It is to be expected that high volatility will remain the key driver for the stock market this week. Given the rally on Friday, the opening on Monday is likely going to be negative to flat on Wall Street and depending on the latest news of each weekday, markets could go up or down in big numbers fast throughout the week.
Fact is that the Federal Reserve and the government - as in every crisis over the past 20 years - have decided to come to the rescue. The billions of dollars in relief and support funding are likely to be seen as positive news and could lead to a worldwide short term rally in the next few weeks. However, one has to keep in mind that, to a large extent, this aide is only necessary because of previous governmental market interference that has led to the shut-down of major economic contributors around the U.S. and the world, creating a substantial negative economic impact. Likely, actions taken by governments around the globe (other than U.K. and Switzerland) are going to cost the private sector hundreds of billions in lost revenue for 2020. The outfall of the economic impact will be dealt with only later and will weigh heavily on international capital markets for quite a while. Also, as far as the U.S. is concerned, it is not like the government would have the money for such an emergency scenario available in some sort of disaster relief fund; this is all going to be added to the already skyrocketing national debt and will have even more severe consequences further down the road. Consequently, the U.S. dollar will be further deprived of its purchasing power which is another good reason why being diversified internationally in foreign currency investments with custody outside the country can be a prudent move in order to protect one's long term assets.
Furthermore, it was reported by the Institute of International Finance that high risk corporate debt with banks has exploded from $48 trillion in 2018 to $75 trillion by the end of last year. Low interest rates and cheap production cost, mainly thanks to production outsourcing to low-cost countries (China among others), have fueled this very short sighted pattern of business practices for many companies in the U.S. but also around the globe. Focus has been on optimizing quarterly returns (and executive bonus pay) without any sustainable long-term plans. Given this year's dramatic developments, we are therefore looking at another systemic risk that could impact the financial system severely once the debtors will end up in a position that no longer allows them to serve their debt due to the looming economic downturn. Most likely, governments will step in with another bailout package for companies and systemically relevant banks which, on the one hand, will even further increase the system's fragility but on the flip, will be very positive for the stock market in the mid-term since most of the additional liquidity will find its way into the equity market and drive stock prices up further. This mainly due to low or negative interest rates and consequently a lack of investment alternatives other than real estate. Clearly, this development is highly unsustainable and will make the system even more vulnerable. However, it could turn out to be very lucrative for equity investors in the meantime.
Last but not least, the Federal Reserve is going to meet on Tuesday and Wednesday this week. Its members are under substantial pressure and will need to present a plan to support a recovery and limit further losses in the market. After all, it is an election year. The problem is that the Fed already has used-up most of its ammunition after 2008 and with the latest measures taken to ensure the system remains liquid, there are not too many options left. Hence, here is a speculative thought:
Some central banks around the world have been actively purchasing stocks on their own balance sheets for years in order to stimulate markets and conduct monetary policy. The Swiss National Bank for example has become what is often referred to as the world's "largest hedge fund", holding approximately $850,000,000,000 in assets and currencies on its balance-sheet as of 2019. Needless to say, if the Federal Reserve decided to start making direct stock market purchases part of their open market operations going forward, this would spike equity markets and for sure speed-up the recovery for stocks on a substantial basis. Even though a majority of legal scholars are of the opinion that such transactions by the Federal Reserve Bank would be against the law, so was quantitative easing. As we all know though, the law was "outsmarted" by what politicians called a "necessity to safe the system" after 2008 (to combat a problem that again was created by government policies and Fed Chairman Alan Greenspan who artificially kept interest rates way too low for far too long). Hence, we do not believe that existing legal restrictions would be an obstacle since government tends to "override" the law (by not following the proper legislative and constitutional process) with no major issues in such times of mainly self-inflicted crisis.
We therefore believe that rumors could be true and that the Fed could be in for a surprise this week which would have an immediate positive effect on the stock market.
Please do not hesitate to contact us if you have any questions or concerns.
Oliver E. Hohermuth, Principal & Chief Investment Officer