Against The Gods: ‘Historically A Losing Proposition’

Bearish arguments which lean heavily on the idea that equities and credit have for years been artificially propped up by central bank largesse always suffered from a fatal flaw – namely, that the premise undermines the conclusion.

If you say asset prices have been artificially inflated by the benefactors with the printing presses, and you can’t point to any evidence to suggest those policies are likely to be abandoned, then the only way to explain a habitually bearish bent is by reference to masochism, insanity or some occupation which doesn’t require you to ever be correct.

That’s not entirely true. You can always argue that “quantitative failure” is just around the corner. Or suggest that policymakers are on the verge of “losing control”. Or (the old standby) that  eventually, running the presses “hot” will lead to hyperinflation.

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The problem is that we’re now nearly a dozen years removed from Lehman and none of those arguments have been any semblance of correct. It’s true that policymakers haven’t been correct either. They assumed that, eventually, ZIRP, NIRP and QE would result in robust growth outcomes and on-target inflation. They were mistaken. But that’s really another debate.

The fact is, there’s an entire echo chamber out there comprised of folks who have somehow managed to obscure the cognitive dissonance inherent in being persistently bearish on assets they simultaneously insist are being intentionally bid to infinity by a cabal of policymakers with a literal license to print unlimited sums of money.

You laugh. And you should. Because it’s funny.

The reason it’s funny is because that argument isn’t so much “circular” as it doesn’t even make it off the starting blocks. The guy holding the starting pistol is firing live rounds instead of blanks and rather than shoot skyward, he just aims right for the ol’ Achilles. “I’m bearish.” “On what?” “Everything really, but equities especially.” “Why?” “Because people who print money are intentionally driving them higher.”

This has been a standing joke for years, but it’s become especially germane under the current circumstances because finally, some arguments around policy failure appear convincing. If ever there were a moment when monetary policy risks running out of ammo and the gods risk losing acolytes in the market, it’s now. As I never tire of reminding folks, central banks came into 2020 having already delivered dozens of rate cuts in 2019. The cupboard really does look bare, especially after last month’s astounding barrage of easing.

With the world staring down the closest thing to a depression seen since the 1930s, there are legitimate (as opposed to “the usual”) questions about policy impotence. Rates are, at best, at the lower bound. At worst, they’re near the dreaded “reversal rate”. Balance sheets are being ballooned at a pace that would have seemed unthinkable a mere three months ago.

And yet, skeptics are now being forced to confront the possibility that while developed market central banks may not be able to meaningfully offset the blow to Main Street, they can, at will, levitate asset prices, simply by doing more of what they’ve been doing for a decade – namely buying assets.

Personally, I happen to agree with the “bear market rally” crowd when it comes to describing the ~25% bounce off last month’s lows. But not because I think everyone is going to suddenly come around to the notion that rallies based on central bank support are somehow not “real”.

Rather, history shows bear markets are typically “interrupted” (so to speak) by sizable rallies, only to revisit lows before it all shakes out. To expect a straight line down to the bottom would be inconsistent with history.

Between that simple observation and the fact that for the foreseeable future (at least five weeks) market participants are going to be bombarded with negative headlines around earnings and the economy, it seems just as likely as not that another swoon is in order.

Indeed, there’s no shortage of convincing arguments for why the fight will be harder won this time for policymakers. Consider this bit, for example, from Bloomberg’s Benjamin Dow:

It’s inspiring that Goldman Sachs analysts have termed a dip to 2,000 for the S&P 500 index as unlikely due to Fed cuts, liquidity moves, and the $2.2 trillion CARES Act. They may be right or wrong about the lower bound of another decline, but among the risks that the economy is currently unprepared to deal with is a significant squeeze on states’ finances. While the prior stimulus has provided some funding for state and local governments, and the Fed has stepped in with a municipal lending program, the National Governors Association puts the additional financing need at $500 billion. With many states operating under balanced budget requirements and public health expenditures soaring (let alone with burgeoning holes in many public pension plans), failure to act could produce some uncomfortable headlines.

