Making sense of a bull market in a bear economy
Below is a lightly edited transcript of the episode:
DONALD TRUMP: A gauge, whether you like it or not, the stock market. The stock market, NASDAQ, hit its all-time high two weeks ago and it’s beaten it 14 different times, okay. The stock market, Dow, et cetera, is a thousand points away from its all-time high, meaning very close. We’re going to have a stock market, perhaps, on November 3rd, that’s the highest in history. [00:38]
CARL QUINTANILLA: We got it, we got it Jim. All-time high for the S&P: 33.93, almost 33.94. The first, fresh inter-day high for the index since the middle of February, Jim, when COVID was simply something that was still going on in China.
JIM CRAMER: The average American is thinking that we are completely and utterly nuts.
LANG: It is often repeated on Wall Street that the stock market is not the economy, and that’s important to remember, especially as the markets are soaring at the same time the coronavirus has only tightened its grip on the U.S. economy.
Only about 52% of Americans have investments in the stock market, and the lower a person’s income, the less likely they are to have assets in the market, meaning that the record-breaking rally hasn’t benefitted the country equally.
MARCUS STANLEY: I think we're potentially looking at an enormous increase in wealth inequality, depending on how this plays out over, over the long term.
LANG: This is Marcus Stanley.
STANLEY: My name is Marcus Stanley. I'm the policy director for Americans for Financial Reform. The wealthiest people in the society, the top 10% to top 20%, and really the top 10% have their wealth in assets, like stocks and bonds, and then the next level down is housing wealth, and then there's wage income. And what we're seeing is that wage income is being hit hardest during this recession.
LANG: Some economists have even started referring to the phenomenon as a K-shaped recovery, where the wealthiest people are experiencing a quick bounce-back from the worst of the pandemic, while Main Street continues to suffer.
STANLEY: I think that the fact that we've supported asset markets and the stock market and bond markets far more effectively than we supported the job market is going to have a huge impact in on inequality if that doesn't change over the coming months.
LANG: When the COVID-19 pandemic arrived stateside, it upended the longest economic expansion on record earlier this year, driving the unemployment rate to 8.4%, causing the U.S. to experience the worst drop in gross domestic product on record in the second quarter and necessitating a massive intervention from the federal government.
It first became clear to investors back in February that the coronavirus posed a serious threat to the economy.
CBS NEWS: The fear and panic surrounding coronavirus has reached a new level tonight, with a number of new developments. Well today, the Dow had its worst one-day point drop, falling nearly 1,200 points. That’s more than 4%, and this is now the worst week on Wall Street since the financial crisis in 2008.
JEFF TOMASULO: I've never seen a down move happen so fast in such a short period of time, and then flip it over. I've never seen an up move in the NASDAQ market happen so quick, in such a short period of time. So it's just — I can attribute that to so many different things, but it's just — it blows my mind. It really is one of those things where you sit there and you go, “Wow.”
LANG: This is Jeff Tomasulo. He’s been a money manager for about 24 years.
TOMASULO: My name is Jeff Tomasulo and I am the co-founder of tacticalincome.com and CEO, Vespula Capital Management. The problem that we face right now is there's so much uncertainty, right. There is a virus that we should have had under, quote unquote, should have had "under control” by now. And I think there's a lot of lack of leadership on how they're dealing with the virus. I think there's that kind of inconsistency that, in my eyes as an investor, scares me going forward.
LANG: Fast forward to now. Seven months later, coronavirus cases are on the rise in many parts of the country as schools and universities attempt to welcome back students and Congress fails to agree on another stimulus package, threatening the swift economic recovery that many had originally hoped for.
But despite the grim outlook and onslaught of record-breaking economic data, the stock market has recovered from the dip it took in March when fears about the coronavirus first set in for investors, and certain indexes like the S&P 500 have even hit new records.
So are investors seeing something that economists don’t, or are economists seeing something that investors won’t? And why is there dissonance between the two? And how long can asset valuations stay high if there are millions out of work and tens of thousands of businesses have closed their doors?
