As the mind virus of misplaced optimism and irrational exuberance continues to spark a rise in both the S&P 500 and the DOW, some of their mesmerized investors have been arguing a new bull market is dawning. But that is premature, as I will show, especially given these investors may not fully appreciate the extent to which the economy (and stocks) hinge on controlling the virus, and hence the success of reopening without further lockdowns. Let's say the jury is still out.
What we do know (cf. WSJ. July 7, p. C2) is that between February 19 and March 22, the S&P 500 fell by more than 30 percent, putting into Bear market territory. (By general definition, a "bear market" is taken to be a drop of at least 20 percent . Similarly, a 20 percent recovery puts an index back in a bull market. However, if you've fallen thirty feet into a hole, does getting two thirds of the way out of the whole count as being "out of and above" the hole? Not really.
To be fair, the market has now rallied 40 % since March 22 - thanks to near zero interest rates (signaling cheap money, and other Fed support, i.e. buying up bonds) to enter what many regard as legitimate bull market status. So many are thinking, "Hey, we're out of the hole and now really in a proper bull market!" But not so fast. As the WSJ 'Business & Investing' piece observes:
"Such rallies can be robust but short -lived. The bear market during the 2007-08 recession included a rebound from early March, 2008 to mid May 2008. Then the downtrend continued."
That may well happen in this cycle as well. Recall in an earlier post I warned about the risks of excessive leverage, e.g.
http://brane-space.blogspot.com/2020/06/is-financial-repression-solution-to.html
Noting:
"Both individual investors and whole companies have now taken to the leverage 'drug' to place their market bets using borrowed money. The losses they have accrued, along with decades of trillion dollar tax cuts, have helped to monumentally add to the $164 trillion in global debt. But WHO is being asked to pay now, even with the party still going on? Well, the average Joe and Jane on Main Street.
In a separate WSJ piece, Paul Hannon warns us:
"In the U.S. and elsewhere, government debt is set to soar this year, reflecting lower tax revenue and the cost of financial aid to households during lockdown. The International Monetary Fund forecasts that U.S. government debt will reach 131% of annual economic output this year, up from 109% in 2019."
Hannon makes clear Joe and Jane American are going to have to pay the piper, especially if we are to avoid bank collapses" (Warned about in a sobering article for The Atlantic’s July/August 2020 issue )"
The argument I made then and which I believe applies now, is that these hyper optimistic investors feeding the current rally are not factoring in the immense risks if we are unable to get the virus under control. All they see now is a light at the end of the tunnel, but that light may well be illusory- especially if there's no real vaccine for 2 years or even more. Couple that with Senate Republicans blocking any further stimulus even as the last financial cushion expires at the end of this month (not to mention the eviction moratorium ending in two weeks) and you have a debt bomb going off and utter calamity.
This is also reinforced by the recent Business & Investing WSJ piece ('Crisis Upends Corporate borrowing Binge', June 24, p. C1) noting how companies "had loaded up on debt after years of low interest rates, buyouts and increasingly lax lending standards." Worse, with much of that debt "bankrolled by an elaborate ecosystem of debt funds called collateralized loan obligations, or CLOs". Which we then learn (ibid.):
"Buy up risky corporate loans and turns them into supposedly safe bonds, bought by banks".
Sound familiar It should because the "elaborate ecosystem of debt funds" also appeared back in 2007-08 but under the name credit default swaps, e.g.
The Financial Black Hole
And those financial entities nearly brought the entire financial system crashing down. See e.g.
http://brane-space.blogspot.com/2020/05/the-equation-that-nearly-brought.html
The point being it is way, way too early to proclaim a viable bull market, given so many countervailing factors many of which carry vast hidden risk if elements go sideways. Perhaps one of the few rational inputs on the situation comes from Anupam Damani, portfolio manager at Nuveen, who terms what we are seeing a "bear market rally". As expressed in the earlier (July 7) WSJ piece:
"She says the rally since March was the result of extra liquidity provided by the Fed, and she sees a disconnect between the fundamental weakness in the economy and the strength of the stock market."
In other words, the investors already betting on a bull market are living in a fool's paradise. Maybe that will change when they behold consumption dry up because of lack of stimulus $$$, and millions tossed out onto the streets after being evicted from their apartments in the midst of a pandemic. Oh yeah, and when they see the banks stuck with over a trillion in toxic business loans on their books.
Stay tuned.
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