There are several reasons why the US stock market looks like it might be having a Wile E. Coyote moment (where the cartoon character runs off a cliff and remains suspended in mid-air before plunging). Valuations have almost never been higher, thanks to decimated earnings and rising share prices since the March lows. Trade tensions between the US and China are bubbling over again as Trump threatens sanctions and apportions blame for the virus. There is huge economic pressure to return to normal daily life even though the virus is still present, threatening a worse second wave (as has occurred in past epidemics). And it is looking increasingly likely that economies are not going to come roaring back as they reopen, with many people either out of work or worried about their financial future. Corporate share buybacks, the largest single source of demand last year, are forecast to be cut by as much 50% this year. The stock market rally appears to be flying on fumes.
This is about par for the course these days. Investors have for many years had to ask themselves if the stock market still has much to do with the economy, thanks to central bank manipulation and government attempts to control the economic cycle. And as we hear that the Democrats are pushing for another $3 trillion stimulus plan on top the $3 trillion already spent, our economic system just keep getting more absurd. Before the virus forced economies to lockdown there were valid concerns about the high levels of government debt that are a drag on economic growth. Fast forward two months and those concerns appear to have been almost completely forgotten. The UK government has agreed to continue paying the nation’s wages until October, at a potential cost of £100bn, whilst heavily indebted US companies are being encouraged to survive by taking out more loans. Another $1,500 cash gift for American households is also under consideration. It is as though we have gone from having no money to suddenly having unlimited money. How is this possible?
Of course we haven’t got more money. In fact, as a result of the lockdown which put the brakes on production, trade and spending, we all have less money. The generous handouts we see in many countries today suggests that things are so bad there is no point worrying anymore. It is easier to ignore the long term damage than it is to deal with short term pain, but this is not a credible solution. The virus response has simply brought forward the day of reckoning, when the system of borrow and spend reaches its limits. The government response today is like a heavily indebted person who refuses to open their post in case there are more demands for payment – it chooses to ignore the inevitable slide into bankruptcy.
Short term thinking has become the norm and is one of the principal reasons why our economic system is under pressure like never before. The stock market may be detached from reality and the negative yields tell us the bond market is broken, but so is our system of government. The money creation we are seeing today, in order to bail out literally billions of people, is a fantasy. We have debts that are so substantial they can never be repaid through work and taxes, and no one has a plan to deal with them. No one in power even dares raise the question of how we return to a sustainable system of balanced taxation and spending, it would be political suicide.
Governments and central banks have boxed themselves into a corner. You can’t reduce the debt burden by lowering interest rates when they are at zero, despite what Trump might think – he clearly learned nothing from the post-financial crisis decade of ZIRP and rising debts. You can’t easily raise taxes on a nation of heavily indebted companies and households, and it is very difficult to wean people off government support when you have provided handouts every time the stock market threatens to goes down. It is not only our financial markets that have parted from reality, our entire economic system could be facing a Wile E. Coyote moment.
Richard McCreery is an investment adviser with over 20 years experience, based in the South of France. www.rmwm.jimdo.com Regulated in France by the Association Nationale des Conseils Financiers (ANACOFI), registration N° E004136. ORIAS member 13000050