For American Banker, I’m Hannah Lang, and this is Bankshot, a podcast about banks, finance, and the world we live in.
LANG: There are a couple of factors that are contributing to the stock market’s record return to a bull market after the shortest bear market in history. The first is that not all stock valuations are soaring — there have been some notable winners and losers in the pandemic market, and one of the biggest winners is big tech.
REUTERS: The big tech quartet demonstrated its dominance on Thursday after Apple, Facebook, Amazon and Google parent Alphabet all reported earnings that beat Wall Street expectations.
YAHOO FINANCE: Ninety minutes into the trading session and Apple has become the first company in U.S. history to hit $2 trillion, a $2 trillion market cap.
LANG: Apple, Amazon, Microsoft, Facebook and Alphabet — the parent company of Google — appear to be carrying the entire stock market on their shoulders right now. Together, the five tech giants make up about 20% of the entire market’s worth, and saw their stock values rise 37% in the first half of this year, while all the other stocks in the S&P declined altogether about 6%.
DEEKSHA GUPTA: These technology stocks have done quite well during the pandemic and they've improved. They've seen improvements in their earnings, and that makes sense. You know, a lot of people are on social media a lot more if they're staying at home and socializing virtually. [3:51]
LANG: That’s Deeksha Gupta, an assistant professor of finance at Carnegie Mellon University.
GUPTA: These companies have a combined market cap of over 4 trillion and they drive what's 20% of the S&P's return. And so I think that's actually a big reason why the aggregate stock market has been doing quite well, because these companies are actually doing quite well during the pandemic, probably because of behaviors that we have adopted in the pandemic.
LANG: Unlike many publicly traded companies, these Big Five tech companies saw their revenues explode during the second quarter of this year, which in turn increased the value of their stocks, which then in turn lifted indexes up because those companies are weighted so heavily.
Even on September 3rdwhen there appeared to be a selloff in big tech stocks after a remarkable rally, that selloff triggered a 3.6% decline in the S&P 500 and an almost 800 point drop in the Dow Jones Industrial average, demonstrating just how powerful moves in those big tech stocks can be for the whole market.
But while the value of the stock market concentrated in five companies, those five companies aren’t very representative of the American workforce, and neither is the stock market as a whole. The companies that make up the S&P 500 index only employ about one-fifth of the American workforce, and many of those publicly-traded companies have been more insulated from the pandemic’s economic shock than private companies.
This is Michael Feroli, the chief U.S. economist at JPMorgan Chase.
MICHAEL FEROLI: Not only is the stock market not the economy, but it's not even a representative sample of the economy. So publicly-traded corporations employ only about one-third of workers in the US and it's not a random one-third, right? It's, actually going to be the third that work at the largest companies in the country, and the nature of this COVID shock is such that for a variety of reasons, it seems to be hurting smaller firms more than larger ones, and larger ones may actually be able to benefit in some way from the reduced competition from, you know, a lot of smaller firms which are going out of business.
JEFFREY MIRON: The recession tends to … has generated a lot of unemployment. That tends to put downward pressure on wages — or at least reduce any upward pressure on wages. But low wages are good for the bottom line of corporations, so that's going to be good for stock prices.
LANG: This is Jeffrey Miron.
MIRON: My name is Jeffrey Miron. I am a senior lecturer and director of graduate and undergraduate studies in the Department of Economics at Harvard University. I'm also the director of Economic Studies at the Cato Institute, a libertarian think tank in Washington DC. Interest rates have fallen, and the Federal Reserve seems committed to keeping interest rates low for a significant period of time. That's good. That lowers borrowing costs for corporations, so that's going to be good for stock prices.
TOMASULO: Not only do we have that are our lifestyles have changed, and now, you know, the NASDAQ and the S&P 500, but mainly the NASDAQ is at all-time highs. The S&P just hit all-time highs. But when you look at the certain individual stocks, there is also a bigger player that is making the stock market go higher. And that's the Federal Reserve Bank of the United States of America.
