Don’t Thank the Fed for Stocks’ All-Time High

The S&P 500 price index closed at a new all-time high today, echoing what the total return index confirmed a week ago: The bear market officially ended on March 23, and a new bull market is underway. One common theme we saw in press coverage of the milestone is that the ginormous fiscal and monetary response from Congress and the Fed deserves most of the credit. We won’t argue their actions had no effect, as they probably did help shore up confidence early in the spring. But to argue fiscal and monetary policy drove the recovery is to argue this bull market can’t keep marching onward without help—a false premise, in our view.

To say a bear market ended because of monetary and fiscal support is to misunderstand how markets work. Stocks are leading indicators of the economy, and in general, they price in economic conditions and corporate earnings anywhere from 3 to 30 months or so out. During bull markets, they generally look toward the mid to longer end of that range, which is how they are able to see past volatility in monthly data and quarterly earnings. They also don’t need things to be anywhere near perfect, as long as expectations are reasonable. A reality that simply goes better than expected, overall and on average, is generally good enough to let stocks rise.

In a bear market, however, stocks shift focus to the shorter end of the range. As recession becomes increasingly likely, stocks’ primary concern is how deep it will get and how long it will last. A bear market’s decline is stocks’ way of pricing in the anticipated economic damage and its impact on corporate earnings. Once stocks have done this and are able to see an end to the recession, they can shift back to the mid-to-longer term and price in the economic recovery’s effect on corporate profits. Not over the next three or six months, but over the next year, two or three. This shift in focus can happen rapidly, which is why the first leg of a bull market tends to be so strong. This is also why that first leg can seem exceedingly out of touch: It immediately follows the most panicky part of a bear market, when fears of mass bankruptcies and sky-high unemployment reign. It also precedes any hint of economic recovery showing up in the data, leading pundits to argue stocks are detached from reality.

If you think stocks are coincident indicators, then yes, they would appear detached in a new bull market. Only if you correctly see stocks as leading indicators does the apparent disconnect appear rational. Then, the main question isn’t what conditions look like today or tomorrow, but whether it is reasonable to believe better times lie ahead over the next couple of years.

Sometimes, fiscal and monetary stimulus can be part of the answer. But we don’t think they are this time around, because nothing the Fed or Congress did really qualifies as stimulus. Most of the Fed’s programs were bailouts in the form of lending to struggling businesses or serving as buyer of last resort in corporate bond markets. The one program advertised as stimulus, quantitative easing (QE), is more of a sedative because it flattens the yield curve and discourages lending. Markets know this, because they saw how QE weighed on loan and money supply growth during the last bull market. So we think it is safe to say stocks have been rising for nearly five months despite the Fed, not because of it.

As for fiscal policy, in our view, the CARES Act wasn’t stimulus either—it didn’t forcibly create demand where none existed. It didn’t inject money into communities via new investments. It was mostly loan guarantees and transfer payments to help get people through a stretch where they couldn’t work. It was a cushion for the economic contraction, not rocket fuel for a recovery. If it were truly critical to a new economic expansion, stocks wouldn’t have continued rising as several of its provisions sunset last month—especially not with so many people warning of severe fallout from those programs’ expiration.

In our view, the reason stocks are back at new highs has basically nothing to do with the Fed and Treasury—and everything to do with a vision of society in 2021, 2022 or 2023 that isn’t hamstrung by COVID-19, whether because we have a vaccine, the virus becomes less virulent, or humans’ extraordinary ability to adapt and advance despite the odds proves itself once again. Nothing we see today defies that belief. Where caseloads have risen, draconian lockdowns haven’t returned. People are getting used to wearing masks while shopping and practicing other social distancing measures. Containment measures are targeted and local, not sweeping and national or global. Meanwhile, the vaccine race is off and running, with multiple participants conducting trials. Stocks don’t need perfect. At a time when everyone fears a return to mass lockdown, society gradually learning how to live with the virus should be enough to beat expectations.

One common mistake investors make in a bull market is searching for reasons to be bullish, as if stocks don’t rise much more often than not. As it happens, they rise about two thirds of the time (on a calendar year basis), so a better approach is to critically assess whether there is a good reason to be bearish—one that is huge and not widely discussed. Unless you see one that has a high likelihood of coming to fruition, then you are probably better off being bullish and recognizing other people’s fears for what they probably are: bricks in a bull market’s proverbial wall of worry.