines, even if they are available, and they will be prone to infections, and thus present a higher risk of re-spreading it in their communities). And, due to the origin of the COVID-19 virus being China, and it being one of a number of dangerous viruses to come from that country in the past years, and, their less than sterling record of transparency, hiding the negative information to protect their international image till it was too late to prevent it from becoming a global pandemic, the World and certainly America, will shift their vital supply chains to their own shores, or to more trusted countries. This shift will certainly change the dynamics of the economies as they emerge from the pandemic, and it will add to more recovery time.
Millions of jobs now lost will not coming back, and that will further challenge the recovery. And the entire spectrum of work, and work-place dynamics, will change going forward redrawing the economies.
There will be a cascade of rolling bankruptcies as the economies adjust to the prolonged shutdowns and tortured recovery attempts as many major economies, countries and continents are just getting infected; with COVID-19 cases and deaths rising steeply as in: India, Brazil, Russia, Africa, Latin-South America, etc.
The Federal Reserve and Central Banks cannot control every aspect of the economies, so in spite of their best efforts, there will be holes through which parts of the economies will fall. And, all the governments’ ability to spend money is always limited, so economic and health disasters will mount as an already overly indebted World sinks under the vastly greater debt burden. One could go on and on, but …
So, the experts are right, and Stock Markets are wrong. Full or even near-full economic recovery will take a long time, and will not be ‘V-shaped’. And, the overly optimistic and stimulus or retail money fuelled Stock Markets will run out of steam as the virus and its effects linger, and the downsides to the Stock Markets will grow, as indeed they are growing even now - and eventually reality will bite – and bite hard!