In the words of legendary investor Mohamed el-Erian, "Markets are in one universe and the real economy is in another." Virgin Galactic Chairman Chamath Palihapitiya, in the meantime, says, "We have completely divorced the economy from the stock and bond markets. The Fed has been the principal agent of that obfuscation."
In short, financial markets no longer mirror what’s going on or what will go on in the real economy. Correctly predicting where a company’s profits are going or where the real economy will go is now irrelevant to the performance of that firm’s equity and debt. The Fed has completely taken over. What does this mean for investors and the global economy down the road?
The short answer of what this means is "great news!" If you made a mistake and didn’t correctly hedge against such a tail risk, it has paid to be negligent! Investors that could not foresee such risks have been rewarded as the Fed is buying, directly and indirectly, those bad investments. Major financial markets now trade higher than they did in 2019. That is, 2020 has been a good year for investors! How is this possible? Perhaps the worst economic crisis in a century has been good for investors? Herein lies the suspension of reality.
The first line of any rule in economics usually begins with “assuming markets are efficient” or “if investors are rational ...” We are now in a period where markets and investors are neither efficient nor rational. The only people who know where to invest are either those that make Fed policy, those with knowledge of said policies, or those that can predict what those policies will be. It’s really that simple. Everyone else is at their mercy. Betting against the Fed is always a big mistake, meaning markets are all “long-only” for the foreseeable future, right? Yes and no. I fear a sustained pandemic coupled with the on-going deterioration of the real economy will result in continued propping up of financial markets. The Fed gravy train, does, however, have to end at some point. What then? This part is the $64 trillion question.
My suggestions for investors is, as always, the same but with a pandemic-era twist. Invest as you normally would in profitable cash-rich companies that have limited pandemic exposure. They will benefit the most from the flight to quality. Then begin planning for a sustained pandemic environment. What if this thing is with us for another three years? Longer? What then? Even if it disappears in a few months, somethings will almost certainly never be the same. Think about anything that requires a high density of people. Now think about those businesses that will benefit from low densities of people. Invest for COVID-20, 21 and 22, not just COVID-19. Good luck and stay safe!