LANG: The Fed has injected a massive amount of liquidity into the financial system since March, and they’ve done it in a couple of different ways. First, they slashed interest rates to near zero in March, buying virtually unlimited Treasury Department-issued debt and mortgage-backed securities. And they’ve also extended their purchases to include corporate debt, expanded lending to banks, and created lending facilities for employers and even state and local governments.
But one side effect of the Fed’s intervention was that investors suddenly had nowhere to park their money. After the Fed cut rates, the yield on government bonds — which are typically the safest investments — dropped off a cliff, and banks followed up by dropping the annual percentage yield on savings accounts. What is more, the Fed has issued forward guidance signaling that it doesn’t plan to raise interest rates for quite a while.
Because returns through savings accounts and other lower-risk vehicles are so low, investors have turned to the stock market as one of the only ways to get a return on their savings.
FEROLI: When the Federal Reserve cut interest rates to zero and then longer-term interest rates went very close to zero as well, you know, there's no real good alternative. And so, you know, with stocks with dividend yields at 2%, that's a lot better than, you know, interest rates at half a percent. And so for that reason people are willing to continue to bid on stocks. I think that’s an important — for me, that’s probably the most important reason why stocks are doing so well.
TOMASULO: So if you're a pension fund, right, who has billions and trillions of dollars to invest, where do you go and get returns? And the only way you're going to be able to get returns is by taking more risk, and where do you get the more risk is you put the money in the stock market.
LANG: As I mentioned earlier, the Fed has also started purchasing corporate debt in an effort to keep borrowing costs low — a new territory for the central bank that has helped to smooth market function and support corporate bond prices. That backstop has served to boost investor confidence, because it has given investors more assurance that they will be paid in return for their investment.
GUPTA: It can also drive recovery in the stock market because, for equity holders, as the debt of a company becomes riskier and riskier, there's a chance that payment is not going to be made on company's debt, because equity holders are going to get paid second after bondholders. For them, that's going to make their equity riskier and it's going to cause the price of the stocks of these companies to fall.
LANG: The Fed has launched a number of emergency lending programs since March, many of which were also in place during the 2008 financial crisis. But several of the programs it has stood up in the COVID crisis, like the Primary and Secondary Market Corporate Credit Facilities as well as the Primary Dealer Credit Facility have helped to buoy both the corporate bond markets — and in turn, the stock markets.
STANLEY: People sometimes say that the Fed doesn't directly support the equities market, but the Primary Dealer Credit Facility actually will lend to primary dealers to buy and sell stocks, and they are intermediaries in that market; they're not really holding them, but I think that's still important. We're seeing really record issuance in the corporate bond markets. So, those corporate bond markets are inflating to very high valuations even for lower credit quality spreads — spreads for basically, what used to be called junk bonds, or high yield bonds, are reaching record lows. So that has supported tremendous issuance and tremendous access to cash by larger corporations, which indirectly, I think, supports their stock price, but it doesn't directly support their stock price.
LANG: The Fed has also committed to keeping interest rates low and emergency lending facilities in place until it is confident that the U.S. has weathered the storm. Here’s what Fed Chairman Jerome Powell had to say about that during a regular press conference on July 29.
POWELL: At the Federal Reserve, we remain committed to using our tools to do what we can, and for as long as it takes, to provide some relief and stability, to ensure that the recovery will be as strong as possible, and to limit lasting damage to the economy.
FEROLI: I think the Fed is going to need to remain quite supportive of the economy because, you know, if it were to let interest rates go back up or direct interest rates back up, then, you know, all these asset valuations would turn right around. And then that would be bad for the economy, of course.
STANLEY: I don't think the Federal Reserve is going to let interest rates go up in the near future. Whether they transition away … they probably will transition away from some of these corporate lending programs, but it's hard to tell. I mean, corporate debt is reaching record level, and that's going to be true next year as well. So they may want to aim for a very gradual transition out of it.
LANG: The third factor that could explain the stock market’s extraordinary recovery is that the market is forward-looking, and investors are betting on a swift recovery. That’s an explanation in particular that Federal Reserve governors have highlighted.
