This Bounce is Nothing More than a Fed-Funded Sugar Hit

Dear Reader,

I can feel it. There’s just an air about it.

After more than 30 years in this business you develop an intuition.

And, I can sense a degree of complacency creeping in. Wall Street’s (apparent) reversal of fortune has steadied nerves. Curves are flattening. The worst of COVID-19 appears to be behind us.

If you believe the media, it’s bear market over, bull market resumes.

But why has Wall Street rebounded? Are corporate earnings looking better? No.

Is GDP growth forecast to rise? No.

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So what’s fuelling the market?

The same old, same old…the Fed’s printing press.

The Fed has flooded banks with liquidity. No surprises there. What do banks do with all those excess reserves? Lend it? Not on your nelly…unless of course the lending is back stopped by the Federal Reserve.

So what do the banks do with all the surplus money? You got it…put it to work in the market.

As the cash — in the billions — is poured into the market, short sellers scurry to cover their positions. Up goes the market.

None of this activity is based on fundamentals. It’s nothing more than a game of hot potato.

Please see this for what it is — T.E.M.P.O.R.A.R.Y support for asset prices. This is not permanent. It simply cannot be. Why?

Since the Dow’s high point in February 2020, here’s a (short) list of what’s changed…

  1. The US economy has completely shut down.
  2. More than 16 million Americans have filed for initial unemployment benefits.
  3. Unemployment is predicted to reached 20%-plus.
  4. GDP growth could be NEGATIVE 20–25%.
  5. Consumption levels — personal and corporate — have plummeted.
  6. Consumer confidence has been shattered.
  7. Investment and capital expenditure plans have been shuttered.
  8. Personal and corporate savings (cash reserves) are being depleted to stay solvent.

In an interview with CBS on 12 April 2020, Neel Kashkari, the head of the Federal Reserve Bank of Minneapolis, made these observations (emphasis added):

…the US, barring some health-care miracle, is looking at an 18-month strategy of rolling shutdowns based on what has happened in other countries.


This could be a long, hard road that we have ahead of us until we get to either an effective therapy or a vaccine. It’s hard for me to see a V-shaped recovery under that scenario.

On a global level, there’s this news from the Financial Times on 15 April 2020:

The Rum Rebellion

Source: Financial Times

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Worse than 2009

With all that’s happening and is yet to happen, Wall Street acts as if the only change from all this will be ‘we’ll wash our hands more frequently’.

Really? But wait, there’s more.

The havoc being wrought on US and European (public and private) pension funds is yet to filter through to the economy.

These funds were seriously underfunded (lacked sufficient assets to meet pension payment liabilities) BEFORE February 2020. They must now be in a world of hurt.

Will payments be suspended, reduced or capped? What impact will this have on member confidence? The insolvency issues surrounding pension funds is a slow burn…but burn they will.

Yet, in the face of this dramatically changed world, Wall Street goes up? Only a fool — one who’s soon to be parted with their money — would fall for this oh so obvious relief rally.

This bounce is nothing more than a Fed-funded sugar hit. Buying time. Trying to scramble. Hoping to cover up past sins. But it won’t work this time.

The US share market is NOT going to give investors an encore performance. The dynamics that created the longest bull market in history, no longer exist.

The August 2019 issue of The Gowdie Letter looked at the how and why of the US market’s stellar performance to see if it could be replicated in the years ahead…

The majority of investors know the US share market has been a standout performer since the events of 2008/09.

But very few know how that performance has been achieved.

Most will cite the strength of the US economy and perhaps the effect of low rates on ‘forcing’ people to buy income producing shares.

But how much have low rates contributed to the market’s performance?

What about the other positive influences…how much have they boosted the performance numbers?

And, more importantly, can they be repeated?

Here’s the chart from [Ray Dalio’s] “Paradigm Shifts” that identifies how much each “booster” has added to the S&P 500 index performance.

Blue line — S&P 500 index performance

Red line — the performance without the assistance of artificially low interest rates

Orange line — the performance without the assistance of low interest rates AND profit margin expansion (more on that later).

Grey line — the performance without the assistance of low interest rates AND profit margin expansion AND Corporate tax cuts.

Dotted blue line — the performance without the assistance of  all of the above AND Share buybacks (reducing the share count).

The Rum Rebellion

Source: Paradigm Shifts

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Absent the stimulatory effects of these “boosters”, the performance of the S&P 500 index would have been lacklustre, a truer reflection of the underlying economic conditions.

The other performance enhancing factor that Ray Dalio did NOT include in the chart, was the impact of PE expansion.

In September 2011, the S&P 500 index average PE ratio hit a low of 13 times. Since then it has expanded to 21 times, a 61% increase.

The Rum Rebellion

Source: Macro Trends

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Let me explain the importance of this contributing factor.

In 2011, a company earning $1 billion was valued @ $13 billion (based on a 13x PE).

In 2019, the same company, earning the same $1 billion is valued @ $21 billion (based on a 21x PE), a 61% increase in value that was achieved solely on an expansion of the multiple paid for earnings.

When you deduct PE expansion from the blue dotted line in Ray Dalio’s chart, the S&P 500 index has gone nowhere since 2009.

What’s the future likelihood of these five factors being repeated?

The Rum Rebellion

Source: Port Phillip Publishing

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The dynamics that powered the Dow Jones Index to record highs are gone. It’s over. The cycle has turned. Expansion is followed by contraction. It’s the natural order of life.

We are faced with a whole different set of drivers, and none of them are positive for share prices.

To further highlight the significant contribution made by one of these factors to the US market’s performance, this is from Bloomberg on 6 February 2019 (emphasis added):

For much of the last decade, companies buying their own shares have accounted for all net purchases. The total amount of stock bought back by companies since the 2008 crisis even exceeds the Federal Reserve’s spending on buying bonds over the same period as part of quantitative easing. Both pushed up asset prices.

This chart was part of the article:

The Rum Rebellion

Source: Bloomberg

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To fund these buybacks, US corporates have been tapping ‘yield-starved’ investors for years.

As the corporate debt pile rose, the credit quality of the bond offerings fell.

On 15 March 2020, CCN reported:

Over the past few years, a corporate debt bubble has been quietly inflating as market conditions encouraged borrowing at low rates.

Ultra-low interest rates meant borrowing was nearly free, which prompted businesses to build up incredible debt piles. Investors largely ignored the growing dependence on cheap credit as a strong economy kept the problem from bubbling to the surface.

But the day of reckoning is here for American corporations laden down by excessive debt obligations. The U.S. economy will pay the price as it’s pushed into a recession.

The Fed has recently cobbled together a ‘rescue’ package for some of this distressed debt. But it can’t save all the corporate zombies.

And, even if the Fed miraculously manages to keep the air in the corporate debt bubble, will corporates have the capacity (or desire) to resume borrowing to fund future buy backs?

I don’t think so. It’s over folks. Recognise this while markets are still in denial.

Anyone who thinks this is all going to go away without any nasty side effects are in for a very nasty surprise.

Please, please take note.


Vern Gowdie,
Editor, The Rum Rebellion

PS: Vern’s 2020 ASX Blacklist – Stocks to Sell NOW. Download his free report.

Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

The Rum Rebellion