Stocks Erase 2020 Loses – We’re Overbought
A great stock market last week as indexes climbed nearly +5% and ended close to erasing the negative return in 2020. We seem overbought here but the market can stay overbought for a surprising amount of time. Much of the record rise off of the March low was due to government stimulus, so as we near a full recovery in the equity markets it worth think about possible side effects from this historical government action.
If we were to have an effective vaccine tomorrow, we would exit this pandemic with interest rates at zero here in the US and negative in most other developed nations. In addition, through various financial wizardry (excess borrowing, quantitative easing, liquidity windows, lower reserve requirements) the Federal Reserve and the Federal Government has drastically increased the supply of dollars in the economy. Traditional economic models would say when you have the same amount of goods, but you increase the amount of the dollars, you get rising prices (inflation). We are not there yet, but as we move forward we are cognizant that low rates and a potential inflation spike is bad news for most bonds. It is generally good for stocks and real estate. That said, economists and investors have been worried about inflation ever since the stimulus from the 2008 recession and it has never materialized. Perhaps we still have more room on that inflation cushion, or perhaps low cost labor in China will no longer provide a shield.
We have plenty to worry about before post-vaccine, but the historical actions taken to prop up the economy are likely to cause a hangover and it pays to be prepared.