Here’s Fed Governor Lael Brainard speaking at a July event with the National Association for Business Economics.
BRAINARD: So I think one of the things that we always have to keep in mind is we expect financial markets and asset prices to be forward-looking, to be influenced by current data, but to be discounting expectations about the future. So to some degree, the financial markets moved earlier and very, very dramatically as it became clearer that COVID was going to be a global phenomenon.
MIRON: The standard economic model of the stock market says that it's forward looking — that the stock price should be equal to, roughly, the total dividends that will be paid out to the people who own the stock.
LANG: That’s Jeffrey Miron again.
MIRON: Overall, as we get past the worst of this recession, which maybe we're already doing, the unemployment rate has come down a lot — although it's still high. GDP, retail sales seem to have started going up, even though they're still well below. As we get past that, the future looks more or less the way the future looked a year ago, and so the stock price should be pretty similar to what it was a year ago.
LANG: So I'm curious, you know, have we always seen this disconnect between Main Street and Wall Street or has this virus just made it more prominent?
TOMASULO: I think we've definitely seen it. Like, it hasn't been as blaring as it has, but you would see, like we're in a recession. And the other thing to think about is markets … markets are forward-looking. The economy is usually … is a lagger, right? Because we might start to see a dip in like GDP, and we might go into a recession. And you can … but remember, the data that we're getting is for … is backward-looking. So the market is always forward-looking. So you will see in the market start to move higher before the economy actually really shows you.
LANG: The stock market is also just having a unique moment, in and of itself, especially with the rise of investing apps like Robinhood that have made trading more accessible.
JERMAINE ELLIS: How much money did I make off of Kodak stock today? What up YouTube, it’s your boy Jermaine back with another video.
ROYCE JAKOB: It’s Royce Jakob, welcome back to the channel, and in this video, I want to talk to you guys about how I was able to make over $18,000 today trading stocks off of Robinhood.
TOMASULO: You think about Robinhood, you think about, you know, I mean, I just get phone calls, like I had — this is where I feel like the market's getting closer to a top is, I have been trading for 24 years, you know, people come and go in your life, traders, and I had a trader friend call me yesterday, and he's like, “I'm thinking about opening an account and start trading again. I hear all these people are making money.” And what that kind of sign says to me there's a lot of euphoria in the market. That is one of my concerns, and especially when you hear how many people now that are staying home, and, and they're trying to look at other ways to make money, and one of the ways they're looking to make money is in the stock market. And that is not a great sign going forward, if you think the market is going to continue to go higher.
GUPTA: I think that there is continuing uncertainty and risk in the market. And definitely there's a question of, is there potentially a bubble in the stock market with people rushing to technology stocks? But I don't know if that's something that is definitely you know, has been established.
FEROLI: Even before the pandemic, there was a lot of discussion about the increasing concentration industry concentration in the U.S., so more and more industries are being dominated by, you know, a handful of firms.
LANG: This is Michael Feroli from JPMorgan Chase again.
FEROLI: That also seems to have some, you know, concerning effects on things like the labor share of income, and you know, and I think it's debated, some people think it may be also holding back capital spending and holding back, you know, having a bunch of other kind of adverse consequences.
GUPTA: I think that that disconnect means is that it's really important not to rely on a single indicator when we're thinking about the health of the economy and based on that deciding on policy, to help support the economy and get us through this crisis.
LANG: The Federal Reserve is in a unique position, where it can inject unprecedented amounts of liquidity into the financial system and deploy lending facilities, but it doesn’t have the power to put money directly into the pockets of the individuals who are hurting the most at the center of the pandemic.
That responsibility lies with Congress. Although lawmakers passed the $2 trillion CARES Act in March that provided enhanced unemployment benefits, small business assistance, and a moratorium on foreclosures and evictions to many Americans, much of those programs have since expired, and Congress has been unable to reach a deal on another round of stimulus, even though most agree that it’s necessary in some form.
