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STOCKS PLAY A RISKY GAME OF HOPE

STOCKS PLAY A RISKY GAME OF HOPE

Investors are playing a risky game based almost entirely on the FED’s willingness and ability to keep the economy inflated and rolling down the road until a solution to the current crisis is formulated. The solution may come in the form of a vaccine or a cure or it may come with time if the rates of infection and death come down to manageable levels. Either way, sees well described in a recent post that said, “So, I have a tire with a big nail in it. No matter how much air I pump in, it will not re-inflate. Does the FED have enough air to keep everything re-inflated?”

The table and charts below show the course the FED has decided how to deal with the current crisis and it comes on the heels of a similar strategy that played out in 2008 and 2013. The FED Balance Sheet has ballooned from $3.75 trillion in September 2019 to $6.5 trillion just 7 months later (chart 1). The action by the FED since 2008 should not be seen as normal. The second chart below shows that the FED’s assets stayed under $1 trillion for decades before the Financial Recession. Now, the Fed’s assets are over 6 times what they were in 2007. The table below shows that the FED’s Balance Sheet now represents 30% of annual U.S. GDP. Even after the first FED move in 2008, that percentage was just 15%.


The final table shows EPS growth for U.S. companies that have so far reported the 1st quarter. 20% of U.S. companies have reported so far. There in only 1 month of Covid-19 effect in the 1st quarter. Earnings growth from all 993 companies is -12%, but the price reaction to bad EPS has been good; the one day price reaction on EPS day is in the lower right quadrant of the table. As TPA has discussed in previous World Snapshots, positive price action to negative news is a good sign. The problem here is, that with EPS growth down 12% on average with only 1 month of Covid-19 effect and only 20% of stocks having weighed in, one has to wonder why? The answer has to be that investors have an awful lot of hope in the power of the FED to keep the tire with a large hole inflated and as the man who taught me how to trade told me, “Hope is a bad investment strategy.”


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