The hype and hope being promulgated by Wall Street and D.C. is that the imminent and well-advertised approval of vaccines will bring the economy back to what they characterize as its pre-pandemic state of health. However, even if these prophylactics are very efficient in controlling the pandemic and lead the economy back to “normal”, the state of the economy was anything but normal and healthy prior to the Wuhan outbreak.
The year over year change in GDP in the fourth quarter of 2020 from the trailing 12 months was just 2.3%. Admittedly, this wasn’t indicative of a terrible economy; but it also was very far from what many have portrayed as the best economy anyone has ever seen on the planet. Most importantly, to even get to that rather pedestrian level of just trend GDP growth for the year, the Fed had to slash interest rates three times in the five months prior to the start of 2020. And, please also remember that the Fed felt it necessary to return to Quantitative Easing (QE) in order to re-liquify the entire banking system and save the markets from crashing.
The reason why the Fed was in full REPO Red-Alert back in September of 2019, was because the business sector of the economy was melting down under the weight of a record amount of debt ($16 trillion, which is 80% of GDP). This was an increase of 60% from the Great Recession of just over a decade ago. The truth is this albatross of debt being lugged around by the corporate sector just could not handle Mr. Powell’s trend towards interest rate normalization, which caused the banking system to seize up. Indeed, some financial institutions were in so much trouble prior to the pandemic that they had to pay 10% to borrow money overnight on a secured loan backed by Treasuries just to stay in business.
Of course, the Fed “fixed” banks by flooding them with new dollars (QE); a practice that continues at present. Hence, a return to what most claim was “normalcy”, in reality, would not at all be a sustainable condition. But even more daunting is what has occurred since the pandemic. Our government has leveraged the prevailing conditions of onerous debt, precarious asset bubbles, an unfathomable falsification of borrowing costs and a massive increase in the supply of dollars…including the Fed’s new ventures into the purchasing of junk bonds and making loans in the primary market.
To be specific, the Federal government has added an incredible 30% to its outstanding debt load, the individual states are in need of a trillion-dollar federal bailout and the business sector is piling on debt at a $3 trillion annual pace during the first quarter of this year. Not only this, because of loan forbearances many consumers didn’t have to pay their student loans, credit card bills, auto loans and/or make a mortgage payment for the past few months. The government also gave consumers more money than they made before losing their job and then gave them thousands of dollars even if they didn’t become unemployed.
So where does this leave us today?
•According to the latest NFIB Survey, as of July 21st 71% of small businesses have exhausted the entirety of their PPP funding.
•According to Yelp, over 90,000 small businesses have permanently closed their doors from March 1 to August.
•According to an American Express survey, 62% of small businesses indicated they needed consumer spending return to pre-virus levels by the end of 2020 in order to stay in business (My Note: that is going to be a big problem for this sector, which employs some 68 million Americans.
The stock market also needs more than a vaccine to become healthy and to justify its rather incredibly lofty level. It is very disturbing to have the valuation of stocks equaling 180% of the underlying economy, which is some 110 percent points greater than this ratio’s historical average. The stock market is holding up very well right now; not only because of QE but also because the consumption driven economy is being supported by trillions of dollars’ worth of fiscal handouts—there has already been $3 trillion in Government transfer payments made to the public so far.
The truth is there exists a near complete consensus that a vaccine will bring employment and consumption back to pre-pandemic levels, which will place the economy back into state of economic nirvana. But even if most people agree to get vaccinated with a new technology that was developed at warp speed—and one that ends up being both safe and effective—the pre-pandemic economy wasn’t all that great; but is now in a much more precarious position.
To think otherwise is to believe the trillions upon trillions of dollars in new debt taken on by government, individuals and businesses will be inconsequential in terms of its effect on debt service payments and productivity growth. This is blatantly false.
The S&P 500 has now recovered all of its loses following the initial pandemic chaos, even though the economy crashed harder and deeper than at any other time in history and remains in an extremely anemic state. This is because the stock market has become more disconnected from economic reality than ever. Precisely due to the massive amount of helicopter money coming from our lawmakers and graciously printed by the Federal Reserve with alacrity.
But what is most likely to occur next is that the pending news on vaccine approvals will be the catalyst for government to begin to attenuate its massive and unsustainable fiscal and monetary support. After all, D.C. conflagration come this fall should mean the end of COVID-19 rescue packages. And, the crumbling US dollar should at least lead to a pause in the rate of increase for Mr. Powell’s balance sheet—or maybe even a complete halt to its increase on a temporary basis.
Then, investors could be left with a flagging economy that no longer can rely on multiple trillions of dollars in stimulus—all of which gets monetized by the Fed–for the primary benefit of Wall Street. In other words, a well-deserved and overdue reality check may be in store for the markets come this fall. Given the recent history of severe and sharp market wipeouts, it would be prudent for investors to stary on high alert and not get lulled to sleep by the dulcet humming of printing presses inside the Eccles Building, which may get throttled back soon. That is, at least until the next bear market gets them running back at full speed once again.