The Fed has tried to support small and medium-sized companies through its Main Street Lending Program, but the program isn’t attractive to many businesses, because the loans will have to be paid back and because accepting a loan means accepting restrictions on dividend and bonus payments as well as share repurchases. As the Fed likes to say, it has lending powers, not spending powers, and it’s limited in the amount of risk it can take.
The failure of Congress to pass another round of stimulus hasn’t had a substantial effect on markets — again, since so much market value is concentrated in large firms like Apple and Microsoft that have been able to adapt quickly to the pandemic, Wall Street hasn’t needed that extra congressional support. But for those outside of Wall Street, it’s a different story.
MIRON: The distributional implications of this recession and really any recession are certainly a concern.
LANG: This is Jeffrey Miron again.
MIRON: When things go bad, people who are lower down in the socioeconomic ladder tend to suffer more. They have fewer ways they can insure themselves, they have fewer resources stockpiled or saved that they can rely on. In this case, there was some specific aspects of that of the disease having bigger impacts on certain ethnic groups and minorities and things like that. But I don't think that's really a concern that's relevant to thinking about why the stock market is what it is. And it's unclear whether it has specific implications for other aspects of policy because it's the negative growth in the economy that's had these bad distributional implications. The one best way, one really good way to mitigate those and to gradually reverse them is to have the economy grow quickly. And so if the stock market is doing okay, that means that those companies are going to continue to invest and they're continuing to hire going forward, and that's going to be good for some of the distributional concerns.
LANG: It also remains to be seen how long the Fed will continue to expend its emergency lending powers to support the economy, and what the transition back to normal will look like. The Fed has already said it will extend the life of several of its lending programs that were supposed to expire in September until the end of this year.
STANLEY: I think that people on Wall Street really feel that the Fed has … has basically signaled that it's going to do whatever it takes to, to continue to support the economy and that assumption is kind of priced in.
LANG: Although the Fed might not be able to carry the weight of the immediate economic recovery from the coronavirus pandemic on its own without fiscal help from Congress, its longer-term objectives could benefit Main Street over time.
After all, the Fed’s dual mandate handed down by Congress is to foster economic conditions that achieve both stable prices and maximum employment, and maximum employment usually benefits lower income earners the most.
This is Powell again during a July news conference.
POWELL: In terms of inequality, really—so I think it’s fair to say that the burdens of the pandemic have fallen on, heavily—they’ve fallen on everyone, but they’ve fallen very heavily on people who work in the service industries in relatively low-paying jobs. You know, in terms of what we’re doing, what we’re trying to do is create an environment in the financial markets and in the economy where those people have the best chance they can have to go back to work to their old job or to a new job. That’s really what we’re doing. Everything we do is directed at that.
FEROLI: There's debate around this, right, because if the Fed can get the job market back in a place of health, you know, that benefits lower income people more than anyone else. So initially, it looks like what the Fed's doing is only supporting, you know, upper income people. But if, if that actually, you know, really does continue to heal the job market that should, should benefit all players.
LANG: Essentially, if the Fed’s stimulus were working in conjunction with fiscal stimulus from Congress instead of alone, maybe we wouldn’t see such a wide gap between Main Street and Wall Street. Here’s Marcus Stanley again.
STANLEY: We're kind of making the Fed our de facto crisis manager in these situations and the truth is that the Fed, the tools the Fed has—what does the Fed do? The Fed supports financial markets by providing liquidity into financial markets. That's what the Fed does. That's how its statute is written. That's what its tools do. And when we, when we prioritize the Fed as our response to a crisis, then the Fed is going to use the tools it has, which support financial markets and provide only indirect support to the broader economy. And by doing that, we're essentially privileging the financial markets and having a crisis response that boosts asset prices, because the financial markets are positioned the closest to that Fed money spigot.
TOMASULO: Congress took a recess, and there was no stimulus bill paid, and who does that hurt? It doesn't hurt Apple. It doesn't hurt Amazon, and it doesn't hurt rich people that are invested in the market, because they're making money in the market. Who does it hurt? It hurts the people on Main Street.