2018-2019 A Tale of Two Realities
by Zach Marsh on Dec 6, 2019
With a couple weeks left in the year it seems pretty safe to say that this year will mark a complete reverse from last year. Last year, if you recall, was a year in which nearly every single asset class in the world was down. Diversified portfolio allocation provided no protection from loss, as every alternative investment option proved to be a dead end—with some assets being “less” bad than others. This year, the opposite appears to be true. To quote the song from the original Lego Movie, “Everything is awesome.” In a complete reversal of fortune, nearly every asset class will post positive returns for 2019. So the question is, what changed?
How do we go from all bad to all good simply by flipping the calendar? If the bull market appeared doomed last year—and on Christmas Eve, last year, the market kind of felt, if not doomed, at least a little “doomy”—was there a fundamental change that occurred that made it all better? I suppose the answer to that question is yes and no. Ironically, when answering the question, we may shine a little flashlight into a corner, exposing a few of the reasons why populism and progressivism have been on the rise across the developed economic world the last number of years.
The answer to what changed on January 2019 that caused the market to reverse its downward trend from 2018 is that the Federal Reserve changed its mind. In fact, not only did the Federal Reserve change its mind, but so did central banks across Europe, Japan, and Australia. In a concerted and coordinated effort, central banks across the world changed course from raising interest rates and/or reducing easing measures, to lowering rates and/or resuming quantitative easing. The change of heart happened nearly as soon as the calendar flipped.
On December 19, 2018 the Fed raised interest rates ¼ of a percent and projected that there would be 2 more interest rate hikes in 2019. The stock market, which had been anticipating the hike since Powell signaled it in late November, fell 15% from November 30th to December 24th. Then on January 4th of the new year, Jerome Powell stated that the Fed would now be “patient” in its approach to monetary policy. The bond market responded to the change of heart by immediately pricing in a 25% chance of a rate cut in 2019 and a 0% chance of a rate hike. In two short weeks the monetary policy outlook went from 2 hikes in 2019 to 0, with a chance for a cut. In essence, the script completely reversed. By June the Fed cut rates for the first time, and in October they cut for the 3rd time.
In one year the Fed Funds rate has fallen ¾ of a point, and the S&P 500 is up over 25%. Since March 2009 the S&P is now up over 370%, while developed international stock markets are up over 175%. The recovery from the 2008 Financial Crisis from the perspective of the financial markets has been swift, complete and magnificent. Yet, when you follow politics across many of the western countries, it seems to tell a different tale. Unlike Dickens’s “A Tale of Two Cities,” which contrasted the lives in Paris and London during the French Revolution, this last decade has been “A Tale of Two Realities.”
One reality as illustrated by the stock market is that the world economy is booming, and that progress and opportunity are increasing. The other reality, as illustrated by political movements across the world, is that the opportunities for a vast number of people are declining, and that fear and worry are rising. How can these two realities co-exist? I can’t help but think that the answer to what changed in January 2019 to cause the market reversal is also the cause of the chasm between the two realities. Global central bankers’ response to the 2008 crisis has been to dump money on/in the market. Using easy interest rate policies and direct capital infusions, the banks have poured money into the market, with the simple, reflexive response being the markets have gone up. The intention of central bankers may have been for the money and benefits to flow down to the masses, and maybe that has happened, but a lot has stayed up at the top.
The divide between the top and bottom has grown substantially since the beginning of this monetary experiment in 2009, but I believe what is creating the political upheaval across the globe is the degree to which the middle has been left behind. In his book “Influence,” author and behavioral psychologist Robert Cialdini discusses the impact of scarcity on starting revolutions. He describes that a common thread across revolutions in the past is that a group of people have been given a taste of something, say a better life, and then have seen that decline. While they may be better than when they started, the falling down from the higher levels triggers a scarcity response, and they now feel worse off than they ever did before.
For the middle classes across the US and Europe, the monetary policy that has lifted markets has failed to lift them back to the lives they had before. Perhaps those lives were lives they saw their parents live or maybe the lives they lived 15 years ago as adults. Either way, it seems as if the “Tale of Two Realities” is careening us toward something dramatic down the road.
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