The Times They are a Changin'
by Zach Marsh on Mar 27, 2020
The Times They are a Changin’
“Avoid Crowds. Practice Social Distancing”
Department of Transportation Service Announcement
Three months ago the Orwellian message above would’ve or should’ve sparked outrage and concern about an overreaching government enacting policy to infringe on personal liberties. Now? Hey, we’re all just doing our part, right? This is one of many dramatic shifts we’ve experienced in the past few weeks, which has turned our world upside down. In a response that makes the steps taken by the federal government in 2008-09 look Lilliputian, the Federal Reserve and the US Congress have committed $6 trillion of life support to a US economy that has entered cardiac arrest. If the calendar read 2021 and not 2020, and you saw the new bills being passed by congress, you’d have assumed Bernie Sanders won the election. Such is the era in which we live; a reminder that change is the only constant, and nothing is more fragile, at any time, than the “current order of things.”
Volatility, Fragile or Sustainable?
At present, the current order of things is that massive monetary and fiscal stimulus is needed to prevent an economic catastrophe on the order of the Great Depression. The magnitude of current stock market gyrations only historical equivalence now is the ’29 Crash and the 1930’s. In 1929, the S&P 500 dropped over 40% from September to November; on Monday of this year, the S&P 500 had fallen 35% from its February peak. By the close of market yesterday, the S&P 500 had gained an incredible 20% from the Monday lows, a three-day gain not seen since 1931, which for those keeping score was just a short-term rally amidst a long-term downtrend. Drawing market comparisons from the 1930’s is never a good place to be. It reminds me of the baseball free agency market when streams of agents are demanding that their client be given a contract on par with another player’s contract from a previous off-season. Somehow these agents are oblivious to the fact that the contract referenced turned out to be a disaster for the team who signed him.
If we are looking to identify what today’s current order is then we have to start with market volatility itself. In the past month one asset reigns supreme, volatility, all other assets must take a back seat. Volatility is a special force, and one that is frequently misinterpreted. It’s difficult to divine definitive information from reading volatility tea leaves. Hyper-volatility, which is what we’ve been witnessing, is not only present in short-term crises, but at the beginning of long-term bear markets as well. Volatility’s role as the king of the assets is fragile and will most likely die down. While medical practitioners search for a peak in the virus contagion as a sign that we are beginning the path to recovery, last week’s high in the Cboe Volatility Index (VIX) seems to have potentially marked the peak in downside panic volatility. But peak volatility doesn’t necessarily mean a floor for stock prices. In 2008 the Cboe Volatility Index peaked in November, but the S&P 500 didn’t find a bottom until March 2009. Similarly, the volatility index peaked following the 9/11 attacks, but the stock market continued to trade lower for another year. Contrary to many market commentators, I don’t believe that volatility is a great predictor of stock market prices. High volatility can mark short-term bottoms, but long-term trends depend on other conditions than an ebb in volatility. Caution is prudent when coming out of high volatility environments.
Modern Monetary Theory, Fragile or Sustainable?
In days of yore, before Modern Monetary Theory[i], when economic cycles determine long-term stock market dynamics, we could rely upon the stock market to mimic, albeit forecast, economic conditions. Now it seems that all we need is a robust monetary policy to prop up the market via direct and indirect methods so that market performance effectively becomes disconnected from underlying economic conditions. This “current order of things” has been going on to one degree or another since the end of the tech bubble in 2001 but went on a steroid binge following the ’08 crisis. Most recent actions by the Fed and remarks from Federal members like Minneapolis President, Neel Kashkari that the Fed has, “an infinite amount of cash…(to) do whatever we need to do to make sure there’s enough cash in the banking system,” takes this steroid era to a whole new level. Fragile may seem too inadequate a word to describe the path that Modern Monetary Theory is leading us down. It is easy to say that up until now, MMT has not led us into unwanted financial conditions.
Inflation control, one of the Fed’s original policy goals going back to inception, has been tame. Quantitative Easing has yet to show signs of causing direct inflationary pressure into the economic system. However, that assumes that one doesn’t include asset prices as part of inflationary pressure. Stock prices, which have fallen so fast and so dramatically, most certainly were major beneficiaries of MMT following the ’08 crash. One could also argue that home prices were major beneficiaries of pre-QE MMT following the 2000 tech bubble crash. The $6 trillion question is what repercussions we will see from this massive cash-printing injection. Can we expect the current order of things to continue? Namely, can we expect low interest rates and “low” inflation in the future? Is there an end to this stimulus? And have we become an opioid-addicted, zombified economy unwilling to experience the slightest economic pain, yet travelling down a path which leads only to a greater future crash? My guess is that this will not be truly known for a while. Fed policy and the Congressional spending bills are good at doing one thing successfully, delaying.
I like running scenarios over in my head. I try to understand economics from an historical perspective, so I borrow from the past to build a story about the future. Today, the scenario that keeps running through my head is that of the Weimar Republic in 1920’s Germany. Faced with mountains of foreign debt following WW1, the German government turned their printing presses on and started pumping. Previously backed by gold, the new Deutsche Mark had nothing but “faith” backing it. Faith didn’t last long, and hyper-inflation soon prevailed. Few assets were spared the wrath of devaluation via inflation. But the worst asset to have held at that time was cash, with bonds a close second. Debt reigned supreme, and a debtor with a fixed rate loan would’ve been king.
I hope we are not headed down a path that leads anywhere in that direction. But it should be a concern and should be viewed as a warning that in an upside down world what seems like safety can often be misleading. Maybe the most prescient advice we can receive has come via the DOT, “To avoid crowds and practice social distancing;” but the crowds to avoid are the crowded trades populated by people who adhere to the current order. Fed Chairman Jerome Powell may not see the risk of potential future inflation, but something tells me Weimar Republic leaders didn’t foresee massive inflation either. Current volatility and uncertainty has many seeking the same comforts and safety, namely cash and other safe havens; yet the future should have us questioning those crowded trades.
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 60 Minutes interview aired 3/22/2020