Big Spending Bernie and the stock market bubble
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Daily new cases of COVID-19 appear to have peaked, falling to 235 thousand on January 14th.
But the daily death rate continues to climb and may do so for several more weeks.
Jobs recovery has stalled, with initial claims jumping to 965 thousand for the week ended January 9th, while federal pandemic unemployment assistance claims added a further 284,000.
Big Spending Bernie
Joe Biden has promised close to $2 trillion in additional stimulus. With Bernie Sanders poised to head the powerful Senate budget committee Democrats' intentions are clear: to spend their way out of the slump. The controversial Vermont senator is known for his belief in big government and describing himself as a "socialist democrat".
With Democrats in control of the Senate, albeit by the slimmest of margins, the biggest check on government spending is likely to be the bond market. 10-Year Treasury yields have already jumped 22 basis points in January.
The only escape valve is the Fed, expanding its balance sheet with further purchases of Treasuries to suppress interest rates. Low interest rates would fuel inflation, while high interest rates would not only check government spending, but threaten a fiscal crisis where Treasury has to borrow to service the interest on its outstanding debt — creating an exponential escalation in public debt from which there is no escape — and a collapse of the stock market bubble.
We expect Jay Powell to err on the side of inflation, as the lesser of two evils, while he attempts to walk the tightrope between conflicting demands on the Fed.
Stocks
Stocks are already pricing in significant growth in nominal GDP, with Warren Buffett's favorite market indicator at a record high: market capitalization at 2.26 times GDP.
History shows that re-balancing normally occurs with a sharp drop in market capitalization rather than an upward spike in GDP.
Conclusion
Current stock market levels are reliant on the Fed put — where the Fed is expected to react to any hesitancy in the market with further stimulus — and out of touch with underlying fundamentals. This creates dangerous imbalances in financial markets. Risk levels are elevated.
Quote for the Week
"We do not think BTC is a bubble; we think BTC is the last remaining functioning fire alarm that has not been disabled by policymakers, and it is issuing an increasingly shrill alarm about the USD and fiat currencies more broadly. We have little doubt that policymakers will attempt to disable BTC as a functioning fire alarm as well, but its traits make that far more difficult to do to BTC than they have thus far done with gold."
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Disclaimer
Colin Twiggs is director of The Patient Investor Pty Ltd, an Authorised Representative (no. 1256439) of MoneySherpa Pty Limited which holds Australian Financial Services Licence No. 451289.
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