A Breath of Fresh Air

Stocks rallied in response to the fiscal and monetary policy response from the government.

On the monetary side, the Federal Reserve announced that they would provide ‘unlimited’ quantitative easing (QE), and announced new facilities to support credit markets.

The Fed had recently committed to buying $500 billion in Treasury bonds and $200 billion in mortgage-backed securities, and said that it would continue in the amounts needed to support smooth market functioning.

When the Fed buys bonds in the open market, they are held on the Fed’s balance sheet.  Before the 2008 financial crisis, the Fed’s balance sheet was less than $1 trillion.  After three QE programs, the balance sheet reached ~$4.5 trillion, but was shrinking, and fell below $4 trillion as the Fed was ‘normalizing’ their policy.

Thanks to their recent activities, the Feds’ balance sheet is now over $5 trillion, and some economists believe that it could reach $10 trillion in response to the current crisis.

On the fiscal side, Congress passed a $2.2 trillion package designed to help cushion abrupt damage to the economy brought on by the response to the virus.

The bill includes $300 billion in direct payments to Americans of one-time checks of $1,200 for most adults and $500 per child.  The bill also features $250 billion in unemployment insurance, $221 billion in tax deferrals and $150 billion in aid to states.  The bill also provides $835 billion in loans and loan facilities.

Broadly speaking, there are two big ideas behind each of the packages.

First, the government knows that it’s important for markets to function properly.  During the past few weeks, markets did function for the most part, although there were some stresses like with exchange traded funds that track bond indexes.  Those imbalances have largely cleared up thanks to the aggressive monetary stimulus.

Second, everyone recognizes that we are headed into a recession, if we’re not in one already.  So far, the only major data point is the new claims for unemployment benefits, which surged to 3.3 million from 282,000 the week before and dwarfed the 1982 record of 695,000 new claims.

The question isn’t whether there will be a recession, but how deep it will be and how long it will last.  Vanguard’s economist, Joe Davis, made a credible argument for a deep recession that is relatively short thanks in part due to the aggressive fiscal response.

And although the current bill was just signed Friday, there is discussion that more may be on the way.  In the mean time, markets will continue to digest the economic data and try to set prices based on the information at hand.

The constant flow of new information is what makes predictions and forecasts basically impossible.

Last week, for example, we could have assumed that there would be large stimulus packages, but it was unlikely that we could have guessed that the Fed stimulus would be ‘unlimited’ in nature.  Or, Congress may not have been able to get a package through – one of the most memorable days in 2008 was when the TARP bill initially failed.

Missing last week would have meant locking in the -30 percent year-to-date losses.  Yes, not being invested meant that you couldn’t lose any more, but as we saw, it also meant not recouping some of the losses.

Our strategy of holding a diversified and well-balanced portfolio means enduring the hard times, but also enjoying the breaths of fresh air that come along in huge quantities like 2019 or in smaller, but important doses like last week.