Mark Twain once said, “History doesn’t repeat itself, but it often rhymes.”
Ed Yardeni, chief investment strategist at Yardeni Research, applied those words to what, for most observers, has to feel like a unique climate for playing the market these days.
But that is not necessarily the case, according to Yardeni.
“We live in interesting, though not unprecedented, times,” he wrote in a blog post. “The Roaring 1920s could be a precedent for the Roaring 2020s.”
For instance, he compared the coronavirus pandemic to the 1918 Spanish Flu, which killed an estimated 50 million people and infected some 500 million around the world.
“The good news is that the bad news during the previous precedent was followed by the Roaring 20s,” Yardeni wrote. “So far, the 2020s has started with the pandemic, but there are plenty of years left for the prosperous 1920s to become a precedent for the current decade.”
The key to the next boom, as it was in the 1920, will be technology-enhanced productivity.
“Today’s doomsters could be confounded by biotechnological innovations that deliver not only a vaccine for COVID-19 but for all coronaviruses, Yardeni said. “Scientists are investigating an array of approaches to fight COVID-19. Hopefully, beyond finding a cure or a vaccine, one of the beneficial outcomes of all this research will be that scientists learn many more ways to combat illnesses in general and viruses in particular.”
Add this to robotics, AI, nanotechnology, blockchain, electric vehicles, quantum computing, etc., and, as Yardeni suggests, we could be looking at a historic transformation, much like the advances in transportation, manufacturing, electricity and plumbing that ensued 100 years ago.
What’s it all mean for the stock market?
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Well, as Yardeni told clients in a note Wednesday, he sees a strong finish to the year for the S&P 500 thanks to historic stimulus and a resilient bullish trend. The buying will spill over into 2021, where the S&P could end the year with a double-digit pop, he predicted.
“The 1920s ended with a stock-market meltup followed by a meltdown,” he said. “The 2020s may already be seeing a meltup, begun on March 23.”
If history does, indeed, rhyme, this rally has lots of room to run, but investors might want to mark their calendars for the fall of 2029.
Meanwhile, the stock market was mixed in Thursday’s trading session, with the Dow Jones Industrial Average DJIA, -0.26% and the S&P 500 SPX, 0.33% losing some ground as the tech-heavy Nasdaq Composite COMP, 1.08% edged higher.
The stock market may fall when a COVID-19 vaccine formally receives approval from the Food and Drug Administration. I know I’m getting ahead of myself, since it’s not guaranteed that an effective vaccine will ever be produced. But with eight vaccines now in Phase III trials, and with Russia claiming bragging rights by being the first to register a vaccine, it’s not too early to begin thinking about how you should react when formal FDA approval for a vaccine is forthcoming.
To be sure, I am reminded of the old proverb that it is difficult to make predictions, especially about the future. I nevertheless began my speculation by searching through U.S. history to measure how the stock market in the past reacted to long-awaited good news. I found only four in the 20th Century that I deemed to be as fateful and significant as a COVID-19 vaccine could be: The end of World War I (Armistice Day), V-E and V-J days at the end of World War II, and Jonas Salk’s announcement of a successful polio vaccine.
Be my guest to suggest other events for my subset. But the four I picked were unquestionably momentous. Following the formal ends of both world wars, for example, millions across the Allied nations poured into the streets in celebration. Life magazine wrote that Americans, after hearing of Japan’s surrender, began celebrating “as if joy had been rationed and saved up for the three years, eight months and seven days since Sunday, Dec. 7, 1941 [the day of the attack on Pearl Harbor].”
I also focused on the announcement of the successful polio vaccine because it is arguably the closest analog to an eventual COVID-19 vaccine. Polio epidemics were common during the first half of the 20th century.
However wonderful each of these events was, the Dow Jones Industrial Average DJIA, -0.23% fell on the news — as you can see from the chart below.
There are several explanations for this surprising result.
1. Discounting the future: The stock market discounts the future. Though each of these four events was unambiguously good news, none was entirely unexpected. We can easily overlook that from our decades-later perspective. In both world wars, for example, the military tide had been turning in the Allies’ favor for some time prior to the formal surrender declarations. And work on a polio vaccine had been progressing for many years.
As a result, the stock market prior to these four announcements had already reflected the good news.
This process of the market discounting the increasing probability will probably be even truer in the weeks leading up to an eventual FDA approval of a COVID-19 vaccine. The news media today obsessively reports every medical development and the results of each trial, and biotech companies are willing co-conspirators in this. FDA approval of a vaccine, when it comes, could be more of a non-event than we think.
One possible scenario is that the market rallies as it becomes increasingly clear that vaccine approval is close. When that approval finally arrives, retail investors could very well jump into the market with both feet. In contrast, institutional money managers and professional traders — the smarter money — will likely use that occasion to start selling.
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This isn’t a new phenomenon. It is common enough, in fact, that Wall Street has an aphorism to describe it: “Buy on the rumor, sell on the news.”
2. Political considerations: Another reason an FDA approval announcement might not be met with a Wall Street rally is the widespread distrust of the process by which vaccines are being hurriedly developed. The FDA has already set a relatively low bar — just 50% effectiveness — and many already are voicing concern that whatever vaccine gets approved will not have received the same degree of rigorous safety testing that previous vaccines have received.
