THE WEEK IN REVIEW: Feb. 21 – 28
Too much of a good thing?
The market hit new highs mid-week on stimulus hopes, expectations for economic improvement and comments from Federal Reserve Chairman Jerome Powell that the Fed will keep rates low for an undisclosed period. That all sounds great, except when you start to consider that too much or even misguided stimulus combined with hyper-growth and fueled by extremely low rates could be just the recipe for a sharp and hard market decline.
Let me elaborate. Most will agree that the virus-induced shutdowns have hurt the economy and individuals. Policy mistakes were made over and over again, priorities continuously shifted and people suffered. Now we have a $1.9 trillion stimulus moving through Congress that is meant to address and redress many of the problems those policy mistakes and shifting priorities created.
Hopefully, this will alleviate much of the economic pain the country has endured. The problem is we’ve already borrowed and spent so much with little to show for it, other than a massive increase in debt. Sure, some of the money will go toward small businesses and there will be payments to individuals. But much more will go to other causes that have nothing to do with pandemic relief. It will also take years to pay out and increase the size of the government. Why does that matter? More debt means more interest payments, which equals less capacity to borrow in the future and fewer funds available to reinvest in our economy and society.
The good news is that the economy is set to expand dramatically in the first quarter, as vaccines become much more widely available and spring approaches. In my opinion, a targeted, smaller stimulus addressing virus-related issues would be far better than a sprawling, all-encompassing bill that tackles needs that have nothing to do with our current mess. It all begins to look like quid pro quo meant to reward supporters disguised as a relief bill. And don’t forget the nearly $4 trillion (plus more if you count the Fed’s efforts) of stimulus last year.
How is all this borrowing and spending possible? Fed Chairman Powell’s testimony before Congress this past week reaffirming the Fed will keep rates artificially low is one major reason. My question is simple: If things are improving, can we really pump all this additional money into the system and not expect a bad outcome? If rates remain low and the economy is booming with cash, what can happen?
The sad truth is that, with so much money out there, people will spend more and some may even do so recklessly. In response, it is likely that prices will go up and we’ll have inflation. The Fed will have to act because it cannot ignore inflation forever; and history has shown that rates will go up and the equity markets will decline. Inflation and the Fed’s ultimate response are not the only things we should worry about; the markets themselves will have a say in where we head from here.
It’s time when the 10-year says it’s time.
The day after we saw record highs, the 10-year U.S. Treasury spiked to over 1.5%. The spike happened after 7-year treasuries failed to attract much attention at the bond auction, forcing the 10-year yield to rise. That sent a shudder through the stock market and the Dow dropped over 550 points to end the day Thursday. When did that ever happen? Record high one day, down 1.75% the next day? The bleeding continued on Friday and we limped into the weekend.
As the 10-year Treasury rises, the equity market will be on increasingly thinner ice. This ties back to what I was saying about additional stimulus and debt. Higher rates mean more money is needed to service the debt and less is available to use elsewhere. Higher debt begets higher rates; if you owe money and need more, you will be charged a higher rate because you have become a higher risk. See how that works? Higher rates will attract more conservative investors who have gone looking for income in less traditional places, so they generally sell out of those to invest in investments with higher yields and lower volatility.
Apologies for having more questions than answers this week, but I have one more. What other tricks does the Fed have? Since the financial crisis, the Fed has been pulling one financial rabbit after another from its magic hat. Sadly, it appears the Fed is scraping the bottom of that hat.
In summary, I have been concerned about this market and its sustainability since the beginning of the year. I’m not saying we are ripe for a correction, but I would be cautious at these levels. It may be time to consider getting more conservative in posture if you have a more immediate investment horizon. In the longer three- to five-year period, I feel we will be at higher levels. However, the near-term has me somewhat concerned.
Coming this Week
  • February jobs will be highlighted this week, with the ADP Employment Report on Wednesday and the Employment Situation on Friday. Weekly unemployment claims continue to be elevated, and it will be interesting if we continue to see improvement or begin losing ground. January unemployment fell to 6.3%, and there were only 49,000 new jobs created.
  • Sandwiched between the ADP Report and the Employment Situation, the new weekly jobless claims on Thursday could add fuel to the fire in one direction or another. If ADP is strong and claims decrease, a solid jobs report on Friday could boost the markets. If the opposite occurs, it could make for a tense ending to the week.
Have a great week!
Tom Siomades
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