Addicted to the Cure

Investors got a double dose of good news to start November. First, the lengthy and acrimonious presidential election was finally decided. Second, the long awaited covid vaccines began to appear on the horizon.

The vaccines are truly something to be thankful for as we reflect on our fortunes this Thanksgiving holiday. The speed with which the vaccines have been developed, about ten months, are remarkable as most vaccines have taken years to get to market. The three developers, Pfizer, Moderna, and Astra-Zeneca, all announced their results within weeks of each other, and each reported unusually high efficacy rates (90-95% effective), giving some hope to strained health care systems, economic policymakers, and the unemployed who have struggled through these dark days of 2020.

The pressure to approve these drugs for the public is tremendous as covid cases reach new highs for the year. This has raised questions whether the drug companies have perhaps cut corners in their testing regimes, or have not considered the efficacy on all the possible patient groups (e.g. pregnant women, children). Moreover, questions remain whether the public regulators will approve the drugs in a ‘shoot first, ask questions later” scenario, as the demand for action overwhelms the naturally cautious process for normal drug approvals.

It is not hard to see why. It was hoped that the warm summer weather would kill off covid, and the pattern would follow that of the flu, peaking in winter and virtually disappearing in summer. But those hopes proved naïve, as covid’s contagiousness and lethality has almost overwhelmed our ability to deal with it. Indeed, the exponential rise of cases has prompted renewed lock-downs and stay-at-home orders, with November becoming the worst month so far of the pandemic.

Have we become addicted to the idea of a miracle cure, a magic bullet, that will eradicate covid?   Despite the common knowledge of the risks and preventative measures announced to the general public, it has been difficult to get everyone on board with prevention.  The mask wearing debate is the clearest manifestation of this schism, as is the continued defiance of large group gatherings.  New covid cases have blossomed after the holidays of July 4th and Labor Day.  Now, despite a well-publicized plea by the Centers for Disease Control to avoid travel for Thanksgiving, more people than ever have crowded airports and the TSA has reported the highest number of passenger embarkations since covid first burst onto the scene in March.  Could Thanksgiving be the mother of all super spreader events?

Could the assumption that a vaccine would inevitably be produced be keeping people from practicing prevention?  Similar to the moral hazard problem in finance, are people willing to ignore the risks of covid knowing they will be “bailed out,” eventually, by receipt of a vaccine?  There is plenty of evidence to support this notion if we look at past human behavior, as poor eating habits, drinking and smoking to excess, and lack of exercise have all contributed to the dreadful state of health among Americans.  Despite years of admonitions and celebrity public service ads backed by scientific studies, humans still pursue harmful behaviors knowing that if they get sick they can simply get medical treatment, mostly paid for by Medicare or employer-paid health insurance.  Even vaccine leader Moderna’s Chief Medical Officer Tal Zaks emphasized “I think it’s important that we don’t change behavior solely on the basis of vaccination.”  By focusing so much attention on the magic bullets of vaccines, has the public forsaken everyday prevention measures that could have gone a long way to avoid today’s record surge of covid?

Wall Street is engaging in its own moral hazard fantasy these days, as positive vaccine news is viewed as the magic bullet to all the economy’s woes, while the plight of the middle and lower classes is conveniently ignored.  For months, economists have argued over what shape the recovery will take: V-shaped, L-shaped, or W-shaped?  It is becoming clear that the form is more K-shaped, with those at the top seeing their fortunes rise, while those on the bottom rungs are going down and down.  This seems a weak foundation for an economic recovery.

With each rally in stocks, another inane article appears arguing whether Bill Gates or Elon Musk is the second richest man in the world, or which money-losing start-up’s stock has been propelled skyward by the fancies of novice day traders.  Meanwhile, food banks across America are overwhelmed by demand, and lines of the needy stretch for miles as families struggle to meet the basics of everyday living.  These are bread lines, exactly the same as in those woeful pictures from the 1930s.  As covid spreads the picture becomes bleaker for those at the bottom.  To underscore this point, initial unemployment claims, which had been stabilizing at (the very high) 750,000 level, have now started to rise again.  And relief is not in sight.

Like a sword of Damocles, on December 31 many of the key provisions in the CARES Act are set to expire if there is no action from Congress. This could be catastrophic for 12 million Americans who will lose access to their emergency unemployment benefits activated in the aftermath of the covid pandemic, which alone could be a drag of up to 1.5% to growth in the first quarter of 2021.  Additionally, the expiration of eviction moratorium, mortgage forbearance programs, and suspension of student loan payments could compound the working poor’s’ financial stresses.

