Shock and Awe: The Fed Won’t Let The Market Crash

This has been a week of extremes. A lot of people are obsessing over superlatives: worst week since 2008, worst day since 1987 and so on. For them, it feels like the end of the world.

I disagree. I lived through Black Monday in 1987 and went on to have a great career as a trader and investor. We all lived through 2008 as well.

We’ll get through this. The biggest threat to the market right now is a crisis of confidence. We’re fighting anxiety itself.

The Federal Reserve sees this. Chairman Jay Powell came to the Fed from Wall Street, lived through the messy Lehman Brothers implosion and has zero interest in going back there.

The Fed unleashed truly staggering amounts of cash yesterday. That money is hitting the market now. Clearly, the Fed is both paying attention and willing to back up their vigilance with action.

Trillions On the Table

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What the Fed wanted to do is prevent another credit crash. As with last week’s surprise rate cut, some people can argue that Powell and company are overreacting or overreaching. I won’t.

I think that the level of fear that was in the credit market early this week had a higher probability of turning into a 2008-level freeze than anything we’ve seen in the past 12 years. Hedge funds were watching each other, wondering which would be the first to fall.

When a hedge fund collapses, it can get messy when there’s nobody willing to buy the assets. And in a world where a lot of smart hands are hoarding cash, even normal liquidity can dry up fast.

Look at the bank stocks yesterday. Wells Fargo & Co. (NYSE:WFC) plunged 16%. Morgan Stanley (NYSE:MS), Deutsche Bank AG (NYSE:DB), Citigroup (NYSE:C) fell a harrowing 15%. American International Group Inc. (NYSE:AIG), the vulnerable heart of the 2008 derivatives crash, fell a full 21%.

These are apocalyptic declines, which have increased suspicions that one or more global financial institutions will vanish in the next six months. The stocks tell us that a bank will become Lehman Brothers. A bank will become Bear Stearns.

That’s terrifying to people who remember 2008. The Fed remembers, and they have the power to intervene.

This should actually be soothing. In 2008, the Fed was unwilling to serve as the buyer of last resort to ensure that all the banks that were considered “too big to fail” could meet their liquidity needs.

Now, there are trillions of dollars standing by to make sure that if an institution needs to sell, a buyer is waiting. If a bank needs cash to make loans, the Fed is their corner.

A latter-day Lehman Brothers would not have to choke on its own assets. This is new and important.

While it isn’t a great sign when the Fed gets nervous, we’re dealing with a global viral outbreak and turmoil in the energy market as well. Hedge funds may be dumping assets to avoid margin calls, creating feedback and fear.

I understand if the banks want to trim their portfolios at a moment when nobody is eager to buy. When all the major players circle the wagons, conditions get worse and nerves get frayed.

A vicious cycle mentality can set, accelerating until someone can’t go on. That’s what happened in the 2008 credit crash. But look at today’s relief moves. The Fed is our friend.

The companies are not going to disappear. What we’re left with are stocks that are at levels which imply a calamity that trillions of dollars insure against.

AIG was a $54 stock a month ago. Here at $26, the gloom is, in my view, extremely exaggerated. I am not recommending it until we can gauge the real weight of the coronavirus on the economy, but any stock priced for an apocalypse that isn’t coming is worth taking a look.

Testing the Bottom

Anxiety is a terrible thing for a market desperate for facts, projections and clear expectations. A staggering 98% of all stocks are down for the week and 70% of them have lost at least 20% year to date.

The selling is both indiscriminate and being driven by a raw urge to cut risk across the board and get liquidity ahead of an unknown future.

I am looking past the immediate questions toward statistical facts: stocks have weathered every storm and the long-term trend for the S&P 500 still points upward at a steady 8-11% per year.

That’s over nearly a century of dramatic and sometimes disruptive change, including global wars, oil shocks, credit crashes and endless corrections and recessions, great and small.

Most bear markets take two to three months to hit their bottom, so we could be here until summer. Coincidentally, that’s when China now hopes the last coronavirus impacts will recede.

We’re looking for the number of infections to peak by April, after which the 1Q20 earnings cycle will tell us a lot about what the recent quarter did to corporate operations and what management thinks about the current environment.

In July, we’ll start getting 2Q20 numbers to confirm that outlook. The first half of the year won’t be pretty, but we would be wise to expect things to be back to normal by summer.

From the bottom, recovery is usually fast. And of course, this particular plunge has been extremely accelerated. This means the rebound can play out faster than usual as well. The virus, after all, is an external shock and not a persistent drag.

When people get better, they’ll get back to work. If the government cushions that process, they’ll come back in a stronger place. Meanwhile, the Fed is watching.

Stay alert for more “shock and awe” as those trillions of dollars start circulating. Meanwhile, brace for another few weeks of volatility. In times like this, my 2-Day Trader service shines.