Three Halloween Ghost Stories

With trick-or-treating canceled in much of the country and It’s the Great Pumpkin, Charlie Brown not airing on broadcast television^[i], this is shaping up to be perhaps the most miserable Halloween in recent memory. Adding to the gloom for investors is a litany of ghost stories that have many fearing the bull market is destined for an early grave. We won’t sit here and dismiss everything spooking investors today, as some—like a second, massive global lockdown—could prove problematic if they were to happen in a manner worse than everyone expects. But the vast majority of today’s fears are no more real than your typical frightful Halloween tale. Or zombies.

The Second Fiscal Response Deal Remains Dead

As Congress and the White House continue bickering over a second economic rescue package—with conflicting reports over how close they are—one fear seems to dominate both sides of the aisle: the fear the economy can’t continue recovering without more help from Uncle Sam. Undoubtedly, more assistance would be a welcome help for businesses still forced to deal with capacity limitations and people still out of work. However, that doesn’t mean the broader economy depends on another round of federal spending. Actually, we already have evidence it doesn’t. Several CARES Act provisions expired at the end of July, including the supplemental unemployment assistance, which an August executive action only partially replaced. Yet consumer spending and retail sales have continued growing since, with the latter hitting new highs.

Some argue spending held up only because out-of-work folks diligently saved while the extra unemployment payments were rolling in and have since spent down those savings. We don’t doubt that was true for some households. But worries over government aid drying up presenting a broad economic headwind frequently emerge in  early bull markets—they are a twist on age-old jobless recovery fears. Unemployment today is largely in line with where it was early in the 2009 – 2020 bull market and economic expansion and it didn’t forestall growth returning then. Recoveries are typically jobless because job growth follows economic growth at a late lag.

You might note we didn’t use the word “stimulus” in the past two paragraphs. That is because, despite popular portrayal of the CARES Act as stimulus, it was more of a bailout. Actual stimulus forcibly creates demand through brand new government spending or investment—transfer payments generally don’t count. Might actual stimulus help now? Sure, we guess. A recession or early recovery is generally when stimulus is most effective. But we don’t think there is strong evidence it is necessary. If the eurozone could emerge from its 2011 – 2013 recession amid sweeping austerity, the opposite of stimulus, then the US can do a-ok now as long as the vast majority of businesses are allowed to remain open.

One From the Shadow Bank Vault: CLOs

While most investors are focused on a repeat of this year’s bear market coming from another round of lockdowns globally, some are still fighting the last bear market’s war and hunting for another bank crisis. A magazine article that made the rounds this summer claimed to have found it in collateralized loan obligations (CLOs), and we still see the discussion making the rounds to this day.

CLOs are securitized corporate debt, which has earned them parallels with mortgage-backed securities and 2008. Adding to the parallel is the fact that banks own a lot of them, and ratings agencies have stamped many of them with their highest grades. With lingering restrictions in some areas still driving come businesses to bankruptcy, the fear is that a wave of bankruptcies will tank the corporate bond market, taking CLOs with it—and bank balance sheets.

We discussed this at length in June, and the analysis holds up today. In short, corporate bond yields aren’t signaling a looming collapse. CLOs most resemble high yield corporate debt. The ICE BofA US High Yield Index has an aggregate yield to maturity of 6.0%, in line with its lowest levels during the 2009 – 2020 stock bull market.^[ii] Even if it were in worse shape, banks’ CLO holdings, which totaled $100 billion at 2019’s end, are all of 0.6% of total assets.^[iii] Only part of that total is even subject to mark-to-market accounting rules. It takes something much, much bigger than that to wallop a bull market.

The Bull Is Only Alive in Tech

You know this one. The bull market, so the story goes, is a mirage—Tech and the Tech-like FANG stocks are the only thing driving the market higher, and September’s volatility is only a foretaste of what to expect when investors turn on these (allegedly) overvalued albatrosses.

But the bull market that began in March is much more than Tech. By the time volatility arose in early September, 97% of the MSCI World’s 1600-plus constituents were up since March 23’s low—83% were up 20% or more.^[iv] Tech is indeed driving US outperformance, but that doesn’t make the rest of the world or the non-Tech US trash. Before September’s swings, if you omit Tech and the FANGs, the S&P 500 was up 46.9% from March’s low.^[v] Continental Europe, widely derided, rose 42.9% over the same span excluding Tech, with 97% of individual stocks positive.^[vi] US Tech gets the headlines, but this bull market is big and broad.