What economic stimulus measures have been taken to tackle the Coronavirus crisis and will they work?
What stimulus tools are at the disposal of the federal government, and how might they continue to trigger growth in our economy? Larry Swedroe explains the impact of both common and lesser-known relief measures.
Hello and thank you for tuning into Ask Buckingham, an ongoing video podcast series where we invite thought leaders across many disciplines in wealth management to respond to questions on your mind. My name is Tim Maurer and I have the privilege of hosting these short Q&A discussions as the Director of Advisor Development for Buckingham Wealth Partners. And I want you to also know that I’m a wealth advisor with more than 20 years of experience and a client of the firm.
The volume of information coming at us these days is so vast, and the pace at which that information arrives is so fast, that it’s a struggle to keep up with what you need to know in order to make the best decisions for you and your family. Our hope, therefore, is that this ongoing conversation will become a source of clarity in the midst of confusion and chaos and provide insight that helps you better understand what’s going on in the world, financially and otherwise.
Today we’ll be hearing from Larry Swedroe, Buckingham’s Chief Research Officer, and here’s the question we’ll be tackling. Larry, I’ve seen numerous headlines about the Federal Reserve getting involved in measures designed to help lessen the economic burden of the COVID-19 crisis. What have they done recently, and what effect do they hope it will have on the markets and the economy?
Yeah, great question, Tim. I think there are two parts in answering that. The Fed has monetary tools that they can employ in two different ways. First is the traditional of lowering interest rates, which help stimulate the economy by lowering the debt burden, of course, for people who are leveraged as well, and it lowers the cost of investing so that typically helps to stimulate the economy.
Unfortunately, we’re not really in a financial crisis. This is a biological one, and lowering interest rates is not going to cause people to go buy a new car, take a cruise, et cetera. The real concern today is one over liquidity, and making sure banks are able to lend. This is important for people to understand. This is not ’08. When the banks were stressed, the banks, especially US banks, are in the strongest capital position they have ever been in.
And so that’s not a problem, at least today. But what the concern is, is that the banks have the ability to continue to lend, especially to small businesses, and the government is now likely, and the Federal Reserve has already taken actions, to increase liquidity in the markets. They are providing almost unlimited liquidity to banks. So the banking system doesn’t lock up. Banks can lend to each other. Secondarily, they’re providing support, if you will, for the commercial paper market, which many people are not as familiar with. But that’s how most companies, high-quality companies, raise capital. And it’s actually the money market funds who are the buyers of the commercial paper.
And the Federal Reserve I think will now start to take action just like they did in a way to accept other kinds of collateral. So we don’t have people panicking. We get a run on the bank, only now or to run on money market fund. I’m pretty confident that we’ll see actions along that line. And then you’ll get actions where the Treasury will go to Congress and ask for approval to make the kinds of loans or equity investments even possible like they did in ’08 with banks. So Congress is likely to pass a law allowing the Treasury to give the Fed permission to make loans to the airline industry.
You’re saying one of the tools that they have is to lower interest rates. The other is to increase liquidity with the banks. How exactly do they do that? How do they increase liquidity to banks?
Well, number one, they opened their discount window, and tell banks “It’s perfectly acceptable to come and borrow from us and at a low rate of interest.” In normal times, that’s viewed as a bad thing. You’re a weak bank. Now they want to make sure that the public and the banks understand, this is not a bad thing. We want you to take that liquidity to keep this system. So that’s number one.
And then the second thing we talked about is allowing the banks, and the Federal Reserve also, to take what they would normally not take as collateral, the banks can put up, or companies can even put up assets, that the federal reserve might lend to. So the Federal Reserve, which traditionally only lends to banks was lending to investment banks, for example, in ’08. We likely will see an extension of those kinds of powers.
Okay. All right, so they’ve lowered interest rates and increased some liquidity to the banks. It strikes me that the market didn’t respond particularly well to those steps taken. Is there a reason behind that? How do you interpret that?
Yeah, well we can all try to speculate on why the market didn’t go well. Number one, the facts on the ground are moving incredibly fast here. And we have to be careful not to engage in hindsight bias. Today’s news is that the crisis biologically is worse than it was say a week ago. And so markets are reacting that way. Governments are reacting with much stricter travel regulations, schools closing down, that’s going to have a greater impact.
