Why is the Stock Market Booming?

The answer to a question you were afraid to ask

2020 will be remembered as The Year the World Shut Down. People from Manhattan to Mali, from Kansas City to Kuala Lumpur were stopped in their tracks by the COVID-19 crisis. Business stopped, education went online, lipstick sales tanked, life ground to a halt. As of August 2020, one thing kept beating: the US stock market.

Whether you are sitting on the sidelines wondering if you missed your chance to hop in, or whether you have been riding this crazy wave, you are surely asking yourself: in a time as chaotic and unprecedented as this, why is the stock market booming?

There are several answers to this question. Obviously, some companies are benefiting from the recent shut down (looking at you Amazon). Some investors feel this is a turbo-charged blast into the future electronic economy we were all already heading toward: a world where we all stay home watching Netflix and Disney Plus and beam our organic vegan meals and new back-to-homeschool wardrobes straight to our living rooms à la Star Trek. I guarantee you that Jeff Bezos has a division working on transporter technology as we speak. There is truth in all of this Brave New Economy stuff. But there are more straightforward reasons for the COVID Stock Market Boost, and it is important to understand them.

First, we should remember that the market is largely made up of gamblers. Some are investment bankers, some are brokers, some are mathematicians, some are conventional day traders, some are Robin Hood investors, pumping millions into the market, one small fraction of a share at a time. But in each of them lives the soul of a gambler with the words “buy low, sell high” tattooed on his or her heart. His heart? Her heart? Let’s be honest. My heart. Your heart.

When the market drops, it doesn’t matter if the planet is on fire. There will always be those among us who can’t resists a deal. Maybe you buy a stock you have dreamed of owning but always thought too pricey. Perhaps you have been following the movements of a certain stock for a long time and are confident it is going to bounce back to its former trading patterns before long. You may have been an early naysayer who thought this COVID stuff would be resolved by the time summer came. But there’s a bigger reason why the market is up — bigger than you and me and Goldman Sachs­ — and it’s important that we investors understand it. It’s called Quantitative Easing, and it’s economic policy jargon for a kind of indirect government price fixing.

If you have ever heard the term Pump and Dump, you might know that this is an illegal strategy for artificially inflating the price of a stock to make a quick gain. The first step is to buy up a ton of shares of the stock at market value or higher so that other investors see the movement and the price of the stock rises. As other investors jump in and buy the stock, the price continues to rise. When it gets high enough, the original investors dump the stock, selling everything as quickly as possible at the new, higher stock price before the market realizes what has happened. Pump, then dump.

Quantitative Easing is an indirect form of pump and dump used for the Greater Good — to prop up a collapsing stock market and calm a panicking economy. It is a newer economic strategy, first employed in the United States during the 2008 Financial Crisis after being pioneered in Japan. It is considered a policy of last resort after interest rates have been lowered as far as they can be lowered and the economy is still gasping for breath. We have had three rounds of Quantitative Easing in the United States since 2008: QE One (I), QE Two (II) and QE Three (III).

QE I was implemented in 2009, when the United States Federal Reserve (aka the Fed) invested roughly $1 trillion in buying up US Treasury Notes, mortgage-backed securities and US commercial bank debt. This massive purchasing program flooded the US banking system with dollars, much of which then had to be loaned out to consumers. As intended, a lot of that money quickly found its way into a badly-battered and undervalued stock market. The infusion brought the Dow Jones Industrial Average (aka the DOW) up from roughly 7000 points to 12,000 points. This was widely considered to be a success.

QE II was implemented in 2011 as the market became erratic once again. During QE II, $600 billion plus gains (a total of approximately $1 trillion) were infused into the economy, with a related rise in the DOW from 12,000 to 15,000. This round of easing was more controversial, with debate on both sides as to its success, or whether it was required at all.

QE III was by far the most controversial round of investment. In 2013 the Fed infused another trillion dollars into an economy that was arguably already standing on its own. QE III sent the DOW from an already heady 15,000 to close to 18,000 — a height many considered to be significantly overvalued. When we consider that three short years earlier, the DOW had hit a Twenty-First Century low of 6,500, the Fed’s actions effectively tripled the value of the Market. It also illustrated a very important concept:

What happens when you pump but don’t dump? The answer: a wildly overpriced stock market.

It is natural for markets to rise and fall–a kind of yogic inhale and exhale of the economy. History tells us that markets cannot rise indefinitely without an occasional correction. But as banking and investment regulation has been loosened over the past few decades, these corrections have lately been viewed as apocalyptic. Our government attempts to modulate the market through monetary and fiscal policy, to keep things flowing on as even a keel as possible. In order to bring balance back to the economy, the Fed began liquidating some of its assets and discussing possible future hikes in the interest rate in 2019.

The Fed hoped to gradually sell off its position in these investment vehicles while also slowly raising interest rates to more sustainable levels. But these efforts are not easily undertaken in a world where the financial markets have come to define the health of the country. The same wave of QE cash that caused stocks to climb would have the inverse effect if the Fed’s assets were sold off and cash was sponged back out of the economy. When every rise and fall is dissected by an army of news sources and Twitter feeds, alternately celebrated and decried by politicians, and magnified by high-frequency trading, trying to unload a $3 trillion portfolio will have a major impact on the market.

Sure enough, in late 2019, the market became erratic again, and the growth engine of QE was implemented once more. If you Google “Quantitative Easing’ for news stories that popped up in Fall 2019, you will see that it was widely covered by the financial papers. If you missed it the first time around, don’t feel badly. The very term, ‘Quantitative Easing” was designed to make you scroll or click away to another article. “Nothing to see here, folks! Just a bunch of econ major and policy wonk jargon!”

So here we are in 2019, and the Fed quietly fires up Round Four of Quantitative Easing. Mind you, this is long before COVID hit the US. It was merely a strategy to calm a market that was starting to feel like a roller coaster ride with dramatic rises and drops rattling investors. By the time COVID shut down the world and the market briefly tanked in March 2020, pulling the trigger on COVID Quantitative Easing was not hard at all. But the scale of investment is staggering. Over the course of the 2008-2009 Financial Crisis and the early years of its aftermath, the US Government’s investment holdings went from $1 trillion to $4 trillion. Over six months leading up to and including the COVID shutdown, the US Government’s holdings went from $4 trillion to $7 trillion — a very rapid infusion of $3 trillion in cash in the economy. Remember, this $3 trillion is entirely separate from any COVID stimulus checks, SBA loan disbursements or pandemic unemployment money that went out.

That $3 Trillion Pump is why your stocks are up.

There’s something new about the Fed’s strategy for QE IV, and it explains a lot. In May of this year, the Fed announced it would start purchasing corporate bonds, initially through Exchange Traded Funds, or ETFs, and later possibly purchasing individual bonds directly. This investment marks a new frontier in economic policy. It is only an ideological hop, skip and a jump from the Fed buying corporate bonds to buying stocks. The potential for conflicts of interest to arise is worrisome. 

Eventually, the Government will have to unwind and sell off some of that investment. At some point there will be a dump to go along with the pump. When? Who knows. When the government attempted to sell some of its assets from QE 1–3 off and raise interest rates in late 2019, markets became erratic. Imagine what will happen with $7 trillion to unload. Who decides these things anyway? Who exactly pulls the trigger on a round of Quantitative Easing? FED Chairman Jerome Powell? Treasury Secretary Steve Mnuchin? That’s a story for another time. For now, just remember why your stocks are up, and be cautious with your money.

image source: https://fred.stlouisfed.org/series/WALCL