Regardless of whether these concerns have merit, they have economic consequences. The slow adoption of a marginally effective vaccine will not lead to a quick end to the pandemic or to a particularly strong and quick economic recovery. As one institutional money manager told me on background, FDA approval of a vaccine might “be the last bit of good news possible, and selling would be a correct decision.”
It’s worth mentioning in this regard the stock market’s reaction to Russian President Vladimir Putin’s announcement that Russia has registered the first COVID-19 vaccine: The S&P 500 SPX, 0.37% fell 0.8% on the day.
The bottom line? While we can only make an educated guess what the market will do if and when the FDA finally approves a COVID-19 vaccine, don’t be surprised if the market falls rather than rises.
Why economics needs new theories about stimulus and inflation
Instead of spinning theories that just say hyperinflation will happen at some unknown point, macroeconomists could look at countries that do experience it and study them.
A shop that reopened in May at Delhi's Nai Sarak | ANI
The coronavirus pandemic has raised deficit spending to new heights. Federal debt held by the public is expected to reach 100% of gross domestic product this year, effectively returning to the levels of World War II.
The Federal Reserve, meanwhile, has also taken unprecedented action, increasing its total assets from about $4 trillion at the start of the pandemic to about $7 trillion now:
Source: Bloomberg
The big question is when, if ever, this aggressive government action starts to incur negative consequences, such as rapid inflation. Macroeconomists should be investigating this question vigorously. But so far, interest in the question has seemed strangely muted among mainstream academics.
Before the financial crisis of 2008, the dominant academic model of the business cycle held that there was a tradeoff between inflation and unemployment — a new version of what’s known in economics as the Philips Curve. By managing interest rates, mainstream theorists argued, the central bank would navigate serenely between the rocks of inflation and the shoals of unemployment. There was not much room for government debt in that model.
The 2008 recession seemed like it might present a huge challenge for this paradigm, but most macroeconomists met the challenge by simply patching up the old models. They shoehorned in a financial sector, and allowed that when nominal interest rates approached zero, fiscal stimulus along with quantitative easing would have to be brought in.
But that still left the question of what the limits of stimulus and QE would be. Mainstream economists realized that because the government can use monetary policy to lower interest rates and even finance government borrowing directly, there would never be a real risk of sovereign default; if private investors stopped buying Treasuries and rates started to rise, the Fed could pick up the slack. The only real constraint on government action was the possibility of inflation, if the Fed created too much money.
But when would inflation kick in? Economists’ only answer was, basically, that it would happen at some point. Some economists fretted that QE was about to cause rapid inflation, even writing an open letter to former Fed chairman Ben Bernanke warning him to stop QE. But Bernanke didn’t stop, and inflation never came. The Bank of Japan engaged in an even more vigorous program, buying up an appreciable fraction of the country’s stock market. But inflation never consistently reached the bank’s 2% target.
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The failure of inflation to materialize in response to enormous fiscal and monetary stimulus in the 2010s should have prompted vigorous activity among academics to try to figure out why. But oddly, it didn’t. A few scholars suggested that low interest rates were actually deflationary, but this idea never caught on. Most macroeconomists, if they bothered to address the question at all, simply assumed that at some point inflation would pick up, and that developed countries simply hadn’t reached that point yet. So far, the coronavirus pandemic looks like a repeat of the financial crisis in this respect; despite unprecedented deficits and monetary expansion, markets expect inflation to be below target for the next decade.
But inflation undeniably happens sometimes, in some places. Venezuela and Lebanon have both recently experienced hyperinflation, with the former reaching an annual rate of more than 130,000%. The economic consequences are devastating — even worse than a sovereign default. The question is why, and where, and under what conditions hyperinflation happens, and how it can be stopped.
Instead of spinning theories that effectively just say that hyperinflation will happen at some unknown point, macroeconomists could look at countries that do experience hyperinflation, or come close but manage to avert it. They should use these historical and international examples to learn lessons about when and where and why this sort of catastrophe happens, and how it can be prevented. But the seminal work on hyperinflation continues to be economist Thomas Sargent’s 1982 paper “The End of Four Big Inflations.” This paper, in addition to being four decades old, draws all its examples from Central European economies in the aftermath of World War I — very different circumstances than the economies of today.
New work on hyperinflation is urgently needed. One key question is whether runaway inflation happens slowly enough that the government can reverse course in time, or whether it’s instantaneous and catastrophic. Another question is whether direct monetary financing of new government borrowing is a trigger for hyperinflation. A third is whether and how capital flight is involved. A fourth is how the type of government spending changes whether markets expect deficits to be temporary or permanent. There are many other important questions besides these.
If academic macroeconomists continue to largely ignore this question, and focus on the models and ideas and questions that they were working on before coronavirus, it will represent a quiet but enormous failure of the discipline, just as significant as the profession’s inability to see the 2008 crisis coming. With academics AWOL on the question of how much the government can safely spend and how much the central bank can safely print, policy makers, businesspeople and financial market participants will turn to poorly articulated theories, old nostrums, political agitators, gut instincts or the raving of random Twitter users. – Bloomberg