So you’re getting, and it’s important for investors to understand this, we’re getting a double whammy, if you will. So first you get earnings forecast going down because the GNP will be slowing, likely, almost certainly going to be a recession, could be a fairly steep one. In the second quarter, we could see on employment getting to 10%. some people think that it’s possible even higher. And the GMP, if it were to drop, say 5%, corporate earnings go down a multiple of that.
Let’s for argument’s sake, say it goes down 20%, but the market’s dropping much more than that. So the second effect comes from valuations or the speculative return. People demand a bigger risk premium now, so our earnings go down, but people are willing to pay a lower multiple, so they discount future earnings at a higher rate. That lowers prices. And that’s where you get these kinds of crashes.
It also shows how efficient the market is. So it’s not going down like 1% a day. We’ve seen a 30% drop in four weeks. And some days, 5%, 6%, 7%, 10%. So that new information is coming in rapidly. So you really can’t act on it unless you’re smarter than everybody else and know with certainty things are going to get worse. One last point, it’s very important for people to understand that governments and central banks already know how difficult this is.
Every day, it gets worse, the pressure to act and pass laws. We’re likely to see, in the next day or so, a trillion-dollar-plus package in the US. Multi-trillions if we add them up all around the globe. All central banks are lowering interest rates, all providing more liquidity. We’ll get all kinds of actions extending employment insurance, et cetera.
Here’s what typically happens. Stocks continue to go down when the news continues to get worse. Once the news, even if it’s bad, but it stops getting worse, even though the economy may likely get worse for a while longer, stock markets are leading indicators, and they typically recover before the economy does. So you could bail out, still see bad economic news, but the market may turn up, and it will be very difficult to get back in because you’re still seeing bad news. And that’s the problem. Once you sell, it’s almost impossible to know when to get back in, because it’s probably too late and the news is still bad.
Yeah. Larry, in relation to this Fed action, and recent actions the Fed has taken, additional actions that the Fed might take. How can we as individuals and investors actually apply that knowledge?
Well, the most important thing I think and the most likely way for you to get through this is if you work with your advisor, had a well thought out plan, that assumes that there’s a virtual certainty. You’re going to experience many of these over your investment life. Tim, I’m going to be 69 this year. I’m planning still hopefully for a long life, say 25 plus years. If you look at history, I need to be planning to have maybe 10 of these types of events big sharp draw downs.
I did a talk in 2008, I looked back at the prior 35 years. I found there were 16 other crises. And I proposed to people, I bet none of the listeners, could name even half of them because we tend to get out of them fairly quickly. Markets eventually recover. If you have faith in our economy and democracy, our capitalist system, you should, of course, have that, or you shouldn’t be invested in stocks anyway.
The hard part is this, living through a crisis is much harder than observing it in a back test, looking at it on paper. So you must have that well thought out plan that accepts the certain day they’re going to happen. You’re going to come under stress. Fear is a natural reaction, and you’ll have what we call this plan B. So in 2008, many of our clients may have been planning on spending say $100,000 a year.
They’re plan B said, “We’re going to cut travel. We’ll delay buying cars. Well drop our spending to $60,000 and to make sure a plan doesn’t blow up.” I would encourage people to talk with their advisor, run a Monte Carlo analysis. Again, looking at their odds of success. Likely, is this still probably in good shape? Maybe they have to adopt their plan Bs, and if they don’t have one yet, really start to think about what actions should be taken to make sure your plan doesn’t blow up.
Excellent. Well, thank you Larry, and thanks to you for tuning into this episode of Ask Buckingham. If you have a question you’d like to see us address, you can do so by navigating to the website, www.askbuckingham.com, or emailing your question to firstname.lastname@example.org. Or easier yet, you can just click the upper right-hand corner of your screen. There are no dumb questions, but unfortunately, there are plenty of poor answers out there. Our hope is that if we give you straight answers to your questions, you’ll be able to apply that knowledge in pursuit of good decision making. So please follow us. And by all means, Ask Buckingham.