Whatever it takes
“Within our mandate, the Fed is ready to do whatever it takes to support the economy. Believe me, it will be enough.”
Wait, did Fed Chief Jerome Powell really say that?
No, he didn’t, but the Federal Reserve’s (The Fed’s) actions seem to have said it for him. Given the speed and force with which the Fed has moved, he might as well have uttered those words.
It was European Central Bank President, Mario Draghi, who actually voiced this promise. In 2012, as Spain and Italy careened towards a financial cliff, Draghi gave a speech (Bloomberg News) in which he said; “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro.” After a pause, he added firmly, “Believe me, it will be enough.”
In some respects, “whatever it takes” became Draghi’s legacy. I don’t remember what he said during the rest of this speech but just the thought of unlimited central bank firepower encouraged investors to step into Spanish and Italian government debt. Long story short: Another financial crisis was averted.
Perhaps the Fed’s rapid response has created a similar level of confidence for American investors. Despite the tanking economy, markets seem fairly robust. Let us do a deep dive on why.
The economy: Worst ever
The economy is in a free-fall. Over a six-week period, there have been 30 million first-time claims for unemployment insurance (through April 25) (https://fred.stlouisfed.org/series/ICSA ). It’s by far the worst number of layoffs we’ve ever seen and it is truly disheartening to see. There was a 7.5% decline in consumer spending in March (https://fred.stlouisfed.org/series/PCE) which is the biggest decline on record. Industrial production slid 5.4% in March (https://fred.stlouisfed.org/series/INDPRO# ), the worst decline since the end of World War II. Nonfarm payrolls for April released May 8 showing 20.5 million jobs lost in April easily exceed the prior record of two million lost jobs (https://fred.stlouisfed.org/series/PAYEMS#0 ) at the end of World War II.
Sadly, we may see an acceleration in the economic contraction this month when April’s data comes in.
“Many standard economic statistics have yet to catch up with the reality we are experiencing,” Powell said at his end-of-April press conference. “Manufacturing output fell sharply in March and is likely to drop more rapidly (in April) as many factories have temporarily closed.”
Put simply, a health crisis has morphed into an economic crisis with the economy contracting at depression-like speed.
“The severity of the downturn will depend on the policy actions taken at all levels of government to cushion the blow and support recovery when the crisis passes,” Powell said.
The markets: Best monthly gains since 1987
During April, the Dow Jones Industrial Average and the S&P 500 recorded their best monthly gains since 1987 (https://www.marketwatch.com/story/after-a-blockbuster-april-for-the-dow-and-sp-500-is-sell-in-may-in-the-coronavirus-era-a-smart-strategy-2020-04-30 ). There is an extraordinary disconnect between the financial economy and the real economy, between Wall Street and Main Street.
One of the recurrent themes I emphasize is that bull markets occur during economic expansions and bear markets coincide with recessions. Expansions outlast recessions and expansions drive the economy to higher levels. Stocks then follow, albeit unevenly. The one glaring exception over the past 50 years was the 1987 market crash which did not lead to an economic contraction.
March’s four-week 34% decline in the S&P 500 (https://fred.stlouisfed.org/series/SP500) qualifies as a bear market. Stocks imploded at a stunning pace as investors sensed the economy was running into a COVID-19 wall. Throwing a twist to all this is the astonishing rally in the markets over the last month given today’s dire economic environment. Year-to-date, losses in U.S. stocks have been quite modest, as the table below illustrates.
How might we explain the disconnect?
The Fed’s unlimited firepower has not been enough to prevent a debilitating economic decline, but its unprecedented steps have kept an economic crisis from morphing into another financial crisis. This is partially due to the massive amount of liquidity and a promise of more support aiding stocks. Further, government stimulus of over $2.5 trillion is helping sentiment. Factors such as the progress of possible vaccine’s in the pipeline, some already fast tracked into clinical trials as well as treatment therapies and an increase in capacity for testing that would either end or at the very least, help better manage this pandemic. I also believe that investors are looking to 2021 and beyond when there is the anticipation that corporate profits will turnaround. Of course, the outlook is very uncertain. Have investors been too optimistic?
Additional government spending and support may be needed to jumpstart economic activity, as Powell alluded to in his press conference. Deficit hawks may cringe at talk of new spending and new programs since they have not been problem-free. So far, fiscal stimulus has received strong bipartisan support. Meanwhile, the reopening of large swaths of the economy may or may not go as planned.
Another wildcard will be consumer behavior. Prior patterns are unlikely to return to pre-crisis behavior, at least not right away. Social distancing at restaurants, airlines and industries that require person-to-person interactions could limit activity and sales in the short-term.
