Nothing's Gonna Stop Us Now

-> German Version

Remember when Donald Trump said that a President Biden would hurt the stock market? Well, apparently markets did not get the memo: The day Joseph Biden and Kamala Harris were inaugurated, the American stock market indices reached another new all time high. Stock markets in Asia and Europe did very well to; it seems that market participants are in a good mood. 

rinnern Sie sich daran, als Donald Trump vor der Präsidentschaftswahl ständig wiederholt hat, dass ein Präsident Biden schlecht für den Aktienmarkt wäre? Nun, es scheint als ob der Markt hat das Memo nicht bekommen hat: Just am Tag der Inauguration von Joseph Biden und Kamala Harris erreichten die amerikanischen Indizes neue Allzeithochs. Auch im Rest der Welt, in Europa und Asien waren die Indizes im Aufwärtstrend, die Marktteilnehmer scheinen guter Dinge zu sein. In view of the prospect of more stimulus and hopes of a resurgence in consumption due to a return to normal, the question arises: Nothing's Gonna Stop Us Now?

Last week I wrote about the dollar here on this blog. When markets made a new high this week it was nice to observe the dollar's current impact on stock markets. When the dollar bounced back last week, stocks struggled and weren't able to go up further. Instead they moved sideways until Janet Yellen's Senat hearing where the dollar started to devalue again while stocks started to rise again. Yellen claimed that it was time to act big to support the public with a huge stimulus bill. 

Abbildung 1: EUR/USD vs. Dow Jones; Bloomberg

However, I doubt that the expectation of more stimulus to come was the only reason that pushed stocks higher because neither did interest rates rise nor did inflation expectations. Tech stocks rose sharply after the hearing and regained some ground, therefore I assume that investors started to invest their cash in tech stocks because bonds still are not very attractive.

Moreover the low interest rate environment is one of the main reasons why tech stocks have reached such heights because with rates this low the present value of future earnings is more or less the same as it is in the future and thus those valuations seem to be justified. Though investors should remember that US-stocks are very expensive compared to stocks in other regions:

Abbildung 2: in which Region are equities Most Overvalued/Most Undervalued; BofA,

If we look at the stock market crashes in 1987, 2000 and 2008, the S&P 500 real earnings yield always bottomed at zero. Now real earnings yield is at 2 % which is near post Great Financial Crisis lows and therefore I think that this is something to watch in the future. 

Abbildung 3: Look Out Below; Bloomberg

Governments and central banks hope that the can keep the economies alive with their easy money policies and it seems that investors see that in a positive light. Admittedly reality shows a different picture: After economic activity has picked up at the end of 2020 worldwide it started to fall again at the beginning of the year:

Abbildung 4: Daily Activity Indicators; Bloomberg Economics

However, spend now, worry about deficits later leads to an even bigger bubble in the bond market. As investors are desperately hunting for yield this bids up prices in stocks and high yield bonds. Look at the chart by Daniel Lacalle which shows the effect of the rise of  Global Money Supply to the MSCI Wolrd Stocks and the Bloomberg High Yield Index: 

Abbildung 5: Global Money Supply vs. MSCI World Stocks vs. Bloomberg High Yield Index; Bloomberg, Daniel Lacalle

As I think that central banks will continue to flood markets with liquidity  I assume that the all time high of this week will  not be the last one. The main driver behind this is (at least in my opinion) the ongoing pandemic and the projection that this will lead to even more economic stimulus programs. 

The narrative of a revival of economic growth because of heavy catch-up effects in consumption can be kept going on as long as we are still fighting the pandemic. Worries that those easy monetary policies may lead to bigger problems in the future are denied with reference to the years after the GFC. On the other hand I would like to point out that those policies did not lead to a strong recovery in economic growth.

But will there be a catch-up effect in consumption after the pandemic? Economists mostly argue that personal savings have gone up heavily since March last year and is way above it's long term average:

Abbildung 6: US Personal Saving as a % of Disposable Income; Bloomberg

After personal savings bottomed below 5 % in 2005, it has gone up slightly and hovered around 7 % since then. We could explain this because of an aging population because scientific evidence suggests that the elderly save more than the young.

