July Market Update: Monetary and Fiscal Stimulus Propel Markets

Published July 1, 2020

The S&P 500 and other market indices are almost back to pre-COVID levels. Credit spreads for the riskiest borrowers are back near historical averages despite depressed profitability expectations in most industries and much higher uncertainty about future profitability. This is occurring at a time of 13% unemployment, unprecedented government deficits, and in a period of heightened social unrest.

How? There are two main things this market has working in its favor: fiscal stimulus and monetary stimulus. Since late March, both the federal government (providers of fiscal stimulus) and the Federal Reserve (providers of monetary stimulus) have taken unprecedented actions.

Fiscal stimulus has come in the form of mailing $1,200 checks to most Americans, $600 per week increases in unemployment insurance, and Paycheck Protection Program loans to businesses of all sizes, among other measures.

Monetary stimulus came first in the Fed’s reduction of short-term interest rates to a range of 0.00%-0.25%. Then, on March 23, came the announcement of the Fed’s unprecedented plan to buy bonds across the credit spectrum. Perhaps not surprisingly, the Fed’s announcement was concurrent with the trough in the equity markets. 

S&P 500 on the day prior to Fed announcement: 2,237
 S&P 500 as of 6/26/20: 3,026
Change:  35%

And more directly, it caused the cost of borrowing for less creditworthy borrowers to shrink dramatically as you can see in this chart

So are stocks really worth what they’re trading at today? Well, it’s difficult to arrive at a reliable measure of intrinsic value, and an asset’s contemporary value is nothing more than what a buyer is willing to pay. Right now, that someone seems to be either the Federal Reserve or those spurred on by the Fed’s actions.

What does all this mean? The optimistic case for stocks relies on continued unprecedented fiscal and monetary stimulus for the economy until it is back to full health. Those less optimistic will look to some combination of terrible GDP data and unemployment data, the destruction the virus continues to cause, the current political uncertainty, and a belief that there are limits to monetary and fiscal stimulus to get us out of these very challenging economic circumstances.

What does this mean for fixed and income annuities specifically? All else equal, the Fed’s maneuvers so far have helped annuity issuers in that they have greater assurance that the bonds and other fixed income assets they hold will not default. However, those same measures from the Fed hurt annuity issuers because they have artificially depressed the yields on the new assets that insurers will buy to back new issuance, which means potentially lower annuity pricing for you going forward.

Where to next? It’s anyone’s guess.

Note: If you’re interested in commentary about the market from a well-respected professional investor, I recommend Howard Marks at Oaktree Capital.

 

Matt Carey

Matt Carey

Financial Planning Professional

Matt Carey is the co-founder and CEO of Blueprint Income. He believes in the power of technology to make retirement simpler. Matt is a regular contributor to Forbes.com and has been quoted in both the New York Times and Morningstar.

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