Bottom in sight?
Market action suggests some type of economic bottom is in sight. Think of it like this: The level and the direction of stocks is the equivalent of the collective wisdom of millions of small and large investors. They are not simply opinions, but real people and institutions that buy and sell equities effectively as they say, putting their money where their mouth is. No one has a crystal ball. No one can tell you where stocks will be at the end of the year because there are too many unknown variables. Those who make forecasts are simply offering opinions and those opinions and forecasts may be right or may be wrong. Opinions and forecast are interesting as there is usually some sort of bias involved. To illustrate and perhaps get you to smile ?, my opinion is the NY JETS are a great football team and my forecast is they will win the next Superbowl. It is clear that as a lifelong die-hard JETS fan, my opinion and forecast are deeply biased and unfounded. Fantasy Football aside, I understand the uncertainty facing all of us. We are grappling with an economic and a health care crisis. It’s something we have read about in historical writings, just something most of us have never faced during our lifetimes.
The Rational of the Capital Markets
A good way to think of how the capital markets function is to think how the folks who oversee corporate capital are thinking. These are highly compensated men and women who run the well-financed, fortune five hundred companies in the S&P 500- they are, as a collective group, rational actors acting to make decisions to preserve the long-term health of the companies and the shareholders they serve.
In periods of cyclical or event-driven financial and/or economic contraction (COVID-19, The Financial Crisis, 9/11, Tech Bubble), rational companies take action to preserve their corporate capital. They may lay off employees for whom there is no work. They may reduce manufacturing due to lower demand. They may close facilities altogether and sell off excess inventory (sometimes at a loss) to help shore up their balance sheets. Furthermore, some companies will take even greater defensive measures such as, reducing or eliminating their dividends paid to shareholders. Any dividends paid to shareholders when earnings are significantly down or even nonexistent simply drain corporate cash.
While all this is going on, there is no doubt the financial news will be shouting about the financial apocalypse with tumbling earnings, slashed dividends and falling share prices. Rest assured in knowing that rational companies take all of these steps mentioned above to endure and to persevere. Taking what may seem like drastic measures, helps these companies emerge as leaner, stronger, better financed and well positioned for when the storm ends. Then with the birth of the next economic expansion they can be even more opportunistic.
A Return to Personal Fiscal Priorities
Once the world returns to normalcy my hope is that this crisis, this hardship we have endured, teaches us a valuable lesson. A lesson I hope we can all learn from and design an even better version of ourselves and for our society. The hard reality is that many people in this country were not financially prepared for a crisis. Many are living paycheck to paycheck and even some with high incomes are spending well beyond their means. Many of the latter thought they could just keep earning to maintain a certain lifestyle they were accustomed to. This is all due to a lack of financial priorities- building of emergency funds, saving and investing diligently for future liabilities such as affording college for your children, an income you cannot outlive, health care, etc.
“You only find out who is swimming naked when the tide goes out” – Warren Buffet. I love this quote. Perhaps those caught with their pants down as the tide just went out will be a lesson in humility. But the bright side here is people can learn from this! They can get their affairs in order and make smarter decisions about their money to avoid making the same mistake twice. When the world returns to normal, and it will at some point, I can reimagine this as an opportunity, a second chance for people to take their finances seriously. Think about the impact we can all have on ourselves and how much better off our county would be as a whole if there was a shift in financial priorities. It is unsettling to me that so many went into this crisis with very little savings. There needs to be a shift in priorities, a shift from taking on too much debt to buy things like big screen TV’s and flashy cars with no money in the bank. A shift from credit card debt with sky high interest rates to an emergency reserve of cash and a well-financed retirement plan. A shift from this consumption economy, constantly having to spend buying the next shinny object. For many this is like a sugar rush only to come down with the burden of greater levels of debt. A shift from working hard simply to consume more goods and services to working hard to save and invest diligently for a better future. To have and enjoy some level of financial security and prosperity, isn’t that the American Dream?
Please recognize that you are not in this alone. We are here to assist you as you formulate a plan. Putting together a plan is critical- It’s half the battle. Sometimes you may actually find out you are in a much better position than you realized, which will relieve an enormous amount of stress. Either way be proactive, not reactive.
I this hope you have found review to be helpful and educational. Let me emphasize again that it is my job to provide guidance and perspective to help you make smart well-informed decisions about your wealth so you can pursue all that is important to you. If you have any questions or would like to discuss any matters, please feel free to give me or any of my team members a call. As always, I am honored and humbled that you have given me the opportunity to serve as the steward of your wealth.
Michael Gold, CFP®, MBA
Founder and CEO, Wealth Advisor
Gold Family Wealth, LLC
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