Bernard Baruch, a legendary financier from the early 20th century, famously said that he knew it was time to get out of the stock market before the roaring ’20s gave way to the 1929 crash when he started getting stock tips from his cook and the boy who shined his shoes. As wing tips have given way to running shoes, we have had to look elsewhere for indicators of irrational exuberance in the equity markets. Today, we have Robinhood.
Robinhood is an Internet platform for “free” stock trading where today’s cooks and shoeshiners can play the markets. According to Robintrack.net, 40,000 Robinhood accounts added Tesla shares during a four-hour span this past Monday — a nearly unheard of level of herd activity. Perhaps those investors know something the rest of us don’t — indeed a lot of hedge funds and professional investors have lost a lot of money shorting Tesla over the past few years — or perhaps when the history is written, those frantically looking to pile into the market over the past weeks will be seen as the shoeshine boys and cooks of the Covid-19 economic collapse.
The defense of the Robinhood stampede is a simple one. “Don’t fight the Fed” is the eons-old mantra of trading stocks. In lay terms, it means that as long as the Federal Reserve Bank is cutting interest rates and pouring money into the system, buying stocks is a good bet. To dispense with all the math and high finance, the rationale is essentially that — all things being equal — the lower the interest rates on Treasury securities fall, the higher asset values — including stocks, bonds, and real estate — should rise. And interest rates have never been lower than they are today. Ever.
The current bull market began 40 years ago, when legendary Federal Reserve Bank Chair Paul Volcker pushed the Fed Funds rate — the primary tool that the Fed uses to stimulate or constrain economic activity — up to historically high levels to quash inflation that had risen to double digit levels during the post-Vietnam War years. As illustrated in this graph, over the ensuing decades, the Dow Jones Industrial Average grew 29-fold, from 900 or so from when Volcker pushed the Fed Fund Rate up to just over 19%, to its current level of nearly 27,000 today, as the Fed has finally joined the rest of the world in adopting a Zero Interest Rate Policy.
Those who have helped push the Dow back up from its late-March, pandemic bear market low, have had more than just declining interest rates on their side. Over the past several months, as the pandemic roiled the domestic and global economy, current Fed Chair Jay Powell made it clear he intended to pull out all the stops to push money into the system. In addition to the Congress flooding trillions of dollars of cash into the economy in the form of payments to individuals and corporations alike, the Fed both pushed interest rates down to historically low levels, and acted to further boost market confidence by creating funding programs to purchase all manner of corporate and asset backed securities. All told, since mid-March over $6 trillion has been pumped into the system, and a lot of that money has found its way into the stock and bond markets, pushing market indices back toward historic highs earlier this year, and producing hefty returns for Goldman Sachs and other Wall Street banks.
The looming question surrounding the apparent disconnect between an ebullient Wall Street and Main Street America rife with depression is whose perception of where we are headed will prove to be accurate. As suggested by this graph here of the “S&P 500 Forward Price/Earnings Ratio,” current stock prices are near historically high levels relative to expected earnings down the road. As shown here, the high point of the forward P/E ratio came in the late 1990s, during the Internet bubble, when investors famously piled into dot.com stocks that showed little or no prospect of profitability in the near term, based on the theory that in time those companies would become enormously profitable. When reality ultimately set in, as happens after market bubbles, stock prices settled back down, with the NASDAQ index declining by 75%.
The problem, of course, is that it is hard to know if stocks are mis-priced until after the fact. This time around, investor exuberance is relying less on normal economic cyclicality, or even continuing Fed intervention, than confidence that the miracles of modern science will bring the pandemic to a swift end and restore economic activity to the halcyon days of this past February. Zero interest rates and the infusion of over $6 trillions into the economy by Congress and the Fed may have been necessary to restore market confidence in the short-term, but it will not be sufficient to restore corporate profitability to levels that justify current stock market values. Investors today are pricing in a best-case scenario that presumes both that a vaccine arrives in short order, and that employment and consumer confidence will be restored with it.
