The disconnect between ‘Main Street’ and ‘Wall Street’

May 23, 2020 Peter No comments exist

Investopedia defines ‘Main Street’ as, “a colloquial term used by economists to refer collectively to America’s independent small businesses. It gets its name from a common name for the principal commercial street of small towns across the country. In England, the equivalent term is High Street.” ‘Wall Street’ on the other hand refers to, “big business and high finance.” Right now the disconnect between these two is about as big as it could possibly get. Not just in the USA but around the world.

Covid-19 has unleashed a financial crisis the likes of which we have not seen for a very long time. The seasonally adjusted insured unemployment rate in the USA for the week ending 25 April was 15.5% with a total of 33 million Americans filing for unemployment benefits. Some States in the USA are already running out of unemployment money and will need to borrow from the Federal Unemployment Account fairly soon.

The Washington Post on 11 May 2020 reported, “Two of President Trump’s top economic advisers projected Sunday that unemployment will climb as the coronavirus pandemic continues its sweep across the United States, with one official predicting that the unemployment rate will jump to 20 percent by next month.”

New York Governor Andrew Cuomo has stated that the coronavirus pandemic has left his State “basically bankrupt”. There are more to follow.

The USA is not alone. Every country has been affected with tens of millions of people losing their jobs. Big corporations are haemorrhaging cash (and suspending dividend payments) with no end in sight and many small businesses will not reopen when the lockdowns end. The Asian Development Bank has warned that the Covid-19 crisis could leave a US$8.8 trillion hole in the global economy.

With all this bad news one would expect the stock markets to be heading south. Apart from a small hiccup they have simply ignored all the bad news.

The Dow Jones Industrial Average (DJIA) tracks 30 well-known large companies that trade on the New York Stock Exchange (NYSE) and the Nasdaq Stock Market (NASDAQ). The DJIA reached an all-time high of 29 551.42 on 12 February 2020 as a result of an 11 year bull market – the longest bull market in history.

The DJIA fell 1 597 points (about 6.3%) on 5 February 2020 although this was not the largest single day fall – that occurred on 29 September 2008 when the DJIA lost 777 points – almost 7% of its value. During the 1930’s Depression the DJIA lost nearly 90% of its value. The DJIA briefly entered a Bear Market earlier this year but has recovered strongly.

The DJIA closed at 24 331.32 on 8 May 2020 – a little over 17.6% off its all-time high on 12 February 2020. Most stock markets around the world have a similar pattern. News that would normally see stock markets fall sharply – like large unemployment numbers – now has them gaining ground. Wall Street is now taking bad news and turning it into good news. It makes absolutely no sense.

The disconnect between Main Street and Wall Street is starting to ring alarm bells. It would appear that greedy investors who are scared of losing out on a market bounce are prepared to accept huge risks in return for possible spikes in the market. It was John Maynard Keynes who said, “markets can stay irrational longer than you can stay solvent”. Wall Street is certainly behaving irrationally right now. Main Street is in a bad way right now and there is more pain to come and Wall Street seems to think we are about to restart the bull market. Perhaps reality will set in when companies report second quarter results.

A big part of the problem, in my opinion, is Reserve Banks pouring trillions of dollars of imaginary money into the markets. Many investors are of the opinion that Reserve Banks (especially the Federal Reserve in the USA) will do whatever it takes to protect the market and protect them from losses. They may be right – Berkshire Hathaway CEO Warren Buffet famously said, “It’s never paid to bet against America”, but he did qualify that by adding, “We come through things, but its not always a smooth ride.

Matt Egan from CNN Business on 12 May 2020 stated, “This is the most expensive time to buy stocks in 20 years.” The problem for investors is there is nowhere else to try and make money. Interest rates are at all-time lows and will remain there for some time.

Today’s investor would do well to remember Warren Buffet’s two investment rules, “Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1”. Buying shares at the most expensive time in the last 20 years in the midst of a pandemic seems to me an almost sure fire way of losing money.

It is interesting to note that Warren Buffet has just sold all of his shares in the USA’s four largest airlines – United, American, Southwest and Delta Airlines. These shares were valued at more than US$4 billion and were sold at a loss. It would seem that he favoured a smaller loss now rather than a bigger loss later. While Warren Buffet – and his research team – were selling the airline shares at a huge loss someone was buying them.

Scott Pelley from 60 Minutes interviewed Fed Chair Jerome Powell with the interview airing in the USA on Sunday 17 May 2020. During the interview Scott Pelley asks Jerome Powell, “What gives you hope in this dark time?” to which Jerome Powell replies in part, “…I would say I would never bet against the American economy or the American people.” It would appear that Warren Buffet and Jerome Powell are singing from the same hymn book.

During the interview Jerome Powell made some interesting comments about keeping the markets functioning. This is how the conversation went:

PELLEY: Fair to say you simply flooded the system with money?

POWELL: Yes. We did. That’s another way to think about it. We did.

PELLEY: Where does it come from? Do you just print it?

POWELL: We print it digitally. So as a central bank, we have the ability to create money digitally. And we do that by buying Treasury Bills or bonds for other government guaranteed securities. And that actually increases the money supply. We also print actual currency and we distribute that through the Federal Reserve banks.”

So there we have it. Someone sitting behind a computer at the Fed simply creates trillions of dollars of imaginary money. Using a combination of smoke and mirrors (and some clever sounding financial terms) the Fed then lends this imaginary money to the USA government where it suddenly appears as real money for the USA government to spend. The Fed is not alone, right now all Central Banks are doing the exact same thing.

This is music to the ears of Wall Street. As long as the Fed is happy to keep pouring money into the market all is well. What could possibly go wrong? I cannot help but feel we are not too far away from the mother of all stock market corrections.

 

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