With the S&P 500 already two-thirds of the way back from its bottom, that prospect -- that virus-fighting stimulus could linger for months or years after the worst of the pandemic has passed -- explains the uncanny confidence of stock bulls in the face of the worst economy since the Depression.
How willing will the Federal Reserve be just to switch off all the stimulus it rolled out to safeguard markets from the coronavirus? The most plausible answer is “not very,” logic that forms the most aggressive bull case on equities. As anyone who has watched the rocky path to reopening cities and states, it’s hard to know when to sound the all clear in waters as uncharted as they are now. Uncertainty dictates prudence. That’s the case in deciding when to allow people back to work, and will logically guide policy makers, too, when it comes to their measures that have kept markets in working order.
With the S&P 500 already two-thirds of the way back from its bottom, that prospect — that virus-fighting stimulus could linger for months or years after the worst of the pandemic has passed — explains the uncanny confidence of stock bulls in the face of the worst economy since the Depression. As they see it, if even a modicum of economic order is restored and stimulus sticks, it’s a recipe for a melt-up.
“The markets have become addicted to stimulus. That is the key factor that is going to continue to drive risk appetite, just like it did in the last cycle,” said David Spika, president of GuideStone Capital Management, which has about $12.5 billion in assets under management. “Going back to the last cycle, the Fed stayed involved for several years even though we returned to previous employment levels and we returned to previous earnings levels — and the Fed continued to buy bonds.”
Make no mistake: as big a role as reopening has played in the rebound, Federal Reserve largess, alongside trillions of dollars in payouts from Washington, has been as a crucial element lifting stocks. While the path of the virus is unknown — Will there be a second wave? Can a vaccine succeed? — one thing that seems certain is perpetual Fed support.
Policy makers are “not going to be in any hurry to withdraw these measures,” said Chairman Jerome Powell late last month.
That’s comforted equity investors, tamping down concerns over a credit crunch or solvency risk. Case in point: A Goldman Sachs basket of stocks with weaker balance sheets rose 4.3% this week, nearly double a similar group of stocks with healthier finances. Tuesday marked the widest gap in favor of the former since May 2009, when stocks were in the early days of their record bull run.
The embrace is also palpable across the universe of smaller companies, where over a third of firms are expected to lose money and per-share profits are forecast to plummet 95% in the three months ending in June, according to Credit Suisse. The Russell 2000 rose 6.4% in May, its best month versus the S&P 500 in over a year.
Crediting the Fed with boosting risk-assets is nothing new but its open-endedness may be the only way to explain a world in which 20 million Americans have lost their jobs and the S&P 500 is about four big days away from making up all the ground it lost since February. And it’s not just a full comeback that is envisioned. Many Wall Street strategists see the potential for the S&P 500 to go even higher than it was before the outbreak began.
Take Fundstrat Global Advisors’ Tom Lee, for example, who sees the S&P 500 ending the year at 3,450 even as company profits plunge. Or Sophie Huynh at Societe General, who predicts the S&P 500 will rise to 3,500 by the end of 2020. It closed Friday at 3,044.
The U.S. central bank has taken unprecedented steps to combat the economic crisis. It cut interest rates to near-zero and pledged to keep policy easy. It resumed asset purchases, declaring Quantitative Easing (QE) unlimited. The Fed is also buying a wide range of securities, including corporate and municipal debt.
As a result, the central bank’s balance sheet has ballooned to $7 trillion, with roughly $3 trillion added in just three months — roughly triple what was added in the year following the financial crisis in 2008. That increase is showing up in broad measures of money supply, including a gauge called money of zero maturity and Federal Reserve M2 money supply.
Such a surge in liquidity is reassuring the bulls. Michael Darda, chief economist and market strategist at MKM Partners LLC, says it shows there’s more upside potential for stocks than downside risk. A measure called the price-liquidity ratio that plots the market cap of the S&P 500 versus total money supply shows equities actually look cheap, even as earnings collapse. Add to that rock-bottom interest rates on bonds, and a stock bull case is born.
And if such stimulative policies remain alongside an economic recovery, its possible inflation will materialize. Tom Essaye, a former Merrill Lynch trader who founded “The Sevens Report” newsletter, points to the years after the financial crisis, when a liquidity explosion led to surges in asset prices — from stocks to bonds, real estate and gold.
“If past is prologue, the lesson is that we need to admit that this amount of liquidity means that asset inflation will likely be unleashed on the economy in coming years,” he wrote to clients. “That’s something we need to consider even in a slow-growth environment.”
Granted, all bets are off if economies must shut again, unemployment levels stay high and a wave of defaults emerges. Chair Powell has made calls for more fiscal stimulus loud and clear, and the latest beige book from the central bank — a report based on anecdotal information collected by the regional divisions — detailed the devastation that’s still apparent across the U.S. economy.
All the more reason, though, for Fed stimulus to remain if the economy is in need. This past week alone, Chevron Corp. and Boeing Co. announced permanent layoffs. Reports surfaced that SoftBank Group Corp. is planning deep staff cuts too.
“The general expectation is that the Fed is going to maintain its supportive posture,” said John Carey, portfolio manager at Pioneer Investment Management. “That’s definitely one of the factors giving people confidence in purchasing shares — they see very strong support from the Federal Reserve.”
To be sure, such extended policy measures could lead to ills down the road including the potential for run-away inflation, according to Sandip Bhagat, Whittier Trust’s chief investment officer. Still, it’s likely it puts a floor under the stock market for now.
“Don’t naturally assume it to be singularly stimulative with no side effects,” Bhagat said by phone. “But all the stimulus will prevent the market from melting down again, I just don’t know if it will sent it off to the races where S&P 500 3,000 becomes S&P 500 5,000.”