For most industrialized countries across the world, a vaccine has not proven to be a precondition for returning kids to school and economic activity to near-normal levels. Across much of Europe and Asia, widespread adoption of recommended public heath practices — face masks, social distancing, contact tracing and hand-washing — have built public confidence and brought the coronavirus sufficiently under control to allow countries to see a path toward the resumption of near-normal life. The United States, of course, did not choose that path, and as a result the timeline for economic recovery is less certain and likely to take longer than many stock investors appear to anticipate. As illustrated in this graphic, Standard & Poor’s projects that the recovery of the economy to 2019 levels is going to take as much as three years or more, varying by industry, with continuing downside risk as the course of the pandemic plays out. The banking sector, in particular, which continues to receive massive support from the Fed, may prove particularly vulnerable as that public support recedes.
The elongated pace of economic recovery laid out by S&P — particularly with respect to consumer-facing tourism, entertainment, travel and non-essential retail industries — suggests skepticism with respect to the timing of a Covid-19 vaccine being widely available, and the economic implications of Donald Trump’s bi-polar relationship with the scientific establishment. On the one hand, the President has consistently undermined the low-tech recommendations of his public health advisors that have proven effective in nations grappling with the virus across the globe, while on the other hand he has thrown billions of dollars at pharmaceutical researchers in the hope that one of them will produce a vaccine quickly enough to rescue his reelection prospects. Trump’s vaccine-or-bust strategy has effectively eschewed the middle ground of suppressing the transmission of and learning to live with the coronavirus that has enabled something resembling normal daily life to return across much of the rest of the world.
Every week, we hear new announcements trumpeting the latest successful steps in vaccine development by one company or another. Yet even as those announcements lead to quick bumps in company stock prices, they are also sowing seeds of distrust that loom to undermine the effectiveness of whatever vaccine the public is ultimately asked to take. The naming of the vaccine development program Operating Warp Speed, the President’s urgent focus on having a vaccine in place by the fall as his path to reelection, and the public neutering of the Food and Drug Administration as a trusted arbiter of vaccine safety and efficacy are each breeding distrust in the vaccine development process.
Economic life revolves around voluntary activity, and the more the President has tried to mandate the return of normal economic activity through threats and dictates, while doing little to address the underlying pandemic conditions that have caused distress and anxiety across the population, the more he has undermined what remains of his waning credibility. Each time one of the drug companies competing in the Operating Warp Speed Olympics announces its latest, greatest news, the public is further reminded of why they distrust the entire undertaking, as evidenced by polling indicating that an increasing share of the population may decline to take the vaccine.
The irony of the President’s decision to go all-in on a silver bullet cure is that if he had done the simple things up front — promoted those public health measures that have worked across the globe — both the economy and his reelection prospects would be in far better shape today. And those public health measures may still constitute our most viable strategy for near-term economic recovery, particularly if, as scientists at the University of California San Francisco concluded this week, coronavirus antibodies turn out to be too short-lived to allow a vaccine to be effective.
GOP analytics maven Bruce Mehlman suggested this week that for the first time since 1900, the nation is facing four “super-disrupters” at the same time: economic recession, pandemic, mass protests and election turmoil. Each day, we can see how those factors are interacting and amplifying their combined impacts. Over the past few weeks, as the pandemic has continue its spread across states in the south and the west, we have seen corporate leaders and banks walk back earlier forecasts of a quick, “V”-shaped economic rebound, and suggest instead that a longer path to recovery lies ahead. Against this backdrop, it would seem that the bloom may be off Wall Street’s rosy scenario, and that the frantic enthusiasm of Robinhood investors may be a signal — as Bernard Baruch suggested of his shoeshine boy nearly a century ago — that the markets are headed for a fall.
Follow David Paul on Twitter @dpaul. He is working on a book, with a working title of “FedExit! To Save Our Democracy, It’s Time to Let Alabama Be Alabama and Set California Free.”