Nothing more powerful than our emotions in the financial markets. Frequently investors may become binaries entities. In the short term, there are just a few instants between total panic and euphoria.
After a historic approval of exceptional U.S. fiscal and monetary aid packages and further promises of more money, financial markets came back for three days in a row. The S&P 500 index has to recover +17% in the last three days (March 23rd to 26th, 2020).
Is it all good now? Are we heading to higher index levels? Are we going to test new lows in the near term? All of them are excellent questions, which nobody could answer right with certainty.
But if we leave behind the fear of missing out of this stock rally, sometimes called FOMO, we could prepare a rational assessment of where we are and where we could go from here. So let us review it coldly.
I will start saying there is no price for human life, and it looks like most world governments agree; they are providing all their resources to beat this virus. I applaud their commitment, and especially those health care professionals, armed forces, police, social, and government workers who risk their lives for us.
The cornerstone of our current predicament is how fast we could control this pandemic and how much it will cost us, first and foremost in human lives, and then in people's economic prosperity.
The lockdown we are living in has a tremendous economic impact. The days we are in lockdown will define future recovery. The economy has never been stopped completely before for so long. The consequences of this standstill are unknown. Many companies might not survive because financial support might be too late for them.
As in every other opportunity in history, when there is a money problem, governments and central banks create even more money. More money means more debt, at the moment when we were in the highest government and corporate debt levels.
So wait a minute, governments and corporations are indebted to the extreme, and we plan to add more fuel to it? Indeed, they will, and they should do it. But what will be the consequences? That is indeed the right and most challenging question to answer.
At first, the primal economic instinct will be that the issue of more debt will cause inflation, but historically this has not been the case for those countries who can finance themselves in their currency. High levels of inflation are a more common effect for those countries that issue excessive debt in foreign currencies.
Second, when everybody is issuing debt, your currency might be worth a little less in the future, but so will be everybody else currency. So in the end, it might not be crystal clear that the U.S. dollar might lose value over time, because so will the European euro, the Japanese yen and the Chinese yuan, and the other currencies.
In the short term, the sharp destruction of demand and supply by the self-imposed lockdown will be compensated partially by the government and Federal Reserve aggressive creation and distribution of new money.
Over time the flow of new money to the economy will permeate to the most needed areas of our society, and there will be as well, certain areas of the economy which did not require it but got help anyway. There will be, therefore, winners and losers in the process.
Highly indebted companies in the low margin and highly competitive sectors of the economy will need to be restructured, merge, or will simply disappear. At the same time, innovators, disruptors, and efficient business models who create a unique business and do things better will have access to quasi-free money. It has been happening in the last ten years, and it might continue at a faster pace.
There is a delay effect we must consider in this money distribution, and it is not just the speed to which the government makes decisions and send the checks to people. The process of firing employees is quicker and abrupt, but hiring employees, it is not.
We just saw an unprecedented 3,2 million people asking for unemployment benefits this week in the U.S. The average weekly of the last years was close to 250 thousand, and there are a couple of weeks ahead to end the lockdown. Markets entirely expected this unusual report, and it was not a surprise at all.
First, even if the economy starts recovering quickly, the employers will hire employees to the extent they have enough business. Therefore they might need fewer people in the short term than they had before because the demand is not there yet.
So if it took the economy two months to shut down, it might take a lot more than that, if everything runs smoothly, to reach the same level of production again.
The implications for the stock markets are more complex than one can imagine. For example, if the demand recovers slowly than predicted, the company's revenues and earnings will take a long time to find the previous levels.
Although the risk and reward balance for the stock market is much better than a month ago, the upside for the stock market in the medium term might not be the same for the medium-term as it was before. The only advantage will be to buy quality names at low prices. Volatility and uncertainty are not yet under control, therefore we could expect markets to keep its extreme swings, until the health crisis phase-out.
Investors will have to be wiser to pick winners and avoid value traps; it is time for active management strategies to shine.
But of course, there is always the possibility that the markets may provide us at any time with an extremely positive surprise once more, in this case, let us hope for a good one!
Please, stay safe!