What a year! Like most folks, I could have done without the trials and tribulations of 2020. It’s been a year like no other in modern times and has become characterized by contrast and conundrums. A startling human toll with hundreds of thousands losing their life to a virus that nobody saw coming at the start of the year. Millions of people in the U.S. and around the globe infected.
Life was forever altered by economic shutdowns, quarantines, and shelter in place. Friends and loved ones lost to an insidious disease and longed-for hugs, friendship, and human closeness restricted. Businesses large and small challenged to the brink of bankruptcy with whole sectors of the economy pushed to the brink of extinction. Governments and central bankers waded into the fray offering lifelines to industry, states, and individuals to forestall a depression-like collapse and bridge the gap to a hoped-for recovery.
Work-life routine has also been upended, schools closed and then reopened only to be closed again. New work from home routines and Zoom meetings have become the mainstay of business meetings and personal communication for tens of millions.
You would think the markets would have slid into a historic bear market. Yet the economy and markets have shrugged off the damage from COVID-19, plunging over 30% in a few weeks during March and then snapping back to quickly recover most of the loss within a couple of months. Investors looked to the government’s backstop to shore up everything. Fundamentals be damned, the Fed “put” seems to be the only thing that matters. The amazing bull market in equities and economic recovery this year is nothing short of flabbergasting and seems to be a great demonstration of the resilience of the American spirit.
As I write this, the Pfizer vaccine is being distributed in the greatest coordinated distribution effort in history. The Moderna vaccine is staged to be released next week after it received emergency use authorization from the Federal Drug Administration (FDA) on December 18, 2020. And there are at least a half dozen other companies racing to bring their coronavirus-fighter to market. The hope of ending the pandemic is within sight and most of the U.S. population could be out of danger by summer. This is the result of a tremendous coordination effort between the government and “Big Pharma.” Both parties deserve to pat themselves and each other heartily on the back!
The biotech stocks at the heart of the vaccine development are enjoying stunning returns as investors factor in the hundreds of millions of doses that must be purchased. More exciting for many is the success they have had developing and deploying new gene mapping technology to build targeted drugs with extremely high efficacy rates. As the trading crowd looks for easy gains these stocks may become all the rage, replacing the social media stocks as the new FAANG favored by the markets.
Markets are also looking for more stimulus to grease the economic skids, to support employment, and help badly damaged companies. The much-needed pandemic relief that has been doled out to date is nothing more than a patch on a badly mangled economic and financial system. The Federal Reserve monetary policy provided massive liquidity support for the economy and markets since the 2008 Financial Crisis.
Unfortunately, Fed policy has also distorted the relationship between economic and market fundamentals and price discovery. While economic growth over the past 10 years has been anemic and sub-par, the stock market has maintained a bull market trend based on investors’ belief that the Fed backstop will solve all problems. Euphoria and speculation have fueled asset bubbles across a wide swath of investable assets. These types of conditions tend to unravel and when they do the potential loss of capital can be devastating. Current investor sentiment and behavior remind me of the tremendous run-up in tech stocks in 1999. The pricing bubble bust turned into the tech wreck in which the technology-heavy NASDAQ Index imploded causing massive losses. Today’s overvaluation is more extreme than in 1999 so the implied risk in markets today seems a bit like déjà vu.
Investors and the market are hooked on Fed policy support and government stimulus. In Chart 1, the FARBAST Index in white represents the U.S. Condition of All Federal Reserve Banks Total Assets, in essence, the Fed’s balance sheet. The CCMP Index in blue is the NASDAQ Composite Index representing the market. Every time from 2017 through December 2020 that the Fed has tried to withdraw support, the market craters as it did in 2018 and 2020. Market price distortion has never been more evident than in 2020 as the COVID-19 pandemic shut down the economy causing the largest decline in economic activity since the Great Depression. Economic contraction caused a huge surge in unemployment and eviscerated corporate revenue and profits and yet stock prices keep rising. It would be reasonable for investors to expect a deep and protracted bear market. Market indexes did fall hard and fast for a few weeks, but they recovered losses and charted new highs within months as the Fed and Government rushed to bail out the market with additional liquidity and stimulus.
Chart 1: Federal Reserve Balance Sheet Expansion 2017-2020
The same relationship can be seen in Chart 2 between the Fed’s balance sheet expansion and contraction during the late 1990s. Easy monetary policy leads to “Irrational Exuberance” according to Alan Greenspan, former Federal Reserve Chairman. With concerns over Y2K, the Fed expanded its balance sheet quickly in the second half of 1999 which drove tech stocks in the NASDAQ Index to an 87% gain for the year. Then it quickly reversed course withdrawing support and leaving investors out over the edge of the cliff as it were. The tremendous bull market turned into one of the largest loss events in history with the tech bubble bursting. The ensuing bear market rout caused the NASDAQ Index to plunge more than 77% over the next 2 years. Just to put that kind of capital loss in perspective: $1,000,000 invested at the beginning of 1999 would have grown to $1,870,000 by year’s end. After the bubble burst, the same account would have been worth approximately $430,000.
Chart 2: Federal Reserve Balance Sheet Expansion and Contraction 1997-2000
The Fed and government can’t afford to continue printing money at the current pace without exploding the deficit to unmanageable proportions. In the prior few years leading up to the pandemic conditions of 2020, the deficit was already expanding by an unmanageable amount of about a trillion dollars per year. With both the Fed and government throwing the kitchen sink at the imploding economy, the deficit is projected to expand in 2020 by $3.5 trillion. It may seem incongruent, if not a little insane, but we believe policy makers need to continue put the pedal to the metal to provide a large and sustained level of fiscal stimulus focused on infrastructure spending.
One of the seemingly biggest mistakes Congress made over the past 10 years was not matching the Fed’s accommodative policy with an equal measure of fiscal stimulus. The consequence of them not taking action appears evident in the anemic recovery that has led to a fragile economy and financial system. The economy needs long-term support that will only be provided by a large dose of fiscal stimulus that is focused on rebuilding economic infrastructure. The first phase of fiscal stimulus should be a strong commitment of at least $3 trillion. The second phase of the plan should include an additional $2 trillion in spending about four-to-five years from now. This would likely get the economy growing at a rate of 4% or more over the next five years and then keep it growing at that rate or better through the end of the decade.
Strong economic growth could heal the financial system and help pay down deficits to more manageable levels so we don’t unnecessarily burden future generations. And let me be clear, a failure to act would leave the economy and markets exposed to the same depression risk policy makers were trying to avoid in 2020. Hey, I’m not being the Grinch here, I believe in American ingenuity, resilience, and the power of capitalism. This is why I think the right kind of long-term stimulus plan can build a virtuous economic growth cycle which will likely drive a stunning new bull market.
I, for one, will be happy to put the trials and anxiety of 2020 behind us. We wish health and happiness in the new year to you and your family. And, as always, WBI will look to protect your capital from large losses, preserving your ability to hopefully meet your retirement goals.
Source of all economic data is WBI or Bloomberg as of 12/9/2020, unless otherwise indicated. Please see the Disclosure section for important information.
Don Schreiber, Jr. is Founder and Co-CEO of WBI, as well as Chief Visionary Officer of Award Nominated WealthTech Platform investwithcy.com and podcast co-host of Bull | Bear Radio.
Disclosures
The views presented are those of Don Schreiber, Jr., and should not be construed as investment advice.
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