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Why the market hasn’t gone back down

By April 27, 2020 No Comments

One of the main talking points in the market right now is the supposed disconnect between Wall Street and Main Street. The S&P 500 hit a low of 2191 on March 23, which represented a drop of 35% from its high. That same week, a record 3.3 million Americans filed for unemployment benefits. In the weeks that followed more than 20 million additional Americans have been laid off and the S&P 500 has risen by 30%. So why hasn’t the stock market gone back down in the face of the greatest economic slow down in modern times? It’s impossible to know for sure, but we’ll do our best to highlight some key points.

In ironic fashion, the stock market started rallying just as millions began losing their jobs.

Unprecedented government Spending

When the 2008 Financial Crisis began to unfold, George Bush was in the twilight of his presidency. Had he been up for reelection, then perhaps his government’s response would have been as large and swift as President Trump’s response has been today. Or maybe it’s an apples to oranges comparison. Regardless, the government’s policy response in 2008 provides the most relevant example for putting the current response into context.

The highest-profile response to the economic fall out from the Coronavirus crisis is the $1,200 stimulus check many Americans received as a part of the CARES Act. Let’s compare that to a somewhat similar measure that was taken in 2008, through the Economic Stimulus Act:

CARES ACT (2020) ESA ACT (2008)
Amount $1,200/individual $600/individual
$2,400/couples $1,200/couples
$500/child $300/child
Date Bill Signed March 27, 2020 February 13, 2008
First Payments Made 2 weeks later 3 months later

As you can see, the checks today were double the 2008 amount and they were distributed much faster.

Juiced up unemployment insurance

In 2008, amid soaring unemployment, President Bush signed the Unemployment Compensation Act. Here’s how those enhanced unemployment benefits compare to the juiced-up unemployment benefits enacted as apart of the CARES Act:

CARES ACT (2020) UCA ACT (2008)
Extended Benefits By 13 weeks 7 or 13 weeks*
Additional Compensation $600/week $0
Expanded Coverage Yes No
Passed Congress March 27, 2020 September 26, 2008
Signed by President March 27, 2020 November 21, 2008

*UCA extended benefits by seven weeks in every state, and by 13 weeks in states with unemployment rates of at least 6%.

Three things stand out about the enhanced unemployment benefits of today versus 2008:

  1. The additional compensation of $600 per week is a huge amount. That equates to $2,400 per month and this is in addition to the amount individuals would otherwise be entitled to receive under state law. No such provision for additional compensation made it into the UCA bill.
  2. The expanded coverage means millions of independent contractors or self-employed individuals are eligible for unemployment benefits. These types of persons were not eligible in 2008.
  3. The swiftness with which the CARES Act passed congress and was then signed into law is unparalleled. Congress passed the UCA on September 26, 2008, but disagreements in the senate slowed down the legislation.

The following graph from CNBC, sourced from an article published by Econofact, shows the impact the enhanced benefits are having today:

For some recently laid-off workers, unemployment benefits are replacing 100% (or more) of their lost income. While one can debate the moral hazard that could be borne out of such generous unemployment benefits, there is no question that the increased benefits are helping recently laid-off workers get through tough times.

Two watershed moments

Many investors point to the collapse of Lehman Brothers as the tipping point in the 2008 Financial Crisis. On September 15, 2008, the day Lehman officially declared bankruptcy, the Dow Jones fell 4.5%. That was its largest drop since the September 11th terrorist attacks. Years from now, the watershed moment of 2020 will likely be remembered as President Trump’s international travel ban, which kick-started state-sanctioned lockdowns across the United States. Markets responded precipitously, falling 10% on March 12th for their largest daily decline since 1987.

The difference is in what followed both market-moving events. Policymakers were far more efficient, (or reckless depending on your view), in responding to market turmoil today than they were in addressing the systematic risks posed by Lehman’s collapse in 2008. Perhaps only with the benefit of hindsight do we now know that Lehman would catalyze a deep freeze of global credit markets, affecting both businesses and consumers, and roiling global stock markets in the process. Whereas it was easier to see the economic fall out coming today due to forced lockdowns put in place in response to the Coronavirus crisis.

However, there were advanced warning signs in 2008, but they didn’t get the attention they deserved. In June 2008, Lehman Brothers told the market it needed to raise new capital. By the end of July, the S&P 500 had fallen 20% from its 2007 high and was in the midst of a recession. In August, Lehman revealed they were exploring options for selling $40 billion worth of troubled commercial real estate holdings. The “troubled assets” like the ones Lehman was looking to dump would become the foundational selling point for a key Washington bailout program: the Troubled Asset Relief Program, or TARP.

TARP’s costly timeline

Even with existing legislation in place in the form of President Bush’s Economic Stimulus Act of 2008, policymakers could not agree on a uniform response to the accelerated fall out from Lehman’s collapse or the recession in general. This disagreement and an overall inability to thoroughly address pain points proved costly. When TARP failed to pass the house on September 29, 2008, markets fell more than 7%. At the time it was the largest decline in 20 years.

Amid more haggling and increased political pressure, an amended version of the bill was passed on October 3, 2008. Yet, just one month later, it was determined that TARP, in its original form, was not making the impact it needed to in order to thaw frozen credit markets. TARP was supposed to restore confidence in the markets. But in fact, it may have only added to market uncertainty at the time. One thing we know for sure is TARP did not stem the market’s decline in the short-term. From the date of its passage to the eventual market bottom on March 9, 2009, the S&P 500 fell 38%.

A coincidental bottom?

So what did coincide with stocks bottoming out in 2009? Well, it doesn’t get much attention today, but stocks started to rally in March 2009 as Congress began pressuring US accounting rule makers to allow more flexibility in mark-to-market accounting. From March 9-April 2, 2009, when the passage of rule changes on mark-to-market accounting became official, the S&P 500 would rally 23%. From the time Lehman collapsed, it would be six months before arguably the most impactful regulatory changes were put in place.

Today, the Federal Reserve has taken its own unprecedented actions to alleviate liquidity issues in riskier assets. This has buoyed debt prices and has no doubt improved sentiment in the stock market as well. A mere two weeks elapsed from the time the US went into lockdown to the time the Federal Reserve took the actions they did. Within those same two weeks, US legislators passed the CARES Act and President Trump signed it into law.

Final thoughts on 2020 vs 2008

It’s been a popular theme to compare the market of 2020 to the market of 2008. However, a short study of the some of key historical events, and responses, shows two significant differences between the actions taken today versus the actions taken in 2008. And these actions may offer a simple explanation for why the stock market has not gone back down the way many were expecting:

  1. The US government and the federal reserve have thrown a lot more money at the problem today than they did in 2008.
  2. The US government and the federal reserve acted much faster to address some of the major issues created by the Coronavirus crisis today versus the problems in 2008. They power-walked in 2008, today they’re Usain Bolt sprinting.

The responses can be summarized like this: in 2008, policymakers and the Federal Reserve were unsure what they were dealing with and they reacted with stimulus and monetary tranches over time. In 2020, policymakers and the Federal Reserve were so scared of having a Great Depression on their watch, that they’ve acted with a stimulus and monetary bazooka, and they are firing rounds as quickly as they can load the ammo.

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