The stock market continues to trade vigorously, with the S&P 500 in touching distance of all-time highs.
This bullish behavior has many investors confused. Those who are optimistic about a U.S. economic recovery think the market is looking past the short-term news and forecasting blue skies ahead. Those paying attention to the data, meanwhile, are left wondering whether the market has lost its mind.
The answer, in our view, goes back to the inevitable nature of stimulus, and the “policy reaction function” of the central bank. What the market understands is that, the worse things get now, the more stimulus that will have to come later.
To put it another way, a dollar not spent staving off economic collapse today — if the initial stages of collapse are allowed to unfold — could mean 10, 20, or 100 stimulus dollars that have to be spent tomorrow or down the road, after the collapse damage intensifies.
In keeping with our Mutant Goldilocks hypothesis, this is awful news for the economy — but bullish news for paper assets, including the stock market. And that is where we are.
Last week, confusion intensified with the collapse of congressional stimulus talks.
As of July 31, tens of millions of Americans are standing on the edge of a financial cliff. The last day of July marked the expiration of a $600-per-week boost to unemployment benefits. It also ended a federal-level eviction moratorium that provided cover to as many as 20 million households.
A national survey from the U.S. Census Bureau indicated 27% of American adults — more than one out of four — missed their July rent or mortgage payment. Of those who rent, 34% expressed little to no confidence in their ability to make an August payment.
Then, too, millions of Americans who had used the $600-per-week in extra unemployment benefits to help with a rent or mortgage payment no longer have that cushion. Without the extra top-up, families are finding that standard unemployment benefits help with food and other essentials, but little more.
Given the above, and the looming end-of-July deadline, there was widespread expectation that Congress would reach a deal on extending the extra unemployment benefits, and possibly the eviction moratorium.
Instead, the stimulus talks failed. The two sides could not come to an agreement, and, in spite of the stakes — and the potentially horrific cost of outright failure — some wanted no deal at all.
In light of the “no deal” result, the White House issued a series of executive orders, mandating various forms of relief and eviction protection, to try and step into the breach.
But legal experts and policy scholars say the executive orders are not at all likely to work, for reasons both constitutional and logistical.
To briefly explain, only Congress has the ability to spend taxpayer funds; the executive order language around evictions appeared to be more “suggestion” than “order,” and would not actually protect renters; and even if the orders were legally implemented, the states would have to run the relief payments through nonstandard channels that could take months to set up.
In sum, no relief is coming, and Washington has failed utterly in its effort to keep tens of millions of Americans from falling into a financial abyss.
As a result, America could soon be recreating a modern version of the 1930s “Hooverville” phenomenon — mass-scale shantytowns populated by the newly evicted and homeless.
Then, too, even if Washington delivers a last-minute stimulus patch-up, the U.S. economic picture was already grim, and nowhere near indicative of a bounce back.
For example, a survey from CreditCards.com suggests “nearly 80% of credit card holders say they’re worried they won’t be able to continue making even the minimum payments on their debt,” CNBC reports, and “1 in 4 people say the pandemic has pushed them to take on more credit card debt.”
In addition, Bloomberg News did an aerial survey of U.S. economic activity in partnership with Orbital Insight, a data-tracking company that uses satellites, drones, and mobile phone geolocation to analyze real-time snapshots of foot traffic, parking lot density, and other forms of alternative data collection.
In analyzing the data, “the picture that emerges is not of a V-shaped recovery,” Bloomberg reported, “but of an economy that’s being reshaped, taking its time to heal and threatening to leave permanent scars.”
The pandemic is also leaving scars, as the total U.S. case count surpasses 5 million, the Midwest braces for a new surge of infections, and states heavily dependent on tourist revenue, like Florida, see revenues and budgets implode.
Remember Mutant Goldilocks. The uglier the picture gets today, the more that the Federal Reserve, and the U.S. government, will have to do tomorrow.
As the saying goes, “an ounce of prevention is worth a pound of cure.” Letting the economic situation unravel means swapping ounces for pounds, and, quite possibly, trillions for multi-trillions, or ultimately even tens of trillions.
In light of the policy reaction function, a scenario where the United States tumbles headlong into the mother of all Great Depressions — worse yet than the 1930s — would be a complete unknown for equities.
And yet that unknown would have massively bullish precedent, as paper asset valuations tend to soar, or even go straight up like a rocket, when a currency is debased so intensely it begins to die.
If it gets not just bad, but really, really bad, the combined forces of monetary and fiscal response would take the financial system to parts unknown. In a scenario such as that, who knows what the proper valuation multiple is for an inflation-proof stream of cash flows. Forty times? Eighty times? More? As the picture darkens, we’re increasingly likely to find out.
