We’ve had quite the roller coaster ride so far in 2020. Between the February/March drop in the market to the subsequent bounce to today’s big sell-off, a monumental struggle is underway as investors try to make sense of the present and, more importantly, the future. What’s been made abundantly clear, yet again, is that nobody knows what’s going to happen even though so many continue to attempt to predict the future.
What We Know
We know the economy has taken a massive hit. We know jobs have rebounded faster than expected. We know day-trading is on the rise. We know the Fed is committed to do “whatever it takes” to support the economy and the markets for the time being. From yesterday’s press conference, we also know the Fed’s growth expectations are very subdued and that rates will be low for quite a while longer. Based on the market action today, it does in fact look like many investors were expecting a v-shaped recovery, which doesn’t appear likely.
What We Don’t Know
We don’t know if there will be another outbreak in COVID-19. If there is one, we don’t know how severe it will be and whether the economy will be shut down again. We don’t know how impaired demand is right now or how it will manifest itself. We don’t how long the Fed can do “whatever it takes” to support the economy and the markets. We don’t know what the fall out will be among smaller, less well capitalized businesses. We don’t know if the recent civil unrest is a one-off event or if it’s going to worsen going forward. To me, there appear to be quite a few matches to ignite further unrest, including this year’s elections and continued fallout from life and the economy being shut down to name a couple.
The Inevitable Tug-of-War
Many of us enjoy a good roller-coaster ride at an amusement park. However, most of us don’t like a roller-coaster in our investment portfolios. The comment that the market always goes up has been made more than a couple of times over the past several weeks. I believe the market goes up until it doesn’t any longer. Very original, I know. I don’t pretend to know what’s going to happen in the future but I believe there is a legitimate tug-of-war going on right now between the support the Federal Reserve is providing and the natural economic forces at play. The mantra of don’t fight the Fed is alive and well and will likely die hard, if it actually dies. I think we’re going to find out in the coming months and years what really happens when an unstoppable force meets an immovable object in the context of financial markets and the economy.
We don’t know what the economic fallout from the global shutdown is yet. We can speculate but we probably won’t know the full extent of what happened for some time. That said, it’s hard to imagine that real demand destruction hasn’t occurred as job losses in some cases may be permanent if life as we knew it at the beginning of 2020 doesn’t return to “normal”. I don’t know what the implications of such a scenario are but add that to the list of potential sources of future civil unrest. I’m sure there will be additional consequences of the shutdown, not to mention the tiff between the US and China.
Countering the natural economic forces is the Fed and what appears to be a willingness to provide unlimited liquidity. The past 11 years have taught us that when the Fed is injecting liquidity, the stock market goes up. Conversely, when the Fed starts taking liquidity out the stock market goes down. Of course, the trend over the past 11 years was in the midst of a recovering/growing economy. It remains to be seen what actually happens when the Fed is injecting liquidity into an economy that is being dragged down due to recessionary forces. It will be a tug-of-war for the ages.
The chart below is courtesy of Leo Chen at Cumberland Advisors. The line represents the ratio of cash or money in checking accounts to the S&P 500. The ratio is above its long-term average after the Fed’s recent liquidity injections, which Leo states is bullish for the equity market and coincides with market bottoms and tops.