March9,2020 BARRON’S 9
UP & DOWN WALL STREET
Instead of calming investors, the Fed’s surprise
half-point interest-rate reduction last week
seemed to worsen their concerns.
workers to their payrolls in February,
nearly 100,000 more than economists
had estimated, with upward revisions
totaling 87,000 in the two preceding
months, the Department of Labor re-
ported on Friday. But that was treated
as ancient, almost irrelevant, data,
given the virus’ anticipated effects on
business. Even the persistently low
level of weekly new claims for unem-
ployment insurance—a component of
the Conference Board’s Index of Lead-
ing Indicators—didn’t change investor
expectations of a looming downturn.
Part of the reason for the violent
reaction is that the financial markets
have become separated from the real
economy, Carson argues. “First, operat-
ing profits for U.S. companies have not
increased for five consecutive years,
and yet the S&P 500 had climbed over
60% during that period. Also, the mar-
ket value of domestic companies to
nominal gross domestic product—a
ratio that is often used to determine if
the equity market is undervalued or
overvalued, relative to a historic
average—stood at an estimated 1.
times at the end of 2019, matching the
record high of 2000.”
That divergence between the stock
market and the real economy has been
fueled by easy money and the expecta-
tion it will continue, Carson says. Given
ultralow interest rates, stocks were
viewed as low-risk, owing to TINA—
there is no alternative to equities.
“What Homer Simpson so wisely
said about alcohol—‘the cause of, and
the solution to, all of life’s problems’—
might equally apply to ground-skim-
ming interest rates,” writes Jim Grant
in the current Grant’s Interest Rate
Observer. Cheap money lifts asset val-
ues and anesthetizes investors to risks.
The Federal Reserve came through
with an extra rate cut on Tuesday, and
a double at that. But the half-point
reduction in the federal-funds target
range, to 1% to 1.25%—twice the typical
move, and made outside a regularly
scheduled Federal Open Market Com-
mittee meeting—failed to lift markets.
In fact, it appeared to worsen their
concerns. Indeed, fed-funds futures are
pricing in another half-point cut at the
next FOMC meeting, a week from
Wednesday. The plunge in Treasury
yields, with the two-year note at 0.51%
and the 10-year benchmark at 0.775%
late on Friday, to well below the fed-
funds target strongly implies signifi-
cantly lower short-term rates ahead.
Even with the most recent data
showing the U.S. at full employment
and the Atlanta Fed GDPNow on Fri-
day upgrading its first-quarter real
growth forecast to 3.1% from 2.7%,
markets were calling for more mone-
tary stimulus (along with President
Donald Trump). But, as Carson notes,
the last two recessions were caused by
sharp plunges in asset prices, “so the
loss of household wealth and liquidity
does raise the odds of a bad outcome.
Consumer confidence now may be
shaken more by the speed of the decline
than the scale.” That would be under-
standable, given the $4.6 trillion tumble
in U.S. stock values from their recent
highs, according to Wilshire Associates.
But easy money might not be the
cure it was for the previous two reces-
sions; it could make the situation
worse. The coronavirus presents a
shock to the supply side of the econ-
omy, writes economist Kenneth Rogoff
of Harvard on Project Syndicate.
“Policy makers and altogether too
many economic commentators fail to
grasp how the supply component may
make the next global recession unlike
the last two. In contrast to recessions
driven mainly by a demand shortfall,
the challenge posed by a supply-side-
driven downturn is that it can result
in sharp declines in production and
widespread bottlenecks. In that case,
generalized shortages—something
that some countries have not seen
since the gas lines of 1970s—could
ultimately push inflation up, not
down,” he contends.
Globalization has been a major fac-
tor in tamping down inflation for the
past four decades, Rogoff continues.
But the coronavirus, along with trade
barriers, threaten to undo those bene-
fits. And he doesn’t mention that both
Trump and one of his likely oppo-
nents in November,Sen. Bernie Sand-
ers, the self-described democratic
socialist, oppose free trade.
“In this scenario, rising inflation
could prop up interest rates and chal-
lenge both monetary and fiscal policy
makers,” Rogoff argues.
If so, it would confound investors
who have been hell-bent on buying
Treasuries at record-low yields well
below 1% and even further under infla-
tion. It appears that Treasuries are
more like gold, bought mainly as a
hedge against risk assets, comments
Cliff Corso, chief executive of Insight
Investment. “In a low-inflation world,
which would you rather own?” he asks.
That may not be a rhetorical ques-
tion. The yellow metal surged 6.8% in
the past week, its biggest weekly per-
centage gain in over four years, to
$1,670.80 an ounce. And amid ultra-
low interest rates and the stagflation-
ary potential of the coronavirus crisis,
gold investments appear to have fur-
ther upside, as our colleague Andrew
Bary writes this week (see page 19).
The challenge of the virus is not just
that there is no vaccine to prevent it.
Thevirusmaybetheblack
swan Wall Street has been
fearing. But it’s not the
stock plunge’s sole cause.
By Randall W.
Forsyth
C
omplex situations
defy being
summed up in
simple words,
though that’s
what’s demanded
in this short-
attention-span era. “Exogenous
shock” sounds as if you were under-
taking some electrical work in your
house without tripping the appropri-
ate circuit breaker. “Black swan” is
supposed to connote something exotic
and evil, but anyone who has spent
time around the water knows the
usual white variety are nasty crea-
tures.
Yet these are the terms employed to
describe the impact of the coronavirus
on the financial markets and economy,
although they don’t seem apt. Could
the extreme reaction to this novel
virus reflect the pre-existing weak-
nesses it has exposed, rather than its
impact on public health?
The steep drop in stock prices—the
S&P 500 index is down 12.2% from its
peak just the Wednesday before last—
recalls the reaction to the 9/11 terrorist
attacks,writes Joseph Carson, former
chief economist at Alliance Bernstein.
“Now that comparison by no means
is trying to compare the financial fears
of last week with the horrific tragedy
of 9/11. 9/11 stands alone in American
history as one of the most tragic
events ever, as it changed a city and a
nation far beyond what any of the
numbers say,” he adds. But the stock
market’s reaction to the coronavirus
has been similar.
Moreover, 9/11 took place in the
midst of a recession that followed the
bursting of the dot-com bubble. In
contrast, the U.S. economy appeared
robust when the virus spread to these
Mark Bridgershores. Employers added 273,
When the Drug Doesn’t
Match the Malady