The Expansion is Dead... Long Live the Expansion
Covid data, government stimulus plans and market reactions are changing daily. I think the worst in market panic and growth rates of infection is over. In March the news worsened every day and it felt like the world was in an information vacuum. In hindsight, it’s easy to say stocks sold off more than they should have, down 34% at one point for the S&P 500 (41% for small cap). Now, even with imperfect virus data coming in from around the world, there’s a sense that the infection rate is peaking in America, and that the collective fiscal and monetary stimulus efforts will help. Stocks are bouncing higher. We were right in February and March to be patient with the portfolios. Some of you may be wondering, stocks seem headed back to their previous highs - should we sell bonds and have a higher percentage in stocks? No. I’ll explain.
The Covid story is easier to quantify than the economy. You either got tested for the virus or you didn’t; you had it and recovered, or you haven’t yet had it or… you’re not reading this letter. Daily data makes charting its progress straightforward. The U.S. and global economy are more complicated. Even if the economy is bottoming today (which I'm not saying it is),
it won’t get measured for a couple weeks, and then not reported for another couple after that (and then revised!). The stimulus programs with the big headline numbers have a helpful psychological effect, because even if checks haven’t hit your mailbox, the public feels like government is doing something. I believe easing unemployment and rent payments and access to low-cost borrowing are the right steps to take, even if the distribution of said benefits is imperfect. The fiscal hawk in me comes out when I can’t help but wonder what the longer term effect of all these stimuli will be. A faster growing economy that can pay back its new debts? Maybe. Maybe not. Capitalists might rather see weak businesses fail, because better ones will rise from the ashes, and then we wouldn’t have all the new debt to pay off. Populists like the CARES Act because it helps the government ensure the continuity of peoples’ work and living conditions; unnecessary suffering is minimized. The debts always end up being repaid, somehow, right? Two quick thoughts on that, followed by a couple charts. One, I think the bad news is not all in yet. Remember how, 12 years ago, unemployed people were out of a job for so long, the story became how their skillsets became outdated? We could be in for a similar problem this time. Look at this chart. I know the print is small, but the colored lines track how long the labor market took to recover once a recession began. The past three recessions all took successively longer for labor to recover from. Our current predicament is the tiny red line at the top left of the chart.
I am concerned that the stock market is going to soon realize that those who haven’t made a rent or tax payment for March, April and May won’t be able to once 3 months of overdue bills hit them in June. Banks aren’t going to want to foreclose and evict, what - 10% of homeowners? - who can’t make a triple mortgage payment. These dislocations would a) penalize the owner, the bank, and the apartment dweller. Weakening bank balance sheets is what made the 2008 recession so intractable. I think we’re going to have a conversation about the CARES Act hangover before long, because we’re adding so much long term debt for such a short term effect. Worse, the short term effect comes and goes, and we find ourselves tempted to extend payment forgiveness again. One of my favorite bond investors is Jeff Gundlach. A couple of weeks ago, when the first and second fiscal stimulus proposals were coming out, he said: “Establishment leadership has already racked up $24 Trillion in National Debt and $132 Trillion in unfunded liabilities…When indebted companies need indebted consumers to be bailed out by an indebted government, Houston, we have a problem.” I know I harp on government spending, and more recently, massive deficit spending when times were good. I’ll admit, the increasing debt load hasn’t mattered much. Adding another few trillion to the debt to smooth over the Covid recession will probably be no different this time. I’m just afraid that one day it will. To close with optimism, here’s a reassuring chart of the Dow Jones Industrial Average going back to 1900 (the blue line). This is the chart that should make you want to buy more stock here!