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PERSPECTIVES: And you thought it was different this time?

Why does the stock market keep going up while the economy seems so bad?

Editor’s note: Today we introduce a new business columnist, Trevor Forbes, President and Chief Investment Officer at Renaissance Investment Group in Lenox, Mass. Trevor has served as the Chief Investment Officer at Standard Life Wealth, ABN Amro, Julius Baer, and Credit Suisse Private Bank. In the 1990s, he served as Head of Global Securities for Citibank Global Asset Management.

Some of the common questions I am asked about investing and the markets are often couched in understandable bewilderment. They include genuine surprise at a rising stock market when the political environment is so apparently chaotic. Some express bewildered disgust at the rising wealth for the few caused by increasing stock prices while income disparity “has never been higher.” There are so many people unemployed, with poor prospects, so how can stock prices rise? It must be due to the few profiting from the misery of the many.

During the near fifty years I have been in the investment markets, these are comments I have heard time and time again. Is it really far worse now than before? That is probably the subject of another commentary, but what I do know is that in a 1987 interview with (Sir) David Frost, then-Senator Biden stated that never had America been so divided, with an intolerable income gap between the haves and the have-nots. Apparently, four decades later and after Democrats and Republicans have held the presidency an equal 16 years apiece, little seems to have changed. None of this is to condone divisions or to support one way of dealing with our many entrenched problems; it is more to emphasize that the issues seem to transcend politics. It is also noticeable that since that interview in 1987, the stock market, as measured by the S&P 500 Index, has risen 1000% — an eleven-fold increase! Indeed, since the peak in February last year, just before the COVID crisis engulfed us here in the U.S., stocks have risen 12% and a staggering 51% since the mid-March low, when the country was in full lockdown.

So, I hear you ask, what is going on? Have investors lost all sense of reality, and are we now in a type of alternate universe where the real world doesn’t matter?

I first started examining this phenomenon in the UK in the mid-1970s during a particularly severe financial crisis-induced recession. Inflation appeared out of control, the government seemed in constant turmoil, unemployment was high and rising, yet stocks were recovering strongly from a two-year severe bear market, when equities had fallen 67%. I remember the tabloid press headlines condemning the “fat cats” in the City of London making money while the unemployed were starving. However, two years earlier stocks were suffering a steep decline and jobs in the financial sector were being cut in half, just as unemployment reached a new low. So, why this disconnect?

While there are many contributing factors, one stands out as a consistent theme: investors’ anticipation of future policies of the Central Bank. Put simply, rising interest rates are expected to be bad for stocks and falling interest rates should be good. Over time, our policymakers at the Federal Reserve Bank and in Congress tend to err either on the side of caution over the future course of inflation either by raising interest rates and risking recession or by reducing interest rates and risking future inflation to take us out of recession.

Since the Global Financial Crisis of 2008/2009, policymakers have pursued the latter, maintaining low interest rates and risking inflation in order to stave off recession. In 2018, the Federal Reserve Bank reversed this policy, and risk assets ended the year in free-fall. The main stock market index fell 14% from the mid-September peak. This was reversed in 2019 and as the COVID crisis unfolded, the Fed and Congress put in place the most extraordinary stimulus we have ever seen outside war time.

As a result, the supply of money in circulation in the U.S. has risen nearly 70% above a year ago and risk assets, including stocks, are surging. The Federal Reserve Bank has indicated this will stay in place for at least two years and, in the meantime, the new administration is proposing a sizable new fiscal stimulus. If this remains in place until the end of 2023, we will have seen a total stimulus to the U.S. economy equivalent to 80& of the size of the U.S. economy at the end of 2019. This is why stocks are surging. The burning question for us now is “for how long”?

Trevor Forbes’s articles and contributions to The Berkshire Edge should not be construed as a solicitation to effect, or attempt to effect, transactions in securities, or the rendering of personalized investment advice for compensation. As an author with specific expertise, his contributions reflect his personal views and do not represent Renaissance Investment Group LLC.


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