We are entering the phase of a bear market where pessimism starts to evolve into extreme doubt, where investors watch the stock market sell-off, as the Federal Reserve announces massive liquidity measures, and think, “Maybe this is it. Maybe the Fed can’t save us this time.”1
This is the phase of a bear market where fear slowly starts to overtake reason, which to me, means it’s a good time to examine what is objectively happening in the capital markets that we can see and measure. The Federal Reserve’s unprecedented actions over the past two weeks are a good place to start.
The first Fed move was one many investors are familiar with – the classic rate cut. The Fed cut its benchmark rate to near zero, and then layered-in a 2008 tactic by also introducing $700 billion of bond buying (Treasuries and mortgage securities). Many investors remember this as “quantitative easing,” or QE. There is a solid argument for QE being ineffective, as it supports the flattening of the yield curve – which isn’t great for banks’ net interest margins (which can hurt lending). But history also suggests that putting downward pressure on longer-term interest rates makes stocks more attractive by comparison, which I believe to be true.
The Fed didn’t stop there. It then expanded its QE commitments to a virtually unlimited dollar amount, signaling to the market that it would do whatever it takes to intervene.
The Fed’s actions included:
- Lowering reserve requirements and telling banks they would not be penalized if reserves fell below the capital requirements established by Dodd Frank;
- Restarting the commercial paper lending facility and the primary dealer credit facility to buy bonds and inject liquidity and backstops into the credit markets ($300 billion estimated financing capabilities);
- Taking the unprecedented step of becoming a lender not only to the biggest financial institutions, but also to households and small businesses struggling to survive;
- Stepping in to shore-up money market funds and purchasing municipal bonds;
- Opening a “Primary Dealers Credit Facility,” which allows banks to get short-term loans needed to buy and hold securities (mainly corporate bonds); 2
- And more.
The Fed is working in conjunction with the U.S. Treasury to make this capital available without exposing itself to high capital loss, which it is prohibited from doing. In all, the Federal Reserve has done more – faster – than it did in late 2008 when the global financial crisis was taking hold. The idea that the Federal Reserve is evolving, albeit temporarily, into a commercial bank as well as a central bank is totally new, and appears in my view to be an important lesson drawn from the mistakes made in 2008.
According to the former Fed Chairman Ben Bernanke, who led the Fed during the 2008 financial crisis, “I think the Fed has been extremely proactive, and Jay Powell and his team have been working really hard and gotten ahead of this and shown they can set up a whole bunch of diverse programs that will help us keep the economy functioning during this shutdown period, so that when the all-clear is sounded, we will have a much better rebound than we otherwise would.”
The Fed’s actions are happening alongside a fiscal cannon, with plans released by Congress for some $2 trillion in new stimulus. Some highlights from the Senate bill include:3
- Providing Americans with incomes up to $75,000 ($150,000 for married couples) a check for $1,200, with an additional $500 per child. For each $100 of income above the thresholds, the check will be pared by $5.
- Broad expansion in unemployment benefits, which would extend to gig workers and freelancers, and increase monthly payments by $600.
- $350 billion in loans to small businesses to cover payroll expenses, rent, and debt relief on existing loans.
- $500 billion towards backstopping Federal Reserve loans to corporations (see above).
- Create new grant program to send $100 billion to health-care providers, with $16 billion for stockpiling medical equipment and protective gear.
In all, the economic bazookas are firing, and while we are almost certain to endure sharp short-term pain, the sheer volume and size of liquidity and spending being dedicated to the economy is unprecedented. I expect it to show up in asset prices sooner than most think.
Bottom Line for Investors
John Templeton once said that the four most dangerous words in investing are: “This time it’s different.” I’ve mentioned this quote a few times in my columns during volatile patches and even bear markets, and many investors and readers are familiar with it.
In the current environment, however, I have seen quite a bit of resistance to the message of the quote. Many people are insisting – correctly, I might add – that this time is different! We’ve never seen this virus, we know very little about it, and the flood and speed of information in this modern era is unprecedented. We’ve never seen the Federal Reserve and the US government have to step in with these unprecedented liquidity and stimulus measures!
I agree that these unique circumstances are affecting society and driving our responses and decision-making in ways that we’ve never experienced before. This time is, in fact, different.
But the point of John Templeton’s quote is not to say that all bear markets are essentially caused by the same things and that they all end in the same way. Templeton’s point is that it would be a huge mistake to assume that this crisis is the one that the stock market won’t recover from. That this is the crisis where the Federal Reserve and federal government’s actions can’t save the economy. That this is the crisis to ruin the economy for good. I can assure you; it isn’t.