The Federal Reserve is getting lots of love from the financial markets because it’s lowered the short-term rates that it controls to just about zero, and has figured out inventive ways to drive long-term rates to ultralow levels and get some formerly troubled parts of the financial system working smoothly again.
The stock market has risen sharply in the past three months, in large part because of the Fed, with the S&P 500 erasing most of the terrifying 34 percent, five-week drop that it suffered from its mid-February all-time high to its March 23 low.
And even though retail sales are still well below where they were before the coronavirus pandemic struck and the unemployment rate is much higher, they’re a lot better than they were not long ago, in large part because of the stimulus created by ultralow interest rates and various pieces of bailout legislation.
But despite the benefits that our economy and stock market have gotten from the Fed, I’ve got a problem with the “we’re not even thinking about thinking about raising rates [for the next few years]” policy of Fed Chair Jerome H. Powell.
That’s despite the fact that ultralow rates have made it much cheaper to finance our country’s 13-digit budget deficits — yes, a trillion has a 1 and 12 zeros — than would otherwise be the case.
So what’s my problem? It’s that millions of individual investors are being forced into the stock market to get any meaningful income from their savings, because they can no longer count on traditional havens such as savings accounts, certificates of deposit, Treasury securities or money market mutual funds.
Bizarrely, the dividend yield on an S&P 500 or total stock market index fund, about 1.8 percent for low-cost funds, is almost triple the yield on a 10-year Treasury note (0.66 percent as of June 30) and considerably higher than the 1.41 percent yield on a 30-year Treasury bond.
But that dividend yield comes with serious risks — especially these days, given the market’s big run-up since March 23 and the uncertainties hovering over the economy.
On June 23 and June 26, for example, the S&P fell by 2.4 percent and 2.6 percent, respectively. That means more than a year’s worth of dividend income from your index fund vanished on two separate occasions in one week.
Those down days notwithstanding, parts of the stock market are showing signs of excess. The Nasdaq market closed at a record high on Tuesday, influenced heavily by five companies that made up 39.2 percent of its value as of June 30: Microsoft, Apple, Amazon (whose chief executive, Jeff Bezos, owns The Washington Post), Facebook and Alphabet (which owns Google).
These companies accounted for 21.7 percent of the June 30 value of the S&P 500, which is a risk that I suspect many S&P index fund owners don’t realize they’re taking.
I’m using the S&P as my market indicator today because trillions of dollars of mutual funds and exchange traded funds are indexed to the S&P, but only a relative pittance are indexed to the most popular market indicator, the Dow Jones industrial average.
In addition to the surge of coronavirus cases, which finally seems to be affecting stock prices, there are some other problems awaiting those of us who’ve got serious money in stocks.
A major problem — at least, I think it’s a major problem — is that even though much of the economic stimulus that Congress put into the economy with the Cares Act and other legislation seems about to run out, there’s no sign of a new round coming anytime soon because Washington’s brief period of bipartisan economy-boosting seems to be ending.
As a result, I think we’re also about to see large workforce reductions by states and cities and other local governments that have had their tax revenue ravaged by the coronavirus fallout and their expenses increased.
Unfortunately, the question of how — or whether — to help local governments cope with the epidemic is turning into a political war. Republicans, who were happy to cooperate with Democrats to provide some assistance to the needy with the Cares Act, as well as a lot of assistance to the non-needy (who include me), don’t seem inclined to do anything anytime soon.
I’m not blaming the Fed for this problem. I’m mentioning it because it’s a risk that many stock owners may not realize they’re running. And because this uncertainty puts even more pressure on the Fed to keep rate-induced stimulus flowing, because maximizing employment is part of its mandate.
I don’t know where stocks go from here — no one knows. But what I do know is that we’re likely to have a bumpy ride for the next few months that could rival the 34 percent, five-week drop in February and March, and the subsequent 39 percent rise from March 23 to the end of the second quarter on June 30.
The other thing I know is that if you’ve got serious money (by your standards) in the U.S. stock market, you had better have both financial and psychological staying power. And you’d better not bet on the Fed being able to bail you out, because it’s already done more than anyone ever thought it could do.