Over the past four months, Federal Reserve Chair Jerome Powell has promised trillions in liquidity (QE Infinity), and has guaranteed the purchase of bonds and fixed income ETFs (Guarantee Infinity) if things don’t go so well. This includes investment grade and high yield bonds, plus more recently, individual corporate bonds (good and bad).

The actual effect of the promised liquidity has been muted because total credit facilities have so far delivered less than $50 billion in purchases, not the $750 billion headline number.

However, what’s ignited risk markets is the guarantee which sets a floor for asset prices by allowing an investor/lender/holder to ‘Put’ the asset back to the Fed if it all goes pear.

Because markets work on sentiment, Powell’s Pandemic Put has delivered market participants a much welcomed sleeping pill, while the promise of endless liquidity has delivered methamphetamine - and that’s why we’re still seeing risk being bought across the spectrum.

Manipulating the curve. 

The meth has been potent at the short end of the curve, but it will no doubt go out longer.

That is, Fed asset buying and guidance, plus continuing investor rotation into U.S. bonds in light of the Put and lower rates for longer has forced short term yields down towards 0%, as per the chart below.

Yields longer out look steeper. See the dark blue curve below.

But not so, a year ago when everyone was screaming yield inversion. See the light blue curve below.

The next manipulations might see the 6 month, 1 year and 2 year fall back closer to the x axis, making the entire curve still lower, but steeper.

In terms of aggregate purchasing, the Fed balance sheet is down from $7.1 trillion to $6.9 trillion, consistent with the Fed’s slowdown a few weeks ago, but still more than 3x higher than immediately after the GFC.

Powell’s Pandemic Put.

So, what we are really seeing in bonds and equities is not fundamentals, it’s the effect of QE Infinity (endless lakes of liquidity) and Guarantee Infinity (the Put) playing out.

More bond issuance and chimney money coming to extend welfare cheques and cover government deficits are looming on the short term horizon and will add to global debt (albeit new bond issuance will suck money out of the market).

The central banks clearly think that there are very few alternatives to this until the world learns how to live with coronavirus and people feel confident enough to re-engage. But there will likely be a limit to this re-engagement. Like 9/11, certain things changed forever.

But perhaps we will start to hear about more loan forgiveness and debt jubilees, or even bank nationalisations in certain countries.

For the time being, capital flow is being propelled into risk assets as a result of treasury intervention, central bank purchasing, loan programs, welfare payments/unemployment insurance and the Put.

Propulsion for powerhouse PE plays.

There is a divide in equities at present.

Traders and investors alike favor high PE tech/high forecast growth powerhouses like Zoom, Tesla, Netflix, Amazon, AMD, Nvidia and some pandemic pharmas, etc.

But think about how long it’s taken for some of these companies to grow. Apple, Amazon and Microsoft took decades to hit the $1 trillion market. Specifically, it took Apple ~12 years after launching the iPhone to hit unitrill status.

So what does it say to you when it takes less than 3 months for these companies to be propelled from $1 trillion to $1.6 trillion in value, during a time of crumbling global growth and massive unemployment rates around the globe?

Yikes!

Still, if you ignore those stocks, the other FAANGs, a few high PE tech/pharma stocks and the Chinese behemoths; you are left with the debt laden Industry 3.0 and/or low PE stocks. Many of these are trading sideways and some down.

Note how the market has abandoned Berkshire. On the other hand, the market is ‘willing up’ Disney (an industry3.0/4.0 hybrid) because while there could be a shut/open/shut scenario with its theme parks it is in the top three streaming companies.

The Pandemic Put is a guarantee by edict, and as such it’s fake. It can’t actually cure the coronavirus, nor reverse the death rate. It can’t reverse the horrible unemployment numbers, and it certainly can’t reverse the towering walls of debt that have fueled asset prices. For the moment, it and other monetary tools can supply ample credit and provide the perception of a guarantee against bad debts while vaccine candidates work their way out of labs.

Central bankers are hoping this will be enough. But it may be a different story in the days/weeks/months ahead as U.S. Q2 earnings continue to roll out, prior to the more ‘telling’ Q3 results in October.

Mike.

NextLevelCorporate is a leading independent strategic corporate advisory firm with a multi-decade track record of delivering transformative corporate finance solutions, in and out of Australia.

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