Equity markets experienced their first material set-back since the March lows during mid-June. The bulk of the selling was done after the Fed meeting and the associated Powell press conference. Although one can study the minutiae of the language to ascribe a reason for the move, the simple fact is that markets have rallied a long way, very fast, and without a material correction in the face of what continues to be a very dicey fundamental outlook.
On the one hand, Powell’s comment that “we want investors to price in risk like markets should” could be taken as a desire to take a little heat out of the recent advance.
Considering the current politically charged environment, roaring equity markets against a backdrop of financial hardship and acute sensitivities to injustice and inequality just doesn’t have a great look or feel to it. Nevertheless, in the realpolitik world of central banking, such optics only go so far. Powell also made it clear that he would not let runaway asset prices get in the way of doing what needs to be done for the benefit of all economic constituents. “A non-working financial system can amplify the economy shock”. Given historic actions and forward-looking statements of intent, we can be confident that a collapsing equity market falls firmly in the camp of “non-working financial system” as far as the Fed is concerned.
Taken together, our assessment would be that the Fed would be quite happy for a few weeks and months to drift by without daily headlines of new highs being set in certain stocks. However, having thrown the kitchen sink at markets, we also doubt that they will be sanguine about letting all that work be undone. Some may question the Fed’s ability to overcome the tidal wave of bad fundamental events that are obviously still to come. Others may take umbrage on moral or intellectual grounds. However, if we keep our analysis solely focused on price outcomes, we see no reason that the mantra that has been in place for over a decade now is suddenly going to change.
While recent events always create the most powerful imagery in our mind’s eye, there are other, slower moving drivers of events at work that are less immediate, less perceptible but over time more powerful and important. In the same way that the response to the Global Financial Crisis in 2008/9 (money printing to boost financial asset prices) morphed from an emergency policy to save the system to a permanent policy to maintain the status-quo, the policy response to coronavirus (money printing to finance government spending) will have similar characteristics. Specifically, the link between taxation and spending has not been suspended, it has been severed. Now the populace has seen that, for countries that can print their own currency, there is no theoretical limit on their spending capabilities, the genie is out of the bottle. The political prospects of anyone standing on a platform of austerity or “sound finance” are dead on arrival. Importantly, the academic “hard yards” to provide the narrative to justify such policies are already in place. In short, even as investors try and process current events, the whole rules of the game are being changed on them.
Keynes wrote the following in his General Theory: "The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas."
For markets, the coronavirus matters a lot, but the change in both perception and reality of what constitutes the economic “rules of the game”, matters more.