When it comes to markets, I try to be agnostic about the data. In other words, I try not to allow data to sway me too much, because for every data point and the accompanying conclusions about the market people draw from it, there’s usually a contradictory data-point out there that, accordingly, leads others to draw contradictory conclusions.
I always try to hear and understand both sides of a particular debate, because if I pick the wrong side, I want to at least be able to know why I was wrong. And before I make a decision about what to do with my money, I like to know why that decision could end up being wrong and losing money.
You’re doing yourself a disservice if you don’t try to poke holes in and disprove your own investment thesis. Investors should always be trying to identify their own potential blind spots, and the way to do this is to be data-agnostic and not put all your faith into one theory about the market, however compelling and logical it may seem.
Right now, for instance, I’ve been studying both sides of the inflation debate. Will we have troublesome inflation, or won’t we?
I’ve been going back and forth on that question all week, and by this point I completely understand the thesis that inflation will soon pick up.
But what if it doesn’t? Why might the inflation fearmongers be wrong?
This article from a couple weeks ago in Barron’s by Matthew Klein, I think, does a good job of laying it out. Basically his point is that while yes, savings are at record highs and are about to go even higher after the new stimulus bill, most of those savings are held by the rich, and they’re not going to go on a spending spree once the economy reopens, which means we’re probably not going to see significant inflation.
The two key points to remember: First, savings in bank accounts are much more likely to get spent than paper gains on illiquid assets such as housing and real estate; second, people with the highest incomes are less likely to spend one-off windfalls than people lower down the spectrum.
According to the Fed, about 28% of the increase in liquid assets from the end of 2019 through the end of September went to Americans in the top 1% of the income distribution. Fully 70% of the extra cash went to Americans in the top quintile [i.e. top 20%], with only 14% of the extra cash—just $330 billion out of $2.3 trillion—held by Americans in the bottom 60% of the income distribution.
It’s likely that the distribution of liquid assets has become even more skewed since the Fed collected its data—leaving even less spare cash for the vast majority of Americans. As government income support was withdrawn over the summer, many Americans were forced to dip into the savings they had accumulated earlier in the year to sustain their spending. Economists at the JPMorgan Chase Institute found that the typical American in the bottom quartile of the income distribution has liquidated almost a third of the money in his or her checking account since September. In fact, most Americans outside the top of the distribution had less money in their checking accounts at the end of last year than they did at the end of the third quarter.
So this idea that everyone in America is flush with cash and about to start spending it like crazy is just nonsense.
Joseph Briggs and David Mericle of Goldman Sachs therefore estimate that, even if the total amount of “excess savings” grows by half between now and mid-2021 because of additional government income support, only about 18% of that money would get spent on goods and services once the economy fully reopens. The rest would likely be used by high earners to invest in stocks or housing, and by lower- and middle-income Americans to build up needed cash buffers.
As a result, all the cash on the sidelines—even after assuming the next $1.9 trillion spending bill distributes $1,400 checks to most Americans—will probably only contribute about 2 percentage points to GDP growth next year. That would be a helpful nudge for the recovery, but not much more than that.
In other words, expect both stocks and housing to keep going up. If most of that money on the sidelines is held by the wealthy, we can expect the wealthy to deploy that money like they usually do: by investing it.
Sure, the middle and lower classes will definitely be responsible for a “boomlet” in spending and inflation, but it won’t be anything crazy. The bottom 60% only has about 14% of that “extra $2.3 trillion” in savings, or in dollar terms, about $330 billion.
That’s the number we’re looking at as far as the amount of money that could potentially flood into the economy in the form of “pent-up demand,” and drive inflation up.
When you look at it in these terms, it’s quite possible that this surge in inflation everyone’s expecting and freaking out about could turn out to be a complete dud.
And by the way, I think this story is a remarkable look in to where all the money that gets printed actually goes. Permabears and fearmongers have been warning for over a decade that all this money that has been printed will one day lead to massive increases in inflation, but it hasn’t. Why hasn’t it? Because, as this article illustrates, all that money wound up in the hands of the wealthy, who in turn invested it in the stock market and in the housing market.
Why hasn’t there been a burst of inflation amid all the money printing? Well, there has been a burst of inflation, it’s just not where most people normally look for inflation. It has been pumped into the stock market since 2009. That’s where the inflation occurred. Most of the money printed and handed out by the government never made it into the “real economy.” It was invested.
I wrote earlier this week that I think we will see one final melt-up in stocks before this thing blows up. We have not seen this bubble go fully parabolic yet. We have not yet seen a late 1999/early 2000 Nasdaq move where the markets just get completely euphoric and delusional, and I think that could be coming in the next couple of months here. As I said the other day, I would not be surprised to see the Nasdaq go up to like 17,000, the S&P up to 4,500+ and the Dow up to potentially 36,000+.
