The topic that I want to cover this week is a bit heavy compared to my other weekly blog issues and that’s for a good reason.
Firstly, it is an extremely important topic that not a lot of people are aware of, especially those who are in their twenties and are not in the related field. I also know that most people that read my blog are around my age, mainly friends and acquaintances (although I’m starting to post on Medium and LinkedIn too). Additionally, this topic is also quite close to my professional work, which inspired me to write about is as a means of learning while adding value to the readers.
Please keep in mind that the following information/analysis will always have its counterarguments, as the financial market/investment management is an extremely dynamic industry.
Stealing From The Future Generation
I’ll get right to the chase.
In the past couple of months, we’ve seen that the financial market and worldwide economy are slowing down, which was predominantly caused by the COVID-19. However, even long before that, thought leaders in financial market and multiple data points have indicated that it is time for the global economy to experience a recession; or at least some version of a downturn, which is perfectly normal because the economy works in a cycle. Click here to watch a great video by Ray Dalio explaining this concept.
Instead, we saw that the market recovered while COVID-19 cases were getting worse around the world and millions of people are out of jobs.
Unsurprisingly, some of my friends -smart individuals that work in other space (tech, consulting, etc.)- have asked me why is the stock market rising when the aforementioned situation is still at hand. Yes — there are signs that we’re handling the virus in a better way and containment efforts in certain cities are working; but overall, there has not been any signs of “getting back to normal” yet. One might argue that the stock market is rising because the virus panic had been priced in and/or that the stock market doesn’t truly reflect a nation’s economy. In 2017, America’s top 10% richest owned 84% of all stocks, and in 2019 the richest 1% owns 50% of all stocks held by American households.
However, the real reason is much more fundamental and recently its because of the Federal Reserve’s (FED) action. The act of printing money in order to bolster the economy was popularized after the Global Financial Crisis in 2008. To be precise, an unconventional form of monetary policy called Quantitative Easing (QE) was conducted by the FED in 2008. This policy enabled the FED (central bank) to purchase certain securities in order to provide money supply and get the economy running. In 2008, the FED purchase mortgage-backed securities (MBS) which to help the housing market. The total amount for QE 1 was ~$1.75 trillion. In 2020, the FED revived QE by purchasing $500 billion in U.S. Treasurys and $200 billion in MBS. Additionally, because of the global economic halt, which causes significant shocks to both the supply and demand sides, the FED decided to expand its QE purchases to an unlimited amount and announced that it would buy corporate bonds exchange-traded funds (ETFs). All of this causes the wealthy and affluent (top 10% and their financial advisors) to believe that the government will do whatever it takes to save the market.
Those who are reading about this topic for the first time might be thinking: “How is that fair?”
After all, young adults, especially people in their twenties are beginning to save money and want to allocate it effectively at the right time. Some of my peers are savvy enough to know that stocks are at all-time high and chose to held more cash in order to take advantage of the next dip/recession. Unfortunately, the current policies make it extremely difficult to do that. There needs to be a limit on how far the government can go when trying to save the economy. The U.S. is currently bailing out companies that conducted insane stock buybacks and printing unlimited amount of USD.
To summarize, here’s an analogy that I like to use when explaining this topic to my friend:
The market is a college kid that’s studying for his finals. First, he drinks coffee to stay awake. When its no longer working, he resorts to energy drinks … then to cocaine … and perhaps even heroin.
Emerging Market Risks
The US Dollar is getting stronger and its growth hasn’t stopped. When the stock market first fell at the end of February, we saw that DXY (US Dollar Currency Index; which compares the USD against a basket of currencies) simultaneously rallied as the stock market found its bottom.
As a person that grew up in an emerging country, I found that the argument from notable figures in the investment space who stated that the USD will continue to get stronger and EM currency will suffer are extremely feasible. In short, growing USD might break the global financial system, there are way too much debt that’s denominated in USD while there aren’t enough USD to go around. Additionally, companies cash flows are also weaker because of the ongoing tariff and the oil market issue.
I’ll be writing more about in the upcoming weeks.
See you soon.