May 12, 2021
As vaccinations spread in the United States, the stock market has been generating fabulous returns. Many of the economic numbers have been nearly as impressive.
If you have held on to broadly diversified stock funds over the last year, reading your latest portfolio statement will be a joyful experience. In the 12 months through April 22, the S&P 500 stock market index returned more than 50%, including dividends. From the market’s low point in March 2020 through Thursday, it returned more than 80%.
As an investor, you aren’t likely to see many years like this. Savor those exorbitant gains while you can.
But when numbers this gaudy appear, it’s worth asking why. And, unfortunately, the most accurate answer is probably the simplest: Things were so terrible a year ago, they had nowhere to go but up.
There have been a few mediocre stretches in the stock market lately. But compared with the early days of the pandemic in the United States, we have entered a period of balm and bliss.
The endless tragedies of the last year, followed by a partial, cash-infused recovery, have skewed the numbers enough that any comparisons should be taken with an entire shaker of salt.
But there are harbingers of trouble already: signs of incipient inflation, rising bond yields, occasional tremors in global markets in response to coronavirus flare-ups or to the reports on Thursday that higher capital gains taxes may be coming for the truly rich. For the most part, though, these portents are being muffled by the profit making.
Recall how bad it was
Consider what happened in the markets in the early stages of the pandemic, and what it has taken to fuel their ascent.
Briefly put, when people began to sicken and die and the awful toll of the novel coronavirus began to be understood in North America, the markets and the economy crashed. Those are not words I’d use casually, but they are appropriate here. In a little over one month, from Feb. 19, 2020, to March 23, the stock market fell 34%.
As businesses shuttered and workers stayed home, the gross domestic product, a broad measure of goods and services, plummeted in the United States. GDP dropped 5% in the first quarter of 2020 and more than 31% in the second, according to the federal Bureau of Economic Analysis. The unemployment rate surged more than 10 percentage points from March to April last year, nearly reaching 15%. That was the highest level and the biggest increase since the Bureau of Labor Statistics began collecting data in January 1948.
In March 2020, the Federal Reserve stepped in. On its own, it couldn’t do much to combat the coronavirus itself — the last presidential administration’s efforts were dilatory at best, historians say. But the Fed and the federal government were able to prop up the markets, provide emergency aid for millions of people, help keep at least some small businesses afloat and put most major corporations in a position to reap big profits as the economy rebounded.
By now, the federal government has committed more than $5 trillion in a variety of coronavirus-related aid packages, and the Fed has made trillions more available in loans, intervened in financial markets, purchased vast quantities of bonds and held short-term interest rates near zero.
The Biden boom
All of this is contributing to what looks like a “Biden boom economy,” as the Princeton economist Alan S. Blinder called it in The Wall Street Journal. Economic growth may exceed 7% for the first quarter, and will almost certainly be spectacular for the year as a whole, when compared with 2020.
But there’s the rub. These annual economic and financial numbers are comparisons with the depths of the pandemic. The statistics are warped, inevitably, by “base effects,” which is to say, in economic jargon, that the coronavirus-induced recession of last year is making many current numbers look unnaturally high. They don’t provide much insight about where we are heading in 2022 and later.
Take inflation, for example
As Neil Irwin explained in The New York Times, the current uptick in inflation may not be as worrisome as it would otherwise seem because its comparisons are based on the depressed prices of a year ago, when so many people were huddled indoors.
What’s more, Alberto Cavallo, a Harvard economist who has studied inflation deeply, told me that by altering consumption and supply patterns radically, the pandemic has had many subtle effects. Lower-income people, for example, who pay a higher proportion of their income for food, have experienced greater inflation than those for whom food is a relatively minor expense.
On the supply side, he said, a vast array of items became difficult or impossible to find as supply chains were disrupted. Because of concerns about the “fairness” of raising prices during a global disaster, many distributors refrained from doing so. They have started now, Cavallo said. And prices have begun to rise on items for which demand is reviving, like fuel and transportation.
As a consequence, inflation is indeed increasing, and worries that it will continue to do so have contributed to rising yields in the bond market. (Bond prices, which move in the opposite direction as yields, have declined.) Because low interest rates have made equities comparatively attractive, these shifts in longer-term interest rates could easily derail the bull market in stocks.
Both the White House Council of Economic Advisers and the Fed have taken a rosier view of inflation, saying that although the numbers will probably rise over the next several months, they are likely to abate over time and won’t threaten the economy.
Wall Street appears to have accepted a version of this narrative, too: Robust growth and rising corporate profits will support a rising stock market, without much risk of unacceptably high levels of inflation. Or so the currently rich share valuations imply.
Risk abounds, even if it is not discussed
But the risk is there, even if it’s not widely recognized. You don’t need to be a disciple of Milton Friedman, the great monetarist, to see it.
He once said: “Inflation is always and everywhere a monetary phenomenon.” Well, the Fed has been pumping money into the economy since the start of the pandemic, and the money supply measurement, known as M2, is increasing as rapidly as it ever has in modern times, Fed data shows. By the end of this year, it is on track to expand by 40% above its pre-pandemic level.
As Ian Shepherdson, chief economist of Pantheon Macroeconomics, an independent research firm, put it: “Nothing remotely like this has ever happened before, and you don’t have to be a monetarist to regard such a massive monetary expansion as a potential inflation threat.”
There are other threats to the recovery and the bull market, too many to enumerate. The possibility of calamity cannot be ruled out, as Robert Shiller observed in a look back at the effervescent 1920s, which ended in the Great Depression.
Bonds, which are lagging now, are likely to outperform stocks if the market turns really ugly, which is why I hold some bonds. If you believe that you are likely to get stronger returns from the stock market over the very long run, as I do, this is a time to prepare for a bumpy road ahead.
Hang in there, but don’t be too greedy.
c.2020 The New York Times Company
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