Stocks fell Friday amid some profit taking. A contributing factor might have been fear that Congress would fail to pass a stimulus bill. But over the weekend, an agreement was reached. Both the House and Senate will vote on it today and President Trump is expected to sign it. The bill offers some small business relief, gives $600 direct checks to middle and low income Americans, and extends an additional $300 in unemployment benefits per week. Nonetheless, futures point sharply lower this morning.
On the surface, it would appear that the main concern is the rapid spread of a new strain of the coronavirus in England. Many countries quickly lined up to ban travel to and from England, although we learned last spring that travel bans aren’t all that effective. While the new strain appears to be more contagious than the main strain of Covid-19, it doesn’t appear to be more severe. Nonetheless, all the travel and leisure stocks are leading markets lower in Europe this morning and sending our futures down sharply.
Perhaps a second explanation is that markets are extended and profit taking is inevitable at some point in time. Normally, markets aren’t weak during the last two weeks of the year, but there are no laws of investing banning profit taking after a bout of irrational exuberance. While I don’t expect this morning’s drop to necessarily be the start of a short-term rout, when literally everyone is bullish and complacent, these air pockets can appear to remind us all that investing isn’t a one-way street going perpetually higher.
One old saw in the investing world is to sell on the news. Investors for the past month have been buying in front of a long delayed stimulus bill. Now that the bill is about to be signed into law, there is little more in the way of good news to look forward to. Yes, the vaccines are arriving. But the rollouts are not without their hitches. That is to be expected, but it is unclear whether they have been priced into markets. In reality, whether most of us that want to be vaccinated get shots in the second or third quarter isn’t all that important from a long-term equity value standpoint, but the psychological impact of delays or disruptions can have an impact. Clearly, the extended viral surge, which could be amplified by new strains, is likely to have a short term impact, and serve as a reminder not to be complacent.
My real concern at the moment, however, is the euphoria that is appearing in parts of the market, an emotion clearly tied to Federal Reserve policy to keep pumping huge amounts of money into markets that simply don’t need it. That is magnified now that the new stimulus bill is about to become law.
The pandemic, as we often discuss, has created massive economic shifts. We are home more often. That changes how we eat, work, and entertain ourselves. The corollary is that we travel less. Highway miles traveled are down. Air travel is still only about 1/3 of what it was at the beginning of this year. The response of both the Fed and Congress has been to float safety nets underneath to keep the most frail surviving. Hence, the direct checks and extended unemployment benefits. But when the Fed pumps trillions into the market through the banking system and financial markets, virtually none of that is reaching the most frail. It isn’t keeping your neighborhood restaurant open. It isn’t enticing us to take an expensive vacation. It just sloshes around looking for a home. And with interest rates near zero, that home could be the stock market, the bond market, a new home, or even bitcoin. Asset prices keep rising while spending remains constrained by viral concerns. Throwing more money out of helicopters isn’t going to entice me to go to a restaurant that might be closed anyway.
At some point, the Fed will have to put the lid back on the cookie jar. With that said, the Fed last week said not anytime soon. But despite the fact that the Fed reinforced its extremely dovish policy, stocks have fallen since the conclusion of its meeting last week, perhaps a sign that the market is beginning to consider that unintended consequences are a threat.
Surging stock prices don’t sound like a dour unintended consequence. But if asset values separate from what is the realm of normality, any smart investor knows not to overstay one’s welcome. To be sure, the pockets of exuberance today are just that, pockets. They are most evident in some recent new issues and the most speculative parts of the market. Note that even the former leaders like Apple#, Microsoft# and Amazon# have not been market leaders since mid-summer. Pauses in those names are healthy reminders that speculation is still somewhat contained. But a purge of some of the excesses can be a good thing, a reminder that stocks can go down as easily as they go up.
Indeed, the recent surge is slowing growth. Right now, schools across the country are planning to reopen after New Year’s Day. But as we learned last fall, intentions to reopen may or may not come into being. Restaurant shutdowns might be extended. There is a good argument to be made that the peak surge is upon us now, leading to better times in the months ahead even without full deployment of vaccines. But, for now, that is a prediction, not a reality.
Thus, we come to the end of the year with hope that 2021 will be a much better year. Earnings will clearly accelerate as the economy recovers throughout the year. That is almost a given. The pace can be disputed. The key will be interest rates, particularly at the long end of the curve. The $600 checks and extended unemployment benefits will help Q1 in particular, probably eliminating any thought of falling back into recession. If that is true, and the economy emerges from the effects of the pandemic, the key will be how the Fed reacts later in the year. While there is little doubt that strong Fed and Congressional action were needed last spring, there is now a strong argument that any further response should be tempered, particularly if the current surge wanes and life continues to normalize. If the Fed waits too long, and vaccines allow animal spirits to erupt as we race out of the bunkers and into the sunshine, there could be a surge in inflation. That won’t happen immediately. But the Fed has a long history of waiting too long. At a minimum, it needs to consider when to slow its pace of bond buying. Markets won’t like that when it happens. The good news is that it won’t happen today or tomorrow. The bad news is that it will happen inevitably.
French President Emmanuel Macron, sick with Covid-19, turns 43 today. Samuel L. Jackson is 72 while Jane Fonda is 83.
James M. Meyer, CFA 610-260-2220