Pablo Martinez Monsivais/AP
- The stock market climbed for a second straight week, ignoring gloomy economic forecasts and bleak data as traders find a silver lining in the Federal Reserve.
- In recent weeks, the Fed has used both old and new programs to ensure credit flows where it’s needed, signaling to investors that the public health crisis won’t necessarily translate into a financial-market collapse.
- While the central bank’s spate of relief efforts haven’t directly lifted stocks, the policies “definitely had ripple effects into the equity market, no question about that,” said Liz Ann Sonders, chief investment strategist at Charles Schwab.
- The Fed’s policies “precluded the prospect of a complete economic collapse,” leading traders to revive their risk-on views, Goldman Sachs analysts said in a recent note.
- Visit the Business Insider homepage for more stories.Â
The stock market seems unshaken as signs of a deep coronavirus recession pile higher and higher. As quickly as the S&P 500 spun out of its 11-year bull run, it’s soared out of bear-market territory and surged 29% in just over three weeks.
This recent divergence between stocks and the economy has been jarring. How is the market so nonplussed by the mounting recessionary wreckage? Look no further than the Federal Reserve.
Over the last several weeks, the central bank has shown it will go to unprecedented lengths to stimulate the economy and prevent further market disruption. Those signals have, in turn, stabilized stocks and allowed them to retrace a significant chunk of their post-coronavirus loss.
Put simply, the Fed has been indirectly backstopping the stock market by reducing investor worries around how much the coronavirus lockdown will hurt corporate profits and strain outstanding debt.
More than ever before
Monetary relief efforts kicked off in mid-March when the Fed announced plans to inject up to $5 trillion into stressed money markets.Â Days later, the FedÂ slashed its interest rate close to zero for the first time since the financial crisis.
In the following weeks, the authority created lending programs for small employers, households, and large businesses to aid cash flow. Purchases of Treasury bonds and mortgage-backed securities added additional liquidity to the crashing markets.
Read more: Bharat Ramamurti is one of just 4 people overseeing a $500 billion corporate bailout fund. He tells us how a 2008-style populist revolt could emerge if executives benefit more than workers – and outlines how he’s pressuring the Fed.
The Fed announced a $2.3 trillion package on April 9 to bolster lending and begin buying corporate debt across a range of credit ratings.
The policy salvo surpassed the Fed’s entire financial-crisis playbook in a matter of weeks.Â Stock prices continued ticking higher over the period, with traders cheering relief programs as an indirect safety net for the battered equities market.
The central bank was responding to a historic glut of negative economic data, all of which points firmly to an imminent recession. Many experts have said the US is already mired in one.
Unemployment claims made over the past four weeks have nearly erased all jobs created since the financial crisis. Retail sales plunged by a record 8.7% in March as the virus kept shoppers at home. Consumer comfort suggested weak revenues were still to come as Bloomberg’s index slid to its lowest level since before President Donald Trump was elected.
The International Monetary Fund projected on Wednesday the world economy would shrink by 3% in 2020, making the “Great Lockdown” the most severe recession in nearly one century. The economic downturn could even last through 2021 in the event of a COVID-19 resurgence, the organization said.
Still, when cracks began to appear in the Treasury market, the Fed stepped in by buying notes. When small businesses showed increased risk of bankruptcy, the central bank formed new credit facilities. In the wake of credit-market chaos, the Fed said it would begin buying bonds.
The corners of the economy may not be directly linked to the equities market, but the message is clear: pain is being addressed.
“The carnage being alleviated there, by virtue of what the Fed did, definitely had ripple effects into the equity market, no question about that,” Liz Ann Sonders, chief investment strategist at Charles Schwab, said in an interview.
The turning point for Goldman
The Fed’s latest stimulus effort – the aforementioned $2.3 trillion economic aid package geared towards small businesses and local governments – was a major turning point in Goldman Sachs’ stock market outlook.
In the days after the announcement, Goldman published a report saying the central bank’s stimulus efforts have set a sturdy floor under risk assets, and declared that the stock market had already bottomed. The analysts in turn boosted their year-end S&P 500 forecast to 3,000 by year-end.
“The Fed and Congress have precluded the prospect of a complete economic collapse,” the team wrote. “The numerous and increasingly powerful policy actions have spurred equity investors to adopt a risk-on view.”
They continued: “The Fed and Congress have precluded the prospect of a complete economic collapse. Investors have been encouraged by the ‘do whatever it takes’ approach of the Fed.”
While the central bank never directly aimed to boost the stock market, its actions have sent a clear signal to investors worried of rising default rates and closed-off credit lines, Seema Shah, chief strategist at Principal Global Investors, said in an interview. By consistently providing monetary aid, investors see the bank living up to its promise to act “forcefully” in keeping the economy afloat.
“They have, in some ways, set up a backstop,” Shah said. “For example, if you feel like there are significant strains building up in one important segment of the market, at this stage it’s fair for a lot of market participants to expect the Fed to intervene in that part.”
After trillions in aid, what comes next?
One drastic additional step for the Fed would be to directly prop up the stock market by buying stocks. But Rich Steinberg, chief market strategist at The Colony Group, thinks this is unlikely. He believes such a measure would throw too large a wrench into regular operations.
“Investors are conditioned for markets to buy dips, and I think it would be problematic if the Fed directly supported the equity market,” Steinberg said in an interview. “I think they’re going to try to stick to their mandate as much as possible.”
So can other additional stimulus efforts from the Fed continue to boost stocks? Shah says that ultimately depends on whether the coronavirus threat subsides to a point where economic activity can resume as normal. In other words, no matter what the Fed does, the virus will dictate the terms of further equity gains.
The Fed’s policies “are able to help the market functioning,” Shah said, noting that a return to normal corporate profitability relies primarily on how quickly the economy can recovery.
Profits – historically the biggest booster of share prices – depend on revenue recovering to pre-outbreak levels. Consumer activity will react on its own once lockdowns are lifted, “with or without the Fed help,” Shah added.
But don’t count the Fed out completely. There’s still time for the market to enjoy more Fed-induced optimism. The Fed has roughly $250 billion of available capital it can lever up as much as 10 times to either enhance existing stimulus programs or launch new ones, according to Bloomberg.
Recent history also shows the central bank isn’t afraid to write its own rules when the situation requires it, Sonders said.
“Based on what they’ve already announced, they haven’t exhausted all of the bullets,” Sonders said. “Let alone the fact that, as we’ve learned, they can launch a whole new set of facilities if they need to.”
Now read more markets coverage from Markets Insider and Business Insider:
email@example.com (Ben Winck), Ben Winck