The Fed is winning.
The Federal Reserve’s unparalleled stimulus measures have, in essence, placed a floor under the markets barring any additional unexpected shocks to the system. Much of the stresses of equity and bond market collapse brought on by the COVID-19 shutdown during February and March were successfully alleviated. Usually the earnings of a company and their future growth prospects ultimately determine their attractiveness for investors. In the current market climate however, fundamentals seem to be given much less consideration, leaving analysts scratching their heads.
Default risk essentially off the table.
The Fed’s massive bond market intervention has removed significant default risk for many publicly traded companies. Some will fail and file for bankruptcy. Yet many poorly managed companies will manage to stay afloat. The process of bankruptcy serves as a mechanism for capital reallocation in the markets. The capital from companies that fold is reallocated to the more productive and efficient enterprises. Removal of default risk will lead to less efficient, more indebted companies selling goods and services to consumers. Consumers who are themselves in worse financial shape than in 2019. Not exactly a recipe for a stable and growing economy for years to come.
TINA situation unfolds.
For those seeking a return on investments, the Fed has truly created a “there is no alternative” situation to equities. Bond yields are scraping bottom. Investors are left allocating capital to an increasingly expensive equity market instead. An equity market with very limited visibility on how earnings will rebound throughout this pandemic. The Fed’s actions brought stability to an unstable market, yes. It also created a strong disconnect between Wall Street and Main Street in the process. The markets appear healthier than the economic data would warrant. Visibility on corporate earnings in the future is murky to say the least. Uncertainty continues, leaving us to tread carefully and maintain investing patience.
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