Finance
Monetary Stimulus and Markets
How has recent policy impacted stocks?
While equity markets hit new highs during the past few months, despite the global pandemic, staggering unemployment, and record business closures, the new month has brought markets down from their lofty levels. Are we experiencing a “September Effect”?
What, exactly, fueled the extraordinary run that took place over the past several months? One of the largest drivers behind the market’s historic comeback has been the unprecedented stimulus provided by governments worldwide.
The unlimited quantitative easing programs embraced by the U.S. Federal Reserve and other central banks have cut interest rates to effectively zero, loosened capital requirements, established the Payroll Protection Program, and purchased billions of dollars of assets.
As a result of the fiscal response, U.S. debt is currently at its highest level compared to the size of the economy since World War II, according to the Congressional Budget Office.
The estimated total cost for the stimulus? As of May, it was approximately $3 trillion.
How has this stimulus impacted stocks?
Wall Street vs Main Street
The income gap between the rich and the poor was growing pre-pandemic and has widened further due to the restrictions that affected labor markets. According to the Pew Research Center, the wealthy keep getting richer. The percentage of total income going to the country’s highest-earning households increased from 43% in 1968 to 52% in 2018.
After the Great Recession, the top 20% of households in terms of earnings were the only demographic to see an increase in wealth, as their median net wealth increased 13% to $1.2 million from 2007–2016. Meanwhile, the median net worth of the lower economic tiers decreased by at least 20%.
Investing for all?
With the stock market at record highs, many individuals are trying their hands at investing, attempting to cash in on the market’s strength.
The portion of Americans who own stocks is approximately 55%, and that figure includes money that may be invested in a retirement savings account, limiting immediate access to those funds. The number of Americans who own stocks has decreased from 62% in the early 2000s, falling after the Great Financial Crisis.
In fact, stock ownership increases based on level of education, as well as yearly salary.
Stock Ownership and Asset Bubbles
Individual stock ownership has increased since the pandemic, fueled by more time at home and greater access to trading platforms. More and more individual investors are investing, taking advantage of free trading apps.
One trading app is Robinhood, whose catchphrase is “Investing for Everyone.” But should every person trade? Using catchy colors and a simplified interface, is Robinhood “democratizing” investing, and therefore making it more equitable for all?
Robinhood’s app allows investors with no experience to invest in the stock market, options, gold and cryptocurrency — all available to trade without a broker or financial professional’s help. But with the many dynamics involved in trading — earnings, profits, R&D, product development — is every person entirely qualified to trade for their own account?
Asset Bubbles and Recessions
With its extraordinary stimulus measures, has the Fed inadvertently caused an asset bubble? While markets will always rise and fall, an asset bubble occurs when the market price is trading excessively higher than the value suggested by the asset’s fundamentals.
The price of the asset may continue its upward trajectory, rather than correcting, due to an increase in the money supply. This is also referred to as the “Cantillon Effect,” whereby a change in the aforementioned supply causes a change in relative prices. It was named for Irish banker Richard Cantillon, who observed that new money drove up prices as it was spent.
Looking at the two most recent bubbles in the stock market, each of these events was followed by a recession — the dot.com bubble was followed by the 9/11 recession, while Great Recession followed the real estate bubble.
Asset Bubbles of the Past 30 Years
Are stocks currently overvalued?
A price-to-earnings (P/E) ratio is used to identify how expensive a company’s share price is relative to its earnings. The current P/E estimate of the S&P 500 (as of 9/3/2020) is 30.18. The ratio was 24.88 at the start of 2020, and 19.6 at the beginning of 2019. The average P/E of the S&P 500 has historically ranged between 13 to 15.
Another way to look at valuations is the ratio of the market capitalizations of all publicly traded companies as a percentage of GDP. Using the broad Wilshire 5000 Index to represent stocks, the ratio at the end of the second quarter was 1.52—higher than before the end of both the dot.com bubble (1.37) and the housing bubble (1.05).
According to Sir John Templeton, founder of Templeton Funds and a legendary investor:
“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”
The end of the summer is bringing election worries, a resurgence in COVID-19 cases, and a return of market jitters. As the monetary stimulus ends, will the influx of dollars to the stock market continue, or has the euphoria ended?
Markets are in constant flux, and the only thing certain is continued uncertainty. To learn more, visit quantumeconomics.io. This information is for educational purposes only and should not be construed as trading advice. Past performance is not an indication of future results.
