Monetary triage has worked far better than expected in the ugly days of March

Don’t fight the US Federal Reserve — repeat that mantra until it sticks.

Jamie Dimon, the boss of JPMorgan Chase, put it well this week. “This wasn’t the bazooka,” he said, referring to Jay Powell’s response to the coronavirus crisis. “The Fed took out the whole military and applied it. Just announcing these programmes reduced spreads [the difference between corporate bond yields and their benchmarks] in the market. It’s going to save a lot of small businesses.” 

In the past month, the equity market’s glass has gone from pretty much empty to at least half full and that’s down to the co-ordinated fiscal and monetary effort from authorities far and wide. You want some quantitative easing? Please, have some more and take some for the journey home. Even those foot draggers at the EU are talking about radical fiscal action. We won’t really see a V-shaped economic recovery, but it seems seem like we’ve stopped the L.

Nonetheless, this is a recovery based so far on asset-price inflation rather than any economic data. Central bank and government action may have restored financial valuations but real incomes will still suffer dramatically for a long while to come. Unemployment and diminished consumption cannot be magicked away.

The stock market is looking even further into the distance than usual to justify its valuations, which is sometimes hard to square away against a constant stream of dire economic statistics and evaporating company earnings. Since quantitative easing (QE) came to life during the global financial crisis, it has paid for investors to cast aside their usual forward-earnings analysis and focus instead on the rising tide of money. The central banks have learnt their post-2008 lessons and have barely put a foot wrong this time.

This is having uneven effects, however. The bulk of the stimulus is coming into investment-grade assets because that’s where central banks feel more comfortable. Credit spreads have recovered most in BBB and A-rated bonds. High-yield yield assets improved sharply at first, but this has abated. The spread between the yields on investment-grade debt and those of junk bonds is still nearly double the levels seen in February.

Similarly, new debt issuance is motoring again but only for the better-quality names. While US banks such as Citigroup and Wells Fargo are returning for the fifth or sixth time in 2020 to replenish capital, the junk sector has been restricted to one-off selective deals — often with eye-watering yields.

The change in stock market sentiment isn’t just about QE. The oil price collapse has come and gone and fears of a devastating second wave of Covid-19 are easing. Short-selling bans have quietly been lifted in several European countries too, and some of the recent improvement may be explained by that. The sound of economies cranking back into life can just about be made out over the whirring of the monetary printing presses, allowing even bombed-out old economy stocks to recover, not just the new technology darlings.

Notably, some of the recent action has been in high-dividend stocks, which had been forced to skip shareholder payouts at the height of the crisis. Investors had feared that the dividend bans might last several years; now they think it may be a quarter or two. Many investment funds work off a dividend-yield model.

Investment managers may be doing the natural thing right now and chasing the rising stock market indices, but that doesn’t mean they’re brimful of confidence. The Bank of America fund manager survey for May shows extreme bearishness pervades, with only 10% expecting a V-shaped recovery and 68% expecting stock prices to fall. Given the recent positive news on the virus and the gradual ending of lockdowns, the June survey might be different.

The fiscal response will determine how the economy recovers over the long term but the monetary triage has worked better than anyone could have expected in those ugly days of March. For that we should be grateful, and for the stock market’s semi-rational exuberance.

Bloomberg