We might honestly see Nasdaq 20,000, S&P 5,000 and Dow 40,000 before this thing is all said and done. I am not ruling that out at all. As crazy as that sounds, S&P 5,000 is only like a 26% gain from current levels. For the Nasdaq, 20,000 is a 49% gain. And for the Dow, 40,000 is only a 22% gain. If markets go full 1999, it’s entirely possible.
I think the real “bubble” right now, if you can call it that, is in faith in the Federal Reserve. Overvalued tech stocks are but a symptom of the real delusion: belief in the Fed’s omnipotence.
Not in terms of the Fed’s ability to tank markets by raising interest rates, but in the Fed’s ability to support markets indefinitely.
Right now there is a widespread belief, even among the bears and fearmongers, that the Fed is all-powerful, and if the Fed wants the markets to go up, the markets will go up for as long as the Fed wants them to go up. There’s a belief that this bull market has only lasted for as long as it has (12 years) because the Fed has propped it up.
For instance, the stunningly quick recovery in stocks last March is often attributed to the Fed taking unprecedented action to restore confidence in the markets by cutting interest rates and providing monetary stimulus. How far might markets have fallen without the Fed stepping in to turn things around? We don’t know and we will never know.
The Fed has our back, investors believe. The Fed won’t let markets fall. Thus, it is perfectly safe to buy overvalued stocks at all-time highs, because the Fed is going to make sure everything keeps going up and up and up. The Fed won’t let it fall, and they proved as much last March.
But simply attributing the abrupt market turnaround last March to the Fed, I think, is over-simplistic. For one thing, the Fed’s ability to restore confidence in markets can only go so far. The Fed can’t prop markets up in the face of overwhelming investor fear. Look back to 2008–the Fed started cutting rates in late 2007, and by mid-2008, the EFFR had been cut from 5.25% all the way down to about 2%, yet the market was crashing anyway:
The Fed was cutting rates the whole time the market was crashing, and even by early 2009 when rates were at 0%, the market still continued to drop for several more months.
Similarly, the Fed massively increased its balance sheet starting in late 2008, but this action still did not arrest the slide in the markets for several months:
Once panic takes over in the markets, the Fed has a very hard time trying to convince investors to remain calm and that everything is going to be fine.
Point is, if investors don’t believe the Fed’s assurances, there’s little the Fed can do to convince them things are okay.
The reason the Fed was able to calm the markets in March 2020 was ultimately because a lot of market participants were watching the remarkable selloff and thinking “this is an overreaction.” At the time people didn’t think Covid warranted a 35% market drop. People thought, “We’ll be out of this in a few months tops. This is a great dip-buying opportunity.”
And of course they were right about it being a great time to buy the dip, but as we all know, “15 Days to Slow the Spread” has now turned into a year.
Certainly the Fed’s actions were instrumental in turning markets around so quickly, but the truth is that investors were looking for a reason to buy the dip, and the Fed merely provided it. A level of fear was certainly gripping the markets during the Covid Crash, but it wasn’t fear like we saw in 2008. In 2008, markets sold off like it was the Financial Apocalypse.
What I’m getting at here is that the Fed’s powers when it comes to supporting markets are ultimately limited, yet a large percent of market participants believe the Fed’s powers are basically unlimited.
In every bubble environment, there is always some fundamental assumption held by investors as to why “this time is different.”
In the 1920s, it was considered a “new era”:
A lesser-known stock bubble is the “Nifty Fifty” bubble of the 1960s-70s, where the top 50 companies in America were considered infallible investments that could and should be bought regardless of valuation.
In the late 1990s, it was considered “different” because tech stocks were supposedly not subject to traditional (i.e. “outdated”) measures of a stock’s value. It didn’t matter how high a stock’s P/E was–of if the stock even had any earnings. The only thing that mattered was the company’s future potential to change the world, and if the company had “.com” attached to its name. Anything “.com” was on a direct flight to the moon.
In the 2000s, people didn’t think the housing bubble was actually a bubble, because housing was considered the most invincible investment one could make. The idea of the housing market failing was unfathomable. If you’ve seen the movie “The Big Short,” you know what I’m talking about. When Michael Burry said he wanted to short the housing market, people laughed in his face. It was the most ridiculous idea they’d ever heard.
And now, the belief that “it’s different this time” is rooted in the assumption that the Fed is omnipotent and will not let markets fall.
It’s not going to end well. Like every other bubble before this, it will all come crashing down eventually.
But if high inflation doesn’t materialize like it’s expected to–and we now see that it’s a very real possibility the expected inflation turns out to be a big nothingburger–then I think this bull run can and will continue. Something else will have to burst the bubble.
What that something else is, I don’t know right now. It’s always easier to see in hindsight. But there will be something.