Additional federal relief programs have been torpedoed by election year posturing, and it is unlikely any progress will be made in the lame duck period prior to Biden’s inauguration.  Also contributing to this inertia is the Georgia state senate runoff race, to be held in early January, which will decide the political tilt of the US senate.  Even if there is immediate passage of relief after Biden’s inauguration, it could be March before any money flows to Main Street.  Until then, Congress has a simple message for those at the bottom: “You’re on your own.”

For Main Street, financial relief was fleeting as many programs ended July 31, and an astounding amount of relief money has never found its way to small business owners.  This prompted Treasury Secretary Mnuchin to break sharply with the Federal Reserve this month, choosing to end a variety of programs aimed at helping markets, businesses and municipalities weather the pandemic and asking the central bank to return the funds earmarked to support those efforts.  This will likely complicate efforts to reinstate relief programs for the incoming president.

Wall Street has had no such problem obtaining relief measures, as the Federal Reserve and their global cohorts continue to print money via quantitative easing (QE).  Currently the Fed is injecting $120 billion of cash per month into the banking system via their bond buying programs, and expectations are that the eight major central banks will add liquidity worth 0.66% of annual nominal GDP, on average, every month in 2021.  This will likely have the effect of pushing stock prices higher but inflating the current asset bubble even further.

Bubble-like conditions continue to prevail in the financial markets, as Wall Street’s addiction to its own cure, virtually limitless liquidity, is provided by the Fed.  One characteristic of a financial bubble is how the narrative of good or bad news is twisted to rationalize ever higher prices.  For instance, in September, brokerage firm economists were fretting that a Biden presidency would be a negative for stocks for myriad reasons, but by October that narrative had changed to listing the many reasons Biden would be positive for stocks.  In a similar vein, the failure to enact additional pandemic relief was seen as depressing economic growth as workers ran out of money, but is now rationalized as positive because it means the Fed will boost its QE efforts even more to make up for lack of Congressional action.  All news is good news, so just keep buying!

This euphoric mood can now be seen in market psychology measures, as overly bullish sentiment dominates trader’s minds.  The long-standing Investor’s Intelligence advisory bullish survey is based on the recommendations of about 150 brokerage and independent newsletters, and categorized into those who are bullish, bearish, or expecting a correction.  Currently, the bulls stand at 64.6%, the highest since early 2018 (66.7% bullish) and just before the Dow Industrials suffered twin 1000-point drops in February of that year.  Just as telling, the percentage of bearish advisors is very low (17.2%), implying that some of those steadfast bears are throwing in the towel on their negative views.

Confirmation of today’s bullish psychology comes from CNN’s Fear & Greed Index, which can be tracked free at:   https://money.cnn.com/data/fear-and-greed/

The Fear & Greed Index is currently perched at a lofty reading of 92, solidly into the “extreme greed” range of values.  This level has been reached infrequently, but when it has, it has proved to be a timely warning of less benign market conditions that followed.  Previous 90+ readings were achieved in early 2018, concurrent with the Investors Intelligence peak reading, and Christmas 2019, two months before covid sent financial markets into the quickest bear market on record (-20% in three weeks).

Extremely high bullishness by itself is not a cause for a market decline, but a condition that indicates investors have gone “all in.”  With the Fed continuing to feed Wall Street’s addiction to virtually free money, it is very possible markets can continue to grind higher for months.  The Fed’s QE policy has negated the need for traditional security analysis and rendered past standards of market valuation null and void.  All that matters now is whether the Fed increases or decreases the supply of money.

Chuck Prince, former CEO of Citigroup, infamously said in 2007, “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

With the Fed playing the siren song of liquidity full blast, today’s bullish psychology indicates the dance floor is packed with revelers enjoying the moment.  Wall Street feels it can ignore the problems of Main Street as long as central banks keep up their QE cure, which shows little sign of stopping.  But such complacency also serves to inflate current financial bubbles to more extreme levels, without solving the problems for those at the bottom.  One thing we can say about financial bubbles is that they always pop, despite the best efforts of policymakers, and so today’s investors should keep a wary eye toward the day when central banks’ cure may lose its effectiveness.