At the beginning of the pandemic personal savings exploded to nearly 35 % and are now still at 13 %. Nevertheless it is worth to dig a little bit deeper, because this does not tell the whole story as the savings rate has not gone up for each income groups equally. 

Basically it is known that low income households save a lower portion of their income than households with a higher disposable income. This is why government interventionists mostly argue that it is important to strengthen low income groups because this money goes directly back into the economy and thus leads to a rise in economic activity. 

As I've shown in my post "How Money Printing Works" central bank and government interventions are different to those of 2008. In 2008 central banks and governments saved banks which got under because of devalued mortgage backed securities which lead to a liquidity crisis. After the central banks bought those securities and others (like the ECB which also bought corporate bonds back then) the money did not reach the real economy. Instead, it went straight into assets and bid up prices there. 

Rising asset prices lead to rising inequality in the western worlds although inequality continued to diminish globally. One could say that 2008 has been a stimulus program for wealthy individuals because it led to a huge rise in asset prices. The following chart shows that the top 20 % of earners own nearly all the stocks held by US households:

Abbildung 7: Wealth Gap; Bloomberg

We know that poorer households have been struck much harder by the pandemic than rich ones. On the one hand because it was mostly low-paying jobs that have been lost during the crisis and on the other hand because low income households face a higher rate of inflation than rich households. Despite of huge transfer payments that have been made to those households by the government, I would conclude that higher income households have benefited more from all programs combined.

Now I would like to answer the question if low income households have increased their savings during the pandemic as the personal savings rate suggests. Recently BofA has published the results of a survey which contradicts this argument. While households with a high income indeed increased their savings since last year the effect for low and medium income households goes in the different direction. They have saved less than a year ago. 

Abbildung 8: Compared to last year, how has your personal savings changed?; BofA

Data from Switzerland led to the same results (in case you have expected that the effect in European countries is different to the US-data because of the implementation of "Kurzarbeit") 

Abbildung 9: Change of Savings since start of 2020, sotomoCH, Isabel Martínez

I can think about one probable argument which justifies the assumption that consumptions will strongly pick up after we have overcome the crisis: If firms would start to hire again and unemployment falls rapidly. Low income households would gain income and their additional expenses would boost the economy. 

However, even this is pretty unlikely in my opinion. Where would those jobs come from? Lots of SMEs have struggled and were only able to survive because of tax deferrals but slowly they are all start to give up. If those business are closed there won't be a huge jobs miracle in my opinion. It is a weak argument to assume that the firms that have survived (which are mostly big corporations) will absorb those jobs. 

There is even a possibility that low income households will face an even worse situation because of continuing rising food prices. If this trend will continue it will diminish the chance of catch-up effects in consumption even further as more money is needed to acquire the same amount of nutrition goods. 

Abbildung 10: Food & especially grain prices are surging much quicker than industrial commodities (%6m); Society General, Business Insider

If those developements continue I think that we won't see a strong economic recovery. The more likely scenario would be an environment of high inflation, high unemployment and weak growth; Stagflation.  Inflation expectations are at an all time high already:

Abbildung 11: Inflation expectations at an all-time high, BofA

Therefore I conclude that the current all time highs in the stock market are driven by two major factors: On the one hand because of extremely loose monetary policy and on the other hand by big expectations about future consumption and therefore earnings. 

Both arguments seem extremely weak (as I've discussed) and therefore I think that all those praised stimulus programs will not take us back to a path of sustainable growth. Even history denies that this would work. 

When will the current stock market rally come to an end? As long as we are in crisis mode, I expect markets to reach new all time highs, governments and central banks will guarantee that. If governments miss their goal and current economic developments cannot be turned around it will be an easy answer: The time when markets will have to face reality...

Have a great weekend!

Fabian Wintersberger

Disclaimer: This is a personal blog. Any views or opinions represented in this blog are personal and belong solely to the blog owner and do not represent those of people, institutions or organizations that the owner may or may not be associated with in professional or personal capacity.