“This is a war, and we need to win this war and we need to spend what it takes to win the war." - Steven Mnuchin, US Treasury Secretary
After a brief (okay, maybe not so brief!) hiatus from writing our Weekly Insight we are excited to get back into a regular rhythm. As you might imagine, these posts take a lot of time and energy to write. It was nice to be able to take a break and free up some much needed time in our schedule during what turned out to be a rather stressful Spring and Summer. But now more than ever we find it essential to crystalize our thinking and remain open and transparent with our clients. Writing on a regular basis aids in this process.
So much has happened in recent months it’s hard to even know where to start. The COVID-19 data has kept us all on our toes, with the curve seeming to have flattened before turning back up over the past two months as lockdown measures have been relaxed. The economy remains bound up in uncertainty, although there are clear pockets of strength and much of the data has come in better than the direst expectations. Meanwhile, Congress and the Fed continue to fire the twin bazookas of fiscal and monetary stimulus in an effort to mitigate the fallout from the lockdown, and of course the stock market has staged one of the most impressive - and perplexing - rallies in history.
Waking the Patient
In a series of recent client emails we described the economic lockdown as a self-induced coma for the world economy. We are now in the process of gradually waking the patient back up. Businesses of all shapes and sizes are slowly re-opening, most under strict virus-related protocols. Some mid-sized gatherings are even starting to take place, and youth and professional sports are cautiously moving forward. The problem is that many parts of the economy may not be fully re-awakened anytime soon, if ever. Over 50 million people have filed for unemployment benefits since March, and many in the service industries of travel, hospitality, entertainment and dining have no visible path towards reengaging. The reality is that the behavioral changes taking hold right now will leave the economy with a noticeable limp even after it’s gotten back on its feet.
According to the IMF, all of this points to the worst economic contraction since the Great Depression. The Great Lockdown, as they have been calling it, is unique in the fact that the world has never seen such a synchronized downturn across all major world economies. But, for that matter, never have we seen such a synchronized response from government policymakers.
Twice As Aggressive, Twice As Fast
A former Federal Reserve staffer, Claudia Sahm, was recently quoted as saying, "Powell's Fed is twice as aggressive and more than twice as fast." The comparison was in reference to the extraordinary measures taken by Bernanke’s Fed during the Global Financial Crisis. Honestly, pegging the relative increase in scope and speed at two times might be understating it in our opinion. The Federal Reserve’s attitude throughout this crisis can be summed up as “Damn the torpedoes, full speed ahead!” Not only is there moral hazard associated with the Fed’s actions, but many call into question whether or not some of the special programs are even constitutional or in compliance with the Federal Reserve Act. Michael Arone, chief investment strategist for State Street Global Advisors, describes it as monetary policy on steroids. Although the nuts and bolts of Fed action are complicated and full of nuance, the chart below showing the total value of assets on the Fed’s balance sheet pretty much sums it up.
As the chart shows, since the crisis began the Fed has increased its balance sheet by roughly $3 trillion, with the expectation of another $3 trillion or so by the end of this year. For every dollar of assets the Fed buys (with “digital” money created ex nihilo, or “out of nothing”) it is removing a dollar’s worth of securities off of somebody’s balance sheet and replacing it with cash. This is the proverbial “printing press” in action. It’s the ultimate “liquification” of the financial system, and that liquidity typically finds its way into something. In this case that something is government, municipal and corporate bonds, all of which the Fed is now buying directly, as well as stocks, commodities, real estate and other more growth-oriented assets which are being purchased with the liquidity by market participants.
Money As Ammunition
The fiscal response, while not as awe inspiring as the Fed’s monetary actions, has been formidable in its own right. The federal government’s role has been to provide stopgap funding for areas of the economy that have been forced into the most restrictive lockdowns. This has included stimulus checks sent directly to individuals and specific sectors of corporate America, the broad based Paycheck Protection loan program for small businesses and expanded unemployment benefits, among other things. In many ways, these measures can be seen as roughly offsetting the loss in GDP thus far. In fact, personal incomes (including government transfer payments) will likely see positive growth in the second and third quarters, and according to JP Morgan roughly 65-75% of unemployed Americans are being paid more per week in government support than they were pre-COVID in their jobs.
The million trillion dollar question is what happens when the fiscal spending runs dry? Or maybe the question is whether or not it runs dry at all? Treasury Secretary Steven Mnuchin sees much more to come, saying “This is a war, and we need to win this war and we need to spend what it takes to win the war." Our elected officials will fight tooth and nail for economic vitality (ego and re-election campaigns might also play a role), and money is their primary ammunition. The Federal deficit is on pace to exceed $4 trillion this fiscal year, and that’s before any additional stimulus is passed. After taking nearly 200 years to reach $1 trillion in 1981, our national debt now stands north of $25 trillion (apparently viruses aren’t the only things that have exponential growth curves). The question of whether or not debt and deficits matter is about to be tested in a real way, and we can all expect much more discussion of the controversial theories surrounding Modern Monetary Theory in the months to come.
So Where To From Here?
All of this leaves the economic and financial markets on uncertain footing, especially as we head into the colder Fall and Winter months that correspond with the height of virus and flu season. We are honestly not sure what to expect. Whether it be the COVID-19 numbers, the resulting policy responses, the election outcome or the reaction of all of the above in the financial markets – trying to predict how the balance of the year plays out would be a fool’s errand. We are, however, reassessing some of the tools we use to manage risk and continuing to look for good risk/reward opportunities that can further diversify our portfolios. We have a lot of thoughts on the stock market bounce, the rise of the retail investor, the various programs being implemented by the Fed and the lack of effectiveness of trend following models through the recent cycle. Suffice it to say there is plenty of fodder for the Weekly Insight over the coming months!
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
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