It's 'Different' this Time...
Updated: Aug 20, 2020
Most marketplaces are undergoing constant evolution, but sometimes there is 'revolution' - instances where an outside force can actually change market structure. Is this most recent stock market recovery, after one of the most violent drops in history, a sign of 'revolution' or more 'evolution'?
In the past we've discussed the difference between a business recession and credit recession. Some simple definitions to explain each:
- a business recession is when supply growth outpaces demand growth to the point that excess inventory becomes a business drag that requires deeper cost costing.
- a credit recession comes from the demand side becoming so overleveraged (too much debt) that they can no longer borrow more to buy more goods.
In a business recession excess inventory can be sold off relatively quickly through price discounting. While this creates losses, it clears the inventory overhang and moves businesses back to production of supply. A credit recession is usually deeper and generally takes much longer to 'clear'. Business and personal credit take much longer to rebuild as banks and other lenders tighten credit and require both business and individuals to pay down the debt they hold before they will make new credit available. Even though businesses with excess inventory may lower price during a credit recession, buyers often do not have the credit to available to buy up the excess inventory and therefore credit recessions take longer to clear.
If we look at stock market crashes over the last century we see the time for the S&P 500 to recover its previous high has indeed shortened. Below is a graphic from www.visualcapitalist.com (an excellent website) that depicts major crashes and their recovery times.
In the graphic above, the 'Great Crash' starting in 1929 and heralding the Great Depression, and the Global Financial Crisis, also called the Great Recession, are the only 2 examples of 'credit' recessions - thankfully. In each case the economic downturn went on for extended periods. Even so, the recovery of the S&P 500 after the Global Financial Crisis happened faster than the 2 previous deep recessions and market crashes even though the Global Financial Crises caused deeper stock market and economic loss. We have now almost completely recovered from Covid 19 crash, and in record time. The drop in GDP and the loss of jobs was even greater than the Global Financial Crisis, though the drop in the S&P 500 was not nearly as severe. This might have been partly caused by the 'event' driven nature of the pandemic with investors expecting a relatively rapid recovery or cure. There are 2 main factors that we believe are driving these increasingly rapid stock market recoveries. The first is technology. Technology is increasing both the rate of recovery and changing the rate and depth of crash/correction. Technology has created a more rapid dissemination of information and access to to capital (electronically). It accelerates the observation, orientation, decision making, and response cycle. It also accelerates the pace at which money can be moved in the economy.
The second factor is the revolution/evolution of monetization tools. Since Keynes, government has played an increasingly active role in the economy, for good and bad. While consumer spending still drives ~65% of the US economy, government has increasingly used its spending capability to both enhance consumer spending, and now, to fund it directly thru payment programs to individuals and corporations. At the same time, the Federal Reserve Bank has driven US interest rates to historic, near zero levels, by purchasing not just US Treasuries and mortgage backed securities, but virtually ever debt and some equity asset classes.
The amount of 'intervention' has created a situation where interest rates are now so low that they hold little investment value, driving more money into the stock market looking for return on investment primarily through growth. At the same time, the interventions have buoyed investors confidence that the government and the Fed Res Bank have put a floor under both the stock market and the US economy. The government response to recession is not 'new', it is an evolution of what has been generally accepted Keynesian economic thought for nearly a century - with the addition of near immediate direct payments to people and companies. The Fed Res Bank response was somewhat revolutionary in the Quantitative Easing done after the Global Financial Crisis in 2007-9, but is now evolutionary in that it expanded beyond US Treasury purchases. Technology has allowed both the government and the Fed to push money into the system much faster through direct electronic transfers. Is it different this time? Yes, and no. The government is more involved in the economy and markets than ever before. The tools and the technology we are using are now evolutionary in that they are 'more', more money being pushed more rapidly into the market. But, two questions remain. Will they eventually run out of 'money', or at least a way of pushing money into the economy 'effectively'? And, when or will the bill for these actions ever come due?