Could 2020 see a replay of the 2000 presidential election scenario, when it came to the US Supreme Court to declare the winner? Quite possibly, but with additional twists. Back in 2000, the vote count issue involved only Florida. This time round, because of the Covid-19 pandemic, it will likely pertain to mail-in ballots throughout the country, particularly since protocols vary state by state, there is no centralised counting facility and, for many voters, it will be the first experience of not voting in person (increasing the risk of ballot disqualification). Also, in the event of Supreme Court intervention, having the loser graciously concede defeat – as Al Gore did in 2000 – seems rather unlikely in the present political climate.
At the risk of sounding somewhat dramatic, we do worry that the foundations of democracy may be coming under attack in the US. Chairman Powell is adamant about the Federal Reserve’s independence, arguing that its current interest rate policy – and recent change in stance with respect to inflation (now aiming for 2% on average, i.e. willing to tolerate periods of inflation above that threshold) – is dictated by the coronavirus-induced economic crisis. Still, no one can deny that he is under intense and regular presidential pressure to keep borrowing costs low, such that the US government be able to afford an ever-expanding budget deficit. Similarly, with a Covid-19 vaccine figuring among President Trump’s campaign promises, the US Food and Drug Administration (FDA) is being forcefully encouraged to speed up its approval procedure, sidestepping some of the usual safety considerations.
Yet, despite the potential chaos that could lie ahead on the political front – and the still difficult economic situation – equities indices continued to rally during the summer months. Investors brushed aside bad second quarter earnings reports, deeming them expected and preferring to focus on the few large high-tech companies that managed to buck the trend. Valuations, too, are no longer seem to matter. And then there are the other signs of market exaggeration. Anyone and everyone seems to be entering the investment fray these days, particularly among the younger generation. And we are seeing “trendy” companies take short cuts to become listed, via either direct quotation or a Special Purpose Acquisition Company (SPAC), thus circumventing the thorough fundamental analysis involved in a classic IPO.
Unproductive Public Debt
German authorities recently decided to extend partial unemployment compensation to 2021. This policy undoubtedly benefits companies, that are not forced to shed staff as revenues come under pressure, as well as workers, who do not lose their income. On public finances, however, the impact is clearly negative. Gone are the days where a debt-to-GDP ratio of 60% was the European “target”. With newly issued or rolled over debt costing near to nothing, no one seems to care any longer about how big the debt pile becomes. Central banks are printing money for politicians to spend: Modern Monetary Theory has effectively become reality.
The problem is that the money created is not being invested in productive ventures. As such it does not serve to generate future income streams, that would translate into higher growth and tax revenues down the road. Rather, it is just financing (or should we say upholding) current consumption – as well as fuelling asset bubbles.
Worse, what is happening at the government level is also true of companies. They too are not using the money that is flowing to them – at least in some sectors of the market – to invest in new capacity or growth projects. Truth be said, the companies that are attracting the largest flows have no need for that money, nor for more factories. So, they end up spending much of it on share repurchases, adding to the upward pressure on their stock price.
When will the “music” stop playing and why? We would argue that, eventually, inflationary pressures will build up to the point where interest rates, on the long end of the curve first, start to climb, breaking the market rally. At that point, fundamentals and valuation will matter again. But predicting when this will happen is of course impossible. For the time being, it remains a matter of riding the upward wave – recognising that this also means having to bear some of the (ultimate) downside risk.