More than a decade ago – during the housing bust, the financial crisis and the Great Recession – we entered a new era of “administrative markets,” where stock market returns are affected as much by government policies as by corporate profits.
At the time, we all thought this was temporary. Now it looks like a permanent development.
Over the last 12 years, we’ve seen corporate bailouts, multitrillion-dollar deficits (aka “fiscal stimulus”), zero interest rates, multiple rounds of quantitative easing, punitive trade wars and federal debt that is now bigger than the economy.
Some of these measures provided stability and improved consumer and business confidence, a key requirement for strong economic growth.
But over the long run, these measures distort markets. And disorient investors.
That was clear last week when investors showed their disappointment – exiting growth stocks en masse – after Federal Reserve Chairman Jerome Powell hinted that he has no plans to do anything about rising interest rates.
(The 10-year Treasury yield – the bond market’s most-watched benchmark – rose from 0.9% at the start of the year to 1.55% last week.)
Higher rates make it more expensive for consumers, businesses and governments to borrow.
They also provide investment competition for low-yielding equities.
That’s why a lot of no-yield stocks got a serious haircut last week, while dividend payers actually rallied.
The glamour stocks were overdue for a trim, in my view.
In a column here several weeks ago, I noted that the market value of Tesla (Nasdaq: TSLA) was completely divorced from ho-hum realities like sales and earnings.
(It has since plunged more than 250 points a share.)
I also cited the temporary insanity in “meme stocks” like GameStop (NYSE: GME), BlackBerry (NYSE: BB) and AMC Entertainment (NYSE: AMC), pointing out that they were guaranteed to fall.
(GameStop traders still haven’t learned their lesson, apparently, and have crawled back into the ring for Round 2 – and an eventual knockout that is no less certain than tomorrow’s sunrise.)
These developments – along with record call option trading, record margin debt and extreme foolishness in cryptocurrencies – were clear signs that “animal spirits” were loose in the markets.
Now investors are shocked to discover that the Fed plans to do what it said it would do: Let inflation run higher than usual in order to promote employment and economic growth.
It’s a mistake to put too much faith in the “Greenspan put,” the idea that the central bank will do whatever it takes to backstop the market.
The Fed’s dual mandate is stable prices and maximum sustainable employment.
“Forever rising stock prices” is not part of the job description.
Don’t get me wrong. It’s natural and desirable for the central bank to step in and support the financial markets during emergencies like the financial crisis and the pandemic.
But it’s dangerous to believe that Powell & Company – and a free-spending Washington – always have your back.
In particular, I’m concerned about the next emergency or serious downturn.
What will the Fed do? Take interest rates from zero into negative territory, like Japan and parts of Europe?
What will Congress do? Take the debt from 100% of GDP to 150% or 200% of GDP?
After a while, it will be like pushing on a string.
And that’s the problem with government programs. They create dependency… a sense of entitlement… and moral hazard.
There’s a good case to be made that the new $1.9 trillion stimulus package is too much, too late, especially since much of it won’t even kick in until next year.
It will be interesting to see how Uncle Sam weans consumers, businesspeople and investors off this largesse.
Stock prices used to rise or fall on something more predictable than government policies and statements from officials.
Sales, earnings and margins were paramount. They ought to be again.