Worst Economy versus Best Stock Market

The quarter with the worst economy since 1929 and the best-performing markets since 1998

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Source: IMF

The worsening forecasts of the International Monetary Fund, the statements by the Chairman of the Federal Reserve, Jerome Powell should leave no illusion on the depth of the recession.

The contrast could not be more striking between Wall Street and Main Street. The real economy succumbs to bankruptcies and unemployment. The United States will probably see a 20% decline in this quarter and at least an 8% decline for the year 2020, according to the International Monetary Fund. However, Wall Street had its best quarter.

Those who try to get their cues from the equity markets have been told a lesson. The movements on Wall Street do not contain any “message” on the economy. Listening to some optimistic Wall Street analysts, one realizes that they have become infatuated by the “reading” of the market grapevines. Their optimism — while the economy collapses — does not make any sense.

This table cries fool.

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Source: S&P

The earnings of the S&P 500 have been decreasing since 2012 while the S&P 500 index went up 200%. Earnings are expected to be at least halved, but the price of stocks surged. Normally the Price to Earnings Ratio, comparing the price of stocks to company earnings, has been around 13 to 15. In 2020, the Price to Earnings Ratio is likely to be between 30 to 40 times at today’s market price. Driven by tech firms, the market ignores what is happening in the other 75% of the economy.

The bubble of 2019 was a demonstration of an increase of 30% in the middle of a decreasing economy and flat earnings.

The Supply-and-Demand rule of Economics 101 is the dominant factor in how markets work today. They can be dealing with an economic collapse, while stocks are surging. The reason is simple: the price is the result of sufficient people wanting to buy stocks.

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Share buybacks over the past years. Source: S&P.

If liquidity in the market is increasing (thanks also to the Fed), investors will choose between assets that produce the most expected returns. In this quarter, it was the equity market that was giving the best returns, when interest rates went to zero.

The recent actions of the Federal Reserve completely ignore the fact that the economy could not absorb $3 trillion in a few weeks. This $3 trillion Fed present had to go somewhere: it went to fuel the market rally, little of it went to the economy.

Additionally, going into high yield and Main Street lending, the Fed turned its back to its mission and started managing the credit spread and nationalizing the credit market.

The submission of the central bank to the yearnings of the market is now fully exposed. Even recent statements of the Fed prove that they lost track of their mission: providing liquidity to the banks who are equipped to handle credit risks and have the equity to absorb non-performing loans.

I expect the losses to emerge and destroy the little that remains of the “equity” of the Federal Reserve.

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Source: JPM

This table says it all. While most central banks intervened for 10% or less of the country’s GDP. With the exception of the Bank of Japan’s gluttony for Japan Government Bonds, the Fed injected liquidity representing 29% of the US GDP. Added to the US Government stimulus, it is 44.4% of the US GDP that has been injected in four months. The combination of those actions is stunning: the NCPR projections find that

  • Under current law, budget deficits will total more than $3.8 trillion (18.7 percent of GDP) this year and $2.1 trillion (9.7 percent of GDP) in 2021.
  • Debt held by the public will exceed the size of the economy by the end of the Fiscal Year 2020 and eclipse the prior record set after World War II by 2023.

Already, the Financial Times predicts that even with the current monetary policy of the Federal Reserve.

Time to focus on the real economy, employment, and debt

The current focus of the authorities and bank economists is basically wrong. How to keep companies who bought back $ 5 trillion of share buyback of the past five years alive?

How to keep the cash rather than distributing cash dividends? How to avoid the destruction of the households’ purchasing power? How to maintain some form of consumption?

No taxpayer money should be spent to boost equity markets.

Let the bubble explode.

Written by

CEO at Galileo Global Advisors and Adjunct professor Columbia Law School.

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