Thursday, June 11, 2020

Cohan: What’s Behind the Bad-News Market Boom

So let me get this right: There are at least 40 million Americans out of work (and probably more if you believe Nobel Prize–winning economist Joseph Stiglitz who says the official Labor Department statistics overlook the self-employed and those who have given up trying to get a job); we have been in an economic recession since February and second-quarter GDP could be a bottomless pit; we remain in the midst of an unprecedented viral pandemic that has already taken the lives of more than 110,000 Americans; we have worse-than-zero political leadership in Washington; and we have, in many cities across the country, nearly nonstop protests by Americans of all stripes in the wake of the brutal killing of George Floyd, allegedly by a Minneapolis police officer. And yet, the Nasdaq is at an all-time high, while the Dow Jones Industrial Average and the S&P 500 indexes are within striking distance of their February highs.

What gives? How can this be happening? How can so much bad news in the real world result in such surprisingly good news in the stock markets? Aside from the obvious answer that no one knows why this happening—or if they say they do, they don’t—there are any number of possible explanations. First and foremost, one has to attribute the amazing stock market recovery after its mid-March collapse to the extraordinary actions that the Federal Reserve Board, and Jerome Powell, the Fed chairman, have taken since the economy went into lockdown, in and around March 10. Initially, Powell returned short-term interest rate to near zero, as they had been for years after the 2008 financial crisis. Then, on March 23 and again on April 9, he signaled that the Fed would do pretty much whatever it could to pump huge amounts of liquidity into the capital markets. He implied that the Fed would be willing to buy nearly any financial instrument that was not tied down, including risky high-yielding junk bonds—something it had not done before—and some have even concluded that the Fed might be willing to buy equities.

In other words, the Fed made clear, it was willing to essentially back-stop the capital markets by once again becoming the buyer of last resort. The Fed news caused an immediate and palpable shift in investor sentiment both in the equity and in debt markets. After reaching an all-time high of 29,551 on February 12, the DJIA collapsed to 18,591 on March 23, a 37% fall in a little more than five weeks. Since March 23—the day the Fed announced its first massive intervention—the DJIA has climbed back to around 27,300, an increase of 46%. The turnaround has been equally pronounced—again thanks to the Fed—in the bond markets. Where essentially the market for new issuance of investment-grade and high-yield bonds was closed in the month of March, they opened in dramatic fashion in the last week of March and into early April. The issuance of investment-grade debt in the last week of March—again thanks to the Fed—was at record levels. Then came the onslaught of junk bond issuers, in April and since. Companies as seemingly destitute as Carnival Corp., the cruise ship operator, were able to issue new bonds, albeit with a 12% interest rate, when absent the Fed that would not have been possible at any price, at least in the public markets.

If I could show you a chart of the high-yield bond index since February 20, you would see just how dramatic what the Fed has been doing has been. On that date, the high-yield bond index was yielding 5%—indicating (to me anyway) that junk bonds were priced for perfection, that the economy would keep humming along, that unemployment would remain low and that consumer spending would remain hot. During the next month, all bets were off. The yield on the index spiked up some 635 basis points to 11.38%, reflecting the abject fear running through the financial markets. Once again, that fear began to dissipate on March 23, when the Fed intervened, and has been dissipating ever since—to a shocking degree. Incredibly, today, the yield on the high-yield bond index is back to 6%, a mere 100 basis points above the perfection rate of 5% of last February. And yet the economic news could not be worse.

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