We are living through a period of irrational exuberance in the markets. Beginning of the year, NY Times (www.nytimes.com) journalists N. Irwin and W. Cai made the following observation:” The central, befuddling economic reality of the U.S. is that everything is terrible in the world, while everything is wonderful in the financial markets.” I totally agree, but how can we explain this paradox ?
To understand the phenomenon , one has to analyze the stimulus programs of the US government since the start of the pandemic and the composition of the jobs market.
EFFECTS OF COVID-19
First, the covid-19 pandemic caused millions of people to lose their jobs. But most of these jobs were low-wage service jobs (restaurants, retail, hospitality). Higher paying clerical and managerial, industrial jobs were preserved. So in spite of massive unemployment, total wages dropped only slightly. At the same time unemployment benefits and household checks compensated loss of income.
As such while unemployed workers managed to survive until November, the employed continued on with better terms.
HOW THE STIMULUS MONEY WAS SPENT
This extra income in the employed worker universe had to be channeled somewhere. Retail and leisure expenditures were limited due to closures. So money flowed into savins, mutual funds, single stocks, etc.
The investable stock universe has narrowed significantly in the last decade due to stock buybacks, mergers and de-listings. With fewer outlets, money flowing into stocks caused a balloning effect.
The popularity of stock market applications like Robin Hood https://robinhood.com/us/en/ added to this effect.
RESULT OF NEW INVESTMENTS
Result is inflated stock valuations and in some sectors bubbles. In the words of former Fed chair Alain Greenspan, an “irrational exuberance”. Of course he was referring to another bubble (the dot com) which spectacularly burst in 2000. This brought on the accomodative interest rate policies of the Fed, causing in turn the 2008 crash.
So bubbles burst one way or another. The question is with how much damage?
POLICY RESPONSE
The fact that the current Fed chair Jerome Powell follows historical facts and is sure not to repeat previous mistakes (i.e Greenspan policies) is a positive.
The recent appointment of Janet Yellen (former Fed chair) as Treasury secretary is also very positive in terms coordinated responses to the crisis.
in the end, the Fed and the US government will do everything to lessen the impact of the bubble bursting on the general population and economy.
But those chasing after the moon by buying Tesla and similar names at these levels will lose their shirts (Tesla is worth more them the largest auto companies combined)
If you are interested, you can arrange for a virtual conference on the subject : https://www.ahmetgokay.ch/finance-public-speaking/
I am Ahmet Gokay,
Finance and English professor with many years of experience in finance and economics in Europe, the US, and the Middle East. A believer in the power of children education and changing the world by passing the knowledge and experience to younger generations; The leaders of tomorrow. Visit my homepage here.