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It's either Sadness or Euphoria

Billy Joel spent much of the summer of 1975 in upstate New York as he worked on his third album, “Turnstiles”. While he was inspired by the beauty of that area, the music on that album reflected the pressures and frustrations of his nascent music career. One of the tracks from that album, “Summer, Highland Falls”, described his feelings of “sadness or euphoria” accompanied by an upbeat piano that ebbs and flows in the background.

In response, the Federal Reserve implemented a series of policy initiatives, rolling out their entire playbook from the financial crisis of 2008-09, and then some.  They slashed short term rates, announced the open-ended purchase of US Treasury and mortgage-backed securities, extended lending facilities to securities firms and banks, and for the first time extended the facilities to high yield (junk) ETF’s as well.  In less than two short months the Fed balance sheet grew from $3.9 to $6.1 trillion.

Countries around the world rushed to implement emergency measures.  In the US both Democrats and Republicans raced to implement stimulus packages that would benefit their individual constituents.  The legislation, now referred to as the CARES Act, started as a $1 trillion aid package, but grew to more than $2 trillion by the time it was enacted, amounting to almost 10% of total GDP.  The bill had something for everyone; payments to households, payments to state and local governments, unemployment benefits, aid to small business and large corporations, Payroll Protection loans, cash grants to college students, student loan deferrals, as well as rent and mortgage forbearance.  In the rush to implement the legislation secondary effects were often overlooked.  For example, the emergency unemployment benefits paid many claimants more than they made working.  This perverse benefit created a disincentive for many to rejoin the workforce when opportunities arose.  Unions representing municipal workers and teachers gamed the system by furloughing members one day per week so they could collect both a paycheck and receive unemployment compensation.  All of this spending was fueled on borrowed money.

We were reminded often as children that “money does not grow on trees”, but for some reason Central Bankers and legislators seem to believe that money can grow magically with “digital entries”.  This cannot go on forever, and when it finally ends it will not end well.  My greatest concern is that the ill effects will be borne not by us or our children, but by our children’s children.
  
The market decline of the first quarter was followed by an equally stunning rebound.  Stocks rose 40% from the lows set in the last week of March through early June (the fastest rally of that magnitude over a 50-day period).  The rebound lifted the S&P 500 index above the year-end close and just 4.5% below the peak set in February.  The move seemed completely disconnected from economic reality.  While some sections of the economy reopened quickly, airlines, restaurants, and retail businesses were operating at limited (and unprofitable) levels.  The disconnect was apparent in the bond markets as longer-term yields remained stable, or drifted lower, indicating that bond investors did not foresee a sustained rebound in economic activity or inflation.

Market volatility of the magnitude recently experienced is often followed by periods of uncertainty, as investors search for investment opportunities in the absence of reliable information.  Since the recent peak inter-day volatility seems much higher as markets react to headline news or sudden reversals of widely followed stocks.  In the absence of reliable fundamental information we will exercise caution to avoid getting whipsawed by market swings from sadness to euphoria.

 

Sincerely,
Daniel A. Morris

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