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The tsunami of money meets the bad news

Despite the terrible fundamentals, a wall of money from the Federal Reserve is propping up markets.

US dollar notes

Charles Stanley

in Features


Over the last few days, rioting and looting have broken out in many US cities following the death of George Floyd. Black lives matter has become a potent rallying cry for legitimate protest. Others have joined in with criminal acts. National Guard troops have been deployed in more than half the US states to try to quell the violence and restore order. People have been injured, properties burned and goods stolen. Curfews have been imposed but have not always been observed. The S&P 500 Index has risen 2% during this new crisis.

It is another extreme example of the growing gap between the news reality and the outlook of the markets. Buyers of equities are said to be looking to the relaxation of the lockdowns, to the strong recovery in output and turnover that will be seen in businesses that have just experienced a period of no turnover, the chances of a vaccine or treatments emerging which will end social distancing altogether, and now to an early end to the riots.

Whilst these events played out, the Fed quietly got on with its task of supplying large sums of money to most in banking and markets who need it. The Fed balance sheet rose by $60bn between May 18th and May 25th as it issued more money, extended more credit and accepted more deposits from banks. Its balance sheet climbed to $7.097 trillion, compared to $4.17 trillion in mid-February. It has lent directly an additional $0.4 trillion in the last three months. No wonder markets seem relaxed about the obvious signs of distress in the economy and on the streets. There is an unprecedented tsunami of money taking up most things as it washes through the system.

There are now signs that some of this money has eased the dollar shortage and is influencing other parts of the world. Equity buyers who understandably wanted to concentrate on the companies and sectors that can survive and flourish in the harsh Covid-19 conditions are now tempted to buy cyclical and traditional businesses on the basis that many of them have now passed the worst.

This is happening even though countries like India and Brazil still have a big fight on their hands against the virus, and the world economy faces months of high unemployment, lower demand and more bankruptcies of the businesses that have lost all or most of their turnover and will find it slow work to regain activity under social distancing rules. The oil price has been rising on the hope of an extension of the substantial OPEC production cuts and on confirmation of reduced US output.

With the indicators still pointing to much lower output than earlier this year, to high and rising unemployment and to much weaker company profits, it is going to take a continuing flow of new cash to markets to keep assets this high and higher.

Investors are not looking much at price-earnings ratios or dividends. They are implicitly accepting that shares are going to get more expensive as earnings fall, with optimists resolutely looking to improvements from a weak base, and realists understanding that it is all about an asset price inflation on the back of plenty of money.

When there is such a gap between economic and profit reality and asset pricing an investor needs to balance the wish to participate against the worry that reality may one day break through. All the time the money tsunami is there, assets will be supported. It still seems more prudent if not as immediately rewarding to buy and hold those shares that can do well even in these troubled times. The recovery stocks may go bust or need equity financing at the expense of existing shareholders. Zoom reminded us just how well some companies are doing out of the disaster hitting the traditional economy. Its turnover leapt up, it dashed into profitability and generated a lot of cash.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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