Meanwhile, America’s small businesses are rapidly going extinct, along with all the jobs they create.

That said, you’d be a fool not to acknowledge that the Fed’s actions (and the actions of central banks globally) are a game changer. As Dow alludes to in the excerpted passage, Goldman’s David Kostin on Monday dialed back his suggestion from a few weeks ago that the S&P could hit 2,000 (see here), for example.

“The Fed and Congress have precluded the prospect of a complete economic collapse [and] these policy actions mean our previous near-term downside of 2,000 is no longer likely”, he conceded.

“The numerous and increasingly powerful policy actions have spurred equity investors to adopt a risk-on view”, he went on to write, adding that “the combination of unprecedented policy support and a flattening viral curve have dramatically reduced downside risk for the US economy and financial markets”.

That isn’t indicative of someone who lacks conviction and it doesn’t beg to be lampooned. Rather, Goldman’s suggestion that stocks could ultimately fall 41% came on March 15. Think about everything that’s happened since then in terms of central bank actions. You can review all of the Fed’s various bazookas and facilities documented in our Fed archive here, and that’s to say nothing of all the accommodation delivered in other locales.

There’s also trillions upon trillions of fiscal stimulus to account for.

Simply put: This isn’t the same policy landscape that prevailed a month ago. Things have changed radically since then. You and I may well believe that the lows will be revisited, but not acknowledging the scope of the policy panic and at least considering that it could render at least some of the pandemic effect null and void in terms of asset prices (but certainly not in terms of the real economy), would be naive in the extreme.

On the other hand, it would also be somewhat naive (even if it turns out to be correct), to believe that stocks bottomed right at the onset of a depression. Not a recession, a depression – with a “D”.

In the same vein, it’s probably not safe to assume that we can draw any conclusions from previous experience, considering there are no historical analogs for 17 million Americans (and counting) filing for unemployment benefits in the space of three weeks.

Goldman is apparently assuming that late March marked the peak for initial jobless claims, and while “peak” always just means “highest”, when you’re dealing with the kind of off-the-charts numbers we’re now staring at, this kind of analysis seems almost trivial.

Additionally, Kostin has picked up on the idea that investors may be prone to writing off (figuratively and, in some sense anyway, literally) Q1 earnings.

“Q1 earnings season will not represent a major negative catalyst for equity market performance”, he says, flatly. “While earnings season always conveys backward-looking data, rarely has the information content of quarterly earnings reports been as outdated as the figures US companies will release starting this week”, he adds, before explicitly saying that not only will market participants likely “look through” Q1 results, “many investors we have spoken with have discounted 2020 earnings altogether, and are focused instead on the outlook for 2021”.

And really, why wouldn’t they? This year is clearly down the drain. Even if you aren’t prepared to treat it that way, other folks might, where that means buying next year’s “V-shaped” recovery narrative now – even as the viability of that narrative will wax and wane with the daily coronavirus news flow.

This will be the ultimate test of central banks’ capacity to engineer and maintain a disconnect between asset prices and the fundamentals. Policymakers have a lot of practice at this game, and betting against them has proven to be a fool’s errand more often than not.

“This crisis is different from any other in recent history in that it was not caused in any way by businesses or investors”, JPMorgan’s Marko Kolanovic wrote Monday.

“Unhindered by moral hazard, the response of fiscal and monetary authorities is and will continue to be unprecedented, with the goal of essentially making everyone ‘whole'”, he went on to say, before suggesting that markets still underestimate the gravity of that implicit (and nearly explicit) promise.

For JPMorgan, the most likely scenario is that markets recover fully to record highs by next year, perhaps even by the first half of 2021.

“Investors with focus on negative upcoming earnings and economic developments are effectively ‘fighting the Fed'”, Kolanovic notes. “Historically that’s a losing proposition”.

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