Did the Fed cross the line?
Last Saturday, I wrote that the investment returns for small cap American businesses would eventually register off the charts, but I didn’t expect it to happen in the next 4 days! For my more aggressive-moderate risk taking clients, I did buy small caps, but not enough given the size of the move. If I had known the Federal Reserve was going to bail out all unsecured debt and junk bond investors, I would have moved 100% of all client assets into small caps. The Federal Reserve is now backstopping most fixed income investments and even buying stocks is on their radar.
This recent move by the Fed got an adverse reaction from Wall Street, except of course for those investors that just got bailed out. Today, the Wall Street Journal editorial board wrote an opinion piece titled, The Fed’s Main Street Mistake, that challenged this recent move by the Fed. (For those interested in reading this opinion, I added it to the bottom of this email.) The editorial board believes that the central bank is favoring Wall Street over small business owners.
Tim Seymour, who in my opinion is one of the best financial journalists, said that the Fed is going off the rails on a crazy train. While they pick winners and losers, people have to wonder, “Where’s my bailout?” He was even wearing a t-shirt, “Where’s my bailout” on CNBC when he gave these comments. Tim has been the biggest advocate for capitalism and one of the loudest cheerleaders for the bull market over the last 5 years.
The investment community consensus is that this was a tragic move for our economy and markets. This move created a moral hazard for investors to take more risk because they know the system is rigged and they will get bailed out if there is any trouble. The Fed did not reward prudent and responsible investing and instead favored investors who were reaching for higher returns. The counterargument is that those risky investors who got bailed out didn’t deserve recent losses because a pandemic was out of their control.
My impression from the recent Fed move is that things are much worse in the economy than anyone is expecting. If the Fed is willing to stick its neck out this far then their internal economic models must be showing a severe economic contraction. The debate on this recent program will be felt for years to come. A more effective program would be to help those small businesses that need aid immediately. The Paycheck Protection Program (PPP), which offers companies forgivable loans didn’t go nearly far enough. It’s a flawed program and needs to help small business owners with expenses other than payroll and rent. The grant money given to these companies needs to be much higher, but so does the verification required that substantial income was lost. The government needs to keep these small business out of debt. I believe that the failure to help these local businesses will stall any economic recovery.
I’m not going to fight the Fed and I’ll make investments alongside the change of rules. It’s a very interesting debate to follow and I have my opinion, but I only care about how this change by the Fed is going to impact your investments going forward. I now feel much more comfortable owning fixed income since the Fed is backstopping everything. The biggest questions going forward for financial markets will be if the Fed is bailing out even the highest risk investors and printing another $6-$8 trillion, what will happen to the value of the dollar, is the government moving us towards socialism, and will this ultimately create inflation? It is clear that the Fed will do anything in its power to keep interest rates low and they want investors to own riskier assets This move is really not much different than what the Fed was doing before the pandemic. The Fed’s was cutting interest rates into a booming economy. I’ll continue to invest alongside the Fed, but I look forward to the time when small businesses get the help that they so desperately need now.
