By Michael Brush
President-elect Joe Biden announced a $1.9 trillion stimulus package and the stock market fell. What the heck is going on?
You might have expected the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.47% , Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +0.18% and Nasdaq /zigman2/quotes/210598365/realtime COMP +0.90% to rise on the news.
The package might be too much of a good thing, and the smart money — professional investors — knows it.
Of course, no one wants to begrudge anyone who needs personal assistance to pay the bills because of hardships not of their own doing, meaning the Covid-19 crisis. That would be heartless.
But investors also consider the big picture. In this sense, the stimulus may eventually create more problems than politicians are bargaining for. It definitely creates winners and losers in the stock market and the economy, and the potential harm could touch almost everyone — but particularly the less well-off. This isn’t a political comment. I am apolitical. It’s just basic economics.
To understand what’s going on, you need to be aware of how absolutely massive the stimulus programs are. So, forgive me for sharing some all-important numbers. I’ll keep it brief.
So far, we’re getting $4.8 trillion in stimulus including what Biden just announced. Plus, huge monetary stimulus in the form of quantitative easing from the 80% increase in the Federal Reserve’s balance sheet. This seems a lot like overkill, compared to the amount of stimulus needed at this point in rebounds from past recessions, points out Jim Paulsen, Leuthold Group’s market strategist.
Consider these numbers. At similar points coming out of the three big recessions since the early 1980s, the federal-deficit-to-GDP ratio was only 2.7%-4.5%. Now it’s a huge, at 15%. Exiting the last three slumps, monetary supply growth was a 1.3%-9.5%, and now it’s a massive 25%. The bond market also offers unprecedented stimulus in the form of cheap money. Historically, coming out of slumps, the 10-year Treasury yield /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y -0.16% was 2.5%-7.2%. Now it’s 1.1%.
Now let’s look at some of the potential winners and losers, and why the stimulus news makes investors nervous.
The relatively massive stimulus may well create short-term gain but long-term pain, cautions Paulsen. How so? The massive stimulus may cause the economy to overheat and inflation high enough for the Federal Reserve to take away the punch bowl to contain it.
A lot of recessions are caused by the Fed acting like this to limit inflation. If another one plays out, the people who’ll get hurt the most may well be the people politicians are trying to help the most now, meaning the low-income, least-skilled and disenfranchised segments of our population. A return of inflation would also hurt the elderly living on fixed incomes.
If inflation does rage, the Fed will act to stifle it. That’s half its job. (The other half is to create adequate employment.) Any Fed action to cool growth to limit inflation may cause investors to freak out and sell. Remember the “taper tantrums” of the past few years, which sparked big selloffs? This is not just investors having trouble getting weaned off the drug of government-induced growth. It’s a legitimate reaction, given that Fed action to contain inflation has caused so many recessions in the past.
Banks have had an amazing run since last summer. A “bank five portfolio” of five banks I suggested in my stock letter, Brush Up on Stocks (see the link in bio, below), on Aug. 11, 2020, was up 45% as of the close Jan. 14, 2021, compared with 14% for the S&P 500. The portfolio includes J.P. Morgan Chase /zigman2/quotes/205971034/composite JPM -0.49% , Bank of America /zigman2/quotes/200894270/composite BAC -0.13% and FB Financial /zigman2/quotes/204236502/composite FBK -0.15% , and two investment banks.
They’re up because the yield curve is getting more upward sloping. Ten-year Treasury rates are rising relative to short-term rates because of the mounting inflation risk. Banks make money, in part, by borrowing at short-term rates and lending at long-term rates, known as the net interest margin. So this helps them. The favorable yield curve trend will likely continue as the prospects of growth-induced inflation continue to mount — due to all the stimulus.
The benefits to banks offset the potential risks of greater regulation by Democrats who now dominate Washington, D.C. Of course, any increased fear of recession sparked by the Fed’s efforts to control inflation would hurt banks a lot.
Many of the biotechnology names I’ve been suggesting in my stock letter have been big winners. But the risks in biotech are now rising, because of “too much stimulus.” Why?
Biotech stocks are “long duration” assets. This means the arc of their earnings potential has a long duration into the future, since so much of their potential growth derives from products coming to market years from now.