Don’t Be Smug About Markets

Many American commentators are gleefully noting that the pandemic-induced bear market for the S&P 500 is now officially on record as the shortest bear market in history.  The stark reality of a pandemic-induced economic slowdown has been countered with a federal reserve-induced monetary stimulus the likes of which has never been seen before.  The first two thirds of 2020 have been remarkable because those nearly eight months have featured not only unprecedented bad economic news, but also a swift and equally unprecedented policy response to counteract it.  As I write this in the second half of August, the American stock market is now slightly higher than where it was to start the year and the Canadian market is slightly lower.


The bear market lasted just over a month.  Using simple math, we experienced a drop of about 1/3 followed immediately by a rise of about 1/2.  Think of it this way.  Say we’re starting with a market level at 300.  A drop of 1/3 brings you down to 200, but a subsequent rise of 1/2 gets you back to 300.   In the half year between February 19 and August 19, we’re right back where we started.  Now what?


The easy narrative is that the storm has passed and the crisis has been averted (or, at a minimum, was extremely short-lived).  I have had many experienced people remind me that the phrase “don’t fight the fed” has never been more apt.  Looking back over the landscape from late March to the present, I grudgingly agree that that has been the case.  By making traditional income investments look extremely undesirable, people have opted to buy stocks pretty much by default.  You may have heard the acronym TINA.  It stands for “There Is No Alternative”.  That’s what central banks around the world have done. They have quite literally taken away all plausible alternatives for retail investors seeking a return on their capital investments.


The story is not over and those who are celebrating should not be so smug.  The two-pronged policy response has been extreme, but it has worked in the short term.  What we have witnessed this year is not only extraordinary monetary stimulus, but also a form of direct fiscal life support (please don’t refer to CERB and its American counterpart as “stimulus”) that will not continue indefinitely.  It is the monetary response that has fueled the stock market rebound.  The massive infusion of liquidity is certain to set off something known as the Cantillon Effect, a phenomenon first identified by French-Irish economist Richard Cantillon.  When a huge amount of money is infused into the system, the short-term benefit is reaped disproportionately by those who get it first.  In this case, we’re talking about big business (i.e., those that make up the S&P 500, which has rebounded smartly).  As the impact of the monetary stimulus trickles down, the benefit is less and less for those farther and farther removed from the initial infusion.  By the time the stimulus reaches Main Street, the impact is often one of inflation due to the rich people (those who got their money first) bidding up prices.


Income inequality has been one of the biggest public policy challenges of our generation.  Our friends south of the border are facing an election in two and a half months where the incumbent is already acting like the plutocrat in chief.  The Trump tax cuts have clearly helped big business (i.e., the S&P 500 again), but the impact on ordinary folk is less clear.  As a result of this and a number of other recent developments, social unrest has never been greater.  It would be folly to think the worst is behind us.  My guess is that we’re just getting started.  Buckle up.


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