Stocks Will Reach All Time Highs- Here Is Why... (05.12.20)

A lot has been happening in the economy since the Covid-19 and US in particular has been facing the most human causalities. In addition there has been financial and economic consequences due to shutdowns. Around March the stock markets were down from all time highs on an average of 40% down. Some stocks were above 80% down from all time highs. In the middle of the March market drop the FED and the US government took drastic steeps to supporting the economy. Drastic would be an understatement here compared to what they did in 08/09 Financial Crisis. To keep things as simple as possible I spell out the pieces of what the FED and US government did in March 2020 that effectively has allow the markets to recover somewhat and potentially have more rallies to come. I by no means am bullish on the markets long term, but wanted to post information for people to understand some of the reasons why the market has recovered significantly since March and what to expect in the next few weeks to months.

$2 Trillion Stimulus Bill - Coronavirus Aid, Relief, and Economic Security Act

In the 2008 Great Financial Crisis there were two bills that was used to stimulate the US economy. First was a $152 Billion tax refund bill and a $787 Billion in spending for the American Recovery and Reinvestment Act. That is a combine total of $939 Billion. Now 2020 the Covid Bill that was passed within a month of its first creation in March 27 is a whooping $2 trillion. That is $2,000 Billion, more than double the 08/09 crisis. Below chart is a breakdown of the $2 trillion spend Courtesy of Visual Capitalist.

What to gather from this billion is that over $800 Billion are used to support corporations and businesses while $600 Billion is for individual tax payer assistance. This bill is mostly serving to assist and quite literally try to save large and small businesses. In a high level perspective just understand that the $2 trillion bill was passed during the time markets were in a free fall weeks earlier. The reaction by the US government to the markets is dramatically faster than that of the Great Recession. In comparison the stimulus in the Great Recession was not pass until February of 2009 , which then had the markets bottom in March 2009. The markets were in turmoil with nearly 50% drop from all time highs in 2007 to March 2009.

To add on to the $2 trillion stimulus by end of April the US government pass another bill of $484 billion to extend help mostly to small business loans. So it is a total of close to $2.5 trillion spent by the US government that have deployed or will be very soon in the hands of corporate businesses use. To summarize the US government basically stimulated the US businesses immediately during the chaos of the Covid-19, shutdowns, and market drop. It should not be a surprise if some of that money is already making an impact on the economy which in turn help lift stock market prices.

FED Funds Rate and Stimulus

In economics there are two essential parts to stimulating the economy. They are fiscal and monetary policies. Government provides the fiscal policies while central banks, in the case of the US is called the FED, provides the monetary policies. So the FED for monetary policies control the cash flow in the economy with the use of interest rates and physically adjusting the quantity of dollars in circulation. On March 16 the FED had cut interest rates to 0-0.25% which basically meant zero. They also went with $700 Billion in qualitative easing (QE). Story reference here from Marketwatch.com. A simplified explanation of QE is the FED would provide cash to purchase US assets such as US treasury bonds and mortgage back securities. In other words what US government owns is sold to the FED for an amount of cash. The idea is once the US economy is healthier the government will receive higher tax revenue and in turn be able to pay back the FED and retake the assets that were sold to.

Reality is the government has been unable to pay back all the loans borrowed from the FED and on top borrowed from other countries. The country is currently running at a $25 trillion in deficit and climbing. Similar to the US government the FED within days double down on stimulus to the economy by promising infinite amount of QE. During the Great Recession the FED put on a limit as to how much QE they would allow to spend. Currently that limit has been removed! So what does that really mean? It basically means the FED is providing limitless capital toward buying US assets. Chart below is from NorthmanTrader Twitter handle

Look carefully at the chart and noticed during the 2008-2013 the monetary policies injected over $1 trillion in new money to the US economy. Compare that to 2020 where almost the same amount was put into the US economy but within a few short weeks. The resultant of the stock markets was a recovery from March lows and is currently still rising.

FED purchasing US Assets

Earlier I talked about QE being a form of purchasing US assets by the FED. However the FED currently by law are not allow to buy stocks which in turn the markets. The idea here is because the FED creates cash out of thin air and can go infinite can lead to asset bubbles. So not allowing to buy stocks would mean they are not going to inflate stock asset values. However there ways the FED have been blowing bubbles in asset prices and continue to do so. The bottom line is the FED is inflated the markets so that on the surface impression is assets remain valuable while the economy takes time to recover from Covid-19.

I digress. The way the FED has or will start to purchase stocks is by hiring a financial firm, Blackrock, to purchase bonds, inside exchange trade funds, to prop up value in those bonds. The bonds in specific are corporate bonds and bonds that are related to businesses loans. Go back to the why the stimulus bill was over $2 trillion is that most of the money was to help businesses survive the Covid-19 pandemic. The FED would be allow to own corporate bonds since its an asset similar by definition as to that of a US Treasury bond. The twist here is that FED is buying the bonds through stock market with the use of exchange trade funds (ETF). In simple terms an ETF is like a bundle of stocks all own under one stock symbol and is group based on specific type of assets. An example of corporate bonds held in ETFs that the FED will be purchasing are LQD and HYG. <a href"https://www.zerohedge.com/markets/fed-will-start-buying-bond-etfs-tomorrow-blackrock-make-over-10-billion-fees">Zero Hedge Article on FED purchasing ETFs.

Final step to markets reaching all time highs?

I put this part out there as question because we have yet to see if the actions currently taken by the FED and government has been enough to keep the markets from crashing again. The reality is there are over 30 million people without jobs and multiple states' economies are mostly inactive due to the current shut downs. The facts are the US economy is currently in terrible shape which should lead to poor performance in corporations. The poor performance should in turn mean lower equity prices in stock market. However it is not the case as current we are witnessing stock indexes closer to all time highs and green for the year like the Nasdaq!

The FED and US government have actually executed the largest stimulus to date in the history of this country in order to maintain some normalcy in the markets. Is this enough will be in question as the real economy is still struggling to find its footing even though assets prices on most things have remain as is before the pandemic. If in fact it is not enough help to support the markets the FED has one more piece they can do and that is to rewrite the law and be able to supply cash to purchase stocks outright. Now US government would have to rewrite the law, but the FED can essential create infinite money supply to prop up stock prices.

A case of this has existing and still operating. In Japan their central bank has systematically been supplying currency to purchase stocks in order for markets to maintain asset value. This has been done for over a decade and the results are not optimistic. Wikipedia info on Bank of Japan. Japan's stock market has yet to achieve all time highs since 1998 even with the central bank supplying the money. Why is this? That is a difficult question to answer, but I only bring this up because the US economy is currently in this trajectory. Now not to say we will follow the Japanese model, but conditions are forcing the FED and government to take actions that ultimately leads to what the country of Japan has face for the last two decades. That is very low interest rates and little to no growth in GDP.

I will end my post on a better note. What I have listed here were actions done by the FED and government that goes way beyond anything the country has ever done in the form of stimulus to supporting the US economy. It is close to purchasing everything but not exactly. Through difficult times such as the Great Recession, World Wars, and other crisis the country had prevailed. Whether financially stronger or weaker the country moved on and people lived on. So what ever has happened and will happen the country will still exist after this crisis. It is not the end of the world.