The Return of the Seventies

About two hours ago, the Federal Reserve Board (FRB) committed to buying unlimited amounts of US Treasury Securities and Mortgage Backed Securities.

More than that, the Federal Reserve is lending directly (almost) to businesses:

Establishment of two facilities to support credit to large employers ā€“ the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.”

The PMCCF will allow companies access to credit so that they are better able to maintain business operations and capacity during the period of dislocations related to the pandemic. This facility is open to investment grade companies and will provide bridge financing of four years. Borrowers may elect to defer interest and principal payments during the first six months of the loan, extendable at the Federal Reserve’s discretion, in order to have additional cash on hand that can be used to pay employees and suppliers. The Federal Reserve will finance a special purpose vehicle (SPV) to make loans from the PMCCF to companies. The Treasury, using the ESF, will make an equity investment in the SPV.

The SMCCF will purchase in the secondary market corporate bonds issued by investment grade U.S. companies and U.S.-listed exchange-traded funds whose investment objective is to provide broad exposure to the market for U.S. investment grade corporate bonds. Treasury, using the ESF, will make an equity investment in the SPV established by the Federal Reserve for this facility.

Establishment of a third facility, the Term Asset-Backed Securities Loan Facility (TALF), to support the flow of credit to consumers and businesses. The TALF will enable the issuance of asset-backed securities (ABS) backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA), and certain other assets.

In addition to the steps above, the Federal Reserve expects to announce soon the establishment of a Main Street Business Lending Program to support lending to eligible small-and-medium sized businesses, complementing efforts by the SBA.

This is unprecedented. The Central Bank is directly lending to the Main Street.

This took me to the piece that John Authers had written few days ago on the melting of the ‘Ice Age’, a concept proposed by Albert Edwards of SocGen.

There are two ways to interpret the calling of the ‘End of the Ice Age’ where Ice Age refers to low growth, deflation or very low inflation and low nominal bond yields.

End of Ice age and the arrival of helicopter money (see the Federal Reserve announcement above; it is almost there) which has been hastened by Covid-19 does not necessarily have to be an equity bull market. It could simply mean the end of the bull market in bonds.

In that case, we could have a return of the Seventies. Those were the years of stagflation. Bad bond returns and worse equity returns, in real (i.e., inflation adjusted) terms.

(1) Pl. see table below (Only USA):

Real Returns on US dollar instruments

Source: This is from the text book, ‘Macroeconomics’ by Dornbusch, Fischer and Startz.

(2) On Real S&P 500 Equity Returns:

(3) Nominal returns for S&P 500 are as follows and interesting:

Source: https://seekingalpha.com/article/2789035-s-and-p-500-index-returns-by-decade-since-1940 (accessed 23rd March 2020)

In the Seventies, nominal returns were positive mainly due to dividends and real returns were negative since the inflation rate averaged 7.2% per annum.

Now, American companies are not in the habit of paying dividends as the table above clearly shows. Therefore, nominal equity returns in the decade of 2020-2029/2030 could be low or negative and real returns even lower (more negative).

So, the end of Albert Edwards’ ‘Ice Age’ could hearld the end of the bond bull market rather than presage the continuation of the QE inspired bull market in stocks which had no fundametnal underpinning as David Rosenberg had pointed out.

So, quite why John Authers is ‘anxious’ (my impression, of course) to point to Albert Edwards as turning bullish towards equities or quite why Albert Edwards should be willing to let that impression prevail is not clear to me. Perhaps, it points to anxious personal hedging. It can be too lonely to be a bear in QE inspired world in which very few are willing to call the emperor out for his nudity.

It is worth keeping in mind that two wrongs cannot make a right.

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