Speaker 1: If you take a look at the stock markets over the past couple of months, it has been on an absolute here. I mean, just over three months, the stock market has increased by over 40 per cent, now getting close to all time stock market highs. However, if we take a look at the economy, it’s doing completely the opposite. It contracted at a five percent annualized rate in the first quarter of twenty, the sharpest speed of decline in GDP since the 2008 Great Recession. So the real question we should be asking is, hang on, why is the stock market increasing by so much?
Surely it should behave similar to what it normally does, which is similar to what the economy does. It’s almost as if this increase is a little bit artificial, as if something is propping it up. And that’s because it’s is there’s this weird force, which I’m sure you’ve all heard of, that has a big set of cards and what happens to the stock market. And of course, I’m talking about the Fed. For those who don’t know, the Fed has been making some very interesting moves, which we can see now has had a massive effect on the stock markets. One of those interesting moves as it’s made an unprecedented decision to buy junk bonds from corporations. Now, let me explain this. You see, during this particular illness lockdown, weird situation that we’re in, a lot of the weaker companies are struggling. And by weaker generally, I mean those who are not prepared. You know, when it comes to personal finance, Dave Ramsey always recommends having a safety net in place and other things to make sure you’re ready for when times get tough. But this is even more important for big companies. You need to have your balance sheet ready.
You need to have enough cash saved that at your disposal just in case there’s a downturn which often occurs. Now, we’ve recently seen one of these downturns and we are still in one. When you look at the economy, the IMF says the US economy will drop by six point six percent in 2020. Now, often what happens in these times is those bad companies who don’t manage themselves well, they go out of business normally. They run out of money, they try and as you debt and no one wants to buy their debts. By the way, issuing debt just means when a company says, can I have some money? And then I will pay you back with interest at a later date. But when you’re a bad company, most investors, they won’t buy your debt. The likes of Warren Buffett, they’ll look at it and think, hang on, there’s a good chance you won’t pay me back even if you give me a good interest rate, I’m not buying it. And then what happens is those companies, they go out of business, which is actually a good thing, except they don’t go out of business. When Uncle Sam decides to step in and buy Uncle Sam, I actually mean Uncle Jerome Powell with his infinite money, Princesa, he comes in and he says, no worries. You need some money to buy your junk bonds. We can just print more money. Anyway, this is a move that we have never seen before by the Fed, where they have chosen deliberately to buy junk bonds. So, you know, normally the Fed is not afraid to buy traditional bonds, and that’s fair enough. But junk bonds may be a step too far for those who don’t know. Let’s just say that traditional bonds are kind of like betting that the Lakers will win their game. Junk bonds, they’re kind of like betting that the Timberwolves or the Pelicans will win. You know, it’s pretty touch and go. So what you’re getting is these companies that normally wouldn’t be getting this money, but because of Uncle Jerome, they are the Federal Reserve stepped in with a 750 billion dollar program to prop up the corporate debt market. And this is a big reason why the stock market is up by so much big companies. They’re getting essentially free money because of these junk bond buys and low interest rates.
So we’re talking the likes of Delta’s bonds, which we all know. By the way, Warren Buffett, he rushed out of Delta very quickly. Once this illness hits, it’s not good enough for regular investors, but it’s good enough for the Fed. It’s just something that we’ve never seen before. And I guess the fear they’re just sitting there with their fingers crossed, hoping that these companies with junk ratings will pay them back. But this isn’t the only move that the Fed has made, which is propping up the stock markets. As I’ve briefly alluded to in this video already, interest rates are sitting at close to all time lows. If we take a look to the bottom right hand corner of this graph, we can see that interest rates have been dropped to zero point twenty five percent, pretty much at the same level as to what it was dropped to in the 2008 Great Recession. OK, so let’s think about that for a second. Why did the Fed lower interest rates to such a low amount? Ten years ago, the answer to that question, it’s pretty obvious they did this to try and stimulate the economy and the stock market again, you see, whenever interest rates are low, it means companies can borrow money for less amounts of payments. So they borrow more. They’re able to keep employing people. They continue with business. So the stock market goes up. And back in 2008, they had to do this. The stock market had crashed by over 50 percent and things weren’t looking good. However, today the stock market is that close to all time highs. And a lot of this definitely is artificial because of these low interest rates. The problem with having interest rates so low is that naturally companies borrow a lot of money. Corporate debt at the moment, they have swelled to a record high with more than thirteen point five trillion dollars as per late last year. If interest rates move up even slightly, this means that interest payments on the debt will increase, which some companies will not be able to afford. And this also means companies will be able to borrow less. Same with investors and thus it could be the tipping points for the stock market’s fall. That’s why the Fed has interest rates so low because they can’t risk increasing them. But the interesting thing is normally interest rates at this point in a bull market would be sky high. Like at the end of the last bull market run in 2007, the federal funds rate was around five point three percent. And the other thing about having a high interest rate, it means when stocks do fully crash and times get tough, the Fed has some power to help things recover. Unlike in 2020, when interest rates are pretty much at zero percent, meaning the Fed doesn’t have any power to lower interest rates and stimulate the stock market more if it were to crash again. And for those who have studied how the Fed works, you know, they have a couple of levers that they use to stimulate the stock markets. One of the big ones is interest rates. They’ve already used that lever. One that they’ve just introduced is buying junk bonds. They have never done that before. Risky, but they’re doing that’s the other key one that they can use is printing money, which Uncle Jerome and his printing press is not holding back on. Over the past three months, the Fed has printed a little over three trillion dollars in order to combat the effects of this world illness that we’re facing. The Fed also made an announcement a couple of months ago that they are willing to buy unlimited amounts of bonds in order to help the stock markets and the economy recover. Well, the thing that we can say about this printing of money buying bonds is that it’s certainly worked when it comes to the stock market. As we all know right now, it’s not far away from all time highs. But the question is, is this sustainable? You know, right now, the Fed have basically played all of their cards.
They’ve done the lowering of interest rates. They’ve printed a lot of money off. The stock market starts to get in trouble again. If we come across a second wave, well, the Fed will not have the power in which they normally would have, a.k.a. like in the 2008 recession, while they had a fair amount of power, they could lower interest rates dramatically because interest rates were high. They were also able to print a lot of money. But right now, you can’t lower interest rates any lower unless you want them to go negative. Also, there’s only so much money that you can print. As Charlie Munger said, I am so afraid of a democracy getting the idea that you can print money to solve your problems and eventually I know that will fail at the end. If you print too much, you end up in something like Venezuela. So that’s just something that the Fed needs to watch out for. Yes, it’s OK to a certain extent if you’re looking to help out certain businesses and help get the economy rolling again. However, announcing that you’re willing to print unlimited money, announcing that you’re going to be buying junk bonds for the first time in history, what can I say about this? I’m not 100 percent sure about these policies, but the stock market certainly isn’t complaining, nor is the bond market, nor are those companies that are basically getting bailed out for free.
But the only issue with this is when the next crisis comes along or if the stock market starts going down again, what then does the Fed have left to do? Well, I guess they’ll just face those hurdles when it comes. All I can say, as I wish them the best of luck.