The Fed Unbound
The markets made the most of a short trading week. In fact, investors came back on Tuesday in a pretty good mood and helped push the indexes higher. The S&P 500 broke above 3,000 for the first time since March 5th, and now trades above its 200-day moving average. The recovery (in the stock market) has been nothing short of miraculous. But you know the old saying, “if it sounds too good to be true?” Despite the fact that the markets are forward-looking, Investors may be getting a little ahead of themselves.
So, what exactly is one supposed to make of the rapid recovery of the stock market? I came across an interesting idea that was suggested this week. With the S&P 500 punching past 3,000, there is starting to form a correlation between the Federal Reserve’s recovery programs and the market exuberance. The market has added $3 trillion in market cap from its lows, which coincides with the $3 trillion added to the Fed’s balance sheet following liquidity, credit, and lending programs implemented at the height of the market unrest. So maybe this is an “L-shaped” recovery after all, with the “L” standing for liquidity.
In terms of the various liquidity programs the Federal Reserve has implemented, one of the most controversial is its latest to allow it to buy exchange-traded funds (ETFs). As part of its monthly update, the Fed released information on its ETF purchases as of May 19. It purchased a total $1.3 billion so far and the investments include iShares iBoxx investment grade corporate bond ETF (LQD), Vanguard intermediate-term corporate bond ETF (VCIT), Vanguard short-term corporate bond ETF (VCSH), and iShares high yield corporate ETF (HYG). Among the many comments I poured through, one asked if it was even legal for the Fed to buy corporate bonds. Not that it matters, but the answer is probably not. The Fed is supposed to only purchase assets that are guaranteed by the U.S. Government, which of course does not include corporate bonds. The current arrangement effectively results in the Fed guaranteeing its own investment, which is against the law. In the meantime, we’re honored to be investing alongside the Federal Reserve.
Since this week is all about the Fed, let’s look at one more program that it is about to launch. It will soon begin lending to small and medium-sized businesses that don’t have access to the capital markets through selling bonds or equity. The “Main Street” lending program is another first for the Fed which its Chairman admits, “crosses a lot of red lines we had not crossed before.” He went on to say, “We felt called to do what we could,” adding that it would be hard to defend not acting when the economy soured so quickly. However, a little less reassuring, he went on to say, “you figure it out afterwards.” After the financial crisis, it was hard to see how the Fed would unwind its balance sheet. Ultimately, it ran out of time before the pandemic struck. If it was hard before, it seems even harder now for the Fed to extricate itself after having found its way into every nook and cranny of our economy. Perhaps expecting the Fed to return to its former self is not realistic.
In closing, the United States is about to do something it hasn’t done in nine years. If all goes as planned, the U.S. will regain its independence on Saturday when it launches astronauts into space from U.S. soil. A launch this past Wednesday was scrubbed with twenty minutes to takeoff due to inclement weather. I don’t know about you, but I am excited to see the innovative new capsule on its maiden voyage, but also in a larger sense, to watch the United States take a leadership role once more in its quest for space travel. The launch is scheduled to take place tomorrow at 3:22pm from Florida’s Kennedy Space Center. There are plenty of live streams on YouTube if you want to see history being made. Now you know.
Bruce J. Mason, MBA