Welcome to the Capital Note, a newsletter about business, finance and economics. On the menu today: Dow moves up, Yellen to move in, GMO and vaccines, urban tax crunches, a secret Chinese plan, and flat tax successes.
The Dow, Yellen, and some reasons to worry
Some of us are old enough to remember the (in)famous Dow 10,000 hats from the height of the dotcom/CNBC (there was a difference?) bubble. I think one of our traders may have had one.
Wandering down the memory lane curated by Google all the way back until 1999, I came across this from The Wall Street Journal:
A few Wall Street traders, hat in hand, are looking to make a buck from a new bull-market commodity — and the New York Stock Exchange isn’t happy about it.
Their wares: the baseball caps tossed into the cheering throng of traders last week by Big Board officials to commemorate the Dow Jones Industrial Average’s first-ever close above 10000.
At the closing bell on March 29, there was a rush to grab the hats. Now, a few savvy traders are testing the market for the hats emblazoned with “Dow 10,000” by hawking them on the Internet.
There were many signs (and not just in retrospect) that the run-up in Internet stocks was going to go horribly wrong. This was probably one of them.
Fast forward to January 2017, and a somewhat chastened CNBC is reporting on Dow 20,000.
One of the people interviewed had this to say:
“When the Dow hit 10K in March 1999 I had sold my first company six months earlier and was riding high. I had no idea there could ever be a crash. I was stupid and young and inexperienced. Volatility happens no matter how high or low the Dow is. . . . When it happened, I bought a big apartment, I invested a ton of money in stupid businesses. I was like a drunken rock star on steroids. Two years later I was dead broke.
“I don’t think Dow 20K means anything. People need to ask: Will the innovation that is happening now change the future? If yes, find the most innovative companies out there, invest, and close your eyes for the roller coaster. The future is not served on a dish. It’s a tough ride to get there and requires leaders and technology and people with vision and passion. But it will get there, like it always does and we’ll all eventually look back on Dow 20K and see it as just another blip on the ride.”
Just over two years later, the Dow troughed at 6,547.05.
And so now, here we are at Dow 30,000.
A rotation into industries that are set to benefit most from an economic recovery propelled indices higher worldwide, with the energy and financials sectors leading gains. The move marked an acceleration of a trend that began in the wake of Joe Biden’s election win earlier this month and has been accelerated by a series of positive results from trials of Covid-19 vaccines.
Donald Trump’s decision to allow the presidential transition to begin after weeks of delay boosted sentiment across trading desks. Indications that Mr Biden will seek to appoint Janet Yellen, the former Federal Reserve chief who is widely respected for her experience in labour economics, as his Treasury secretary added to the upbeat mood.
These factors have all played their part, but the Wall Street Journal took an implicitly darker view, including this observation (my emphasis added):
The market appears locked into a self-perpetuating upward cycle, defying the pandemic and accompanying economic woes. Some pessimists say today’s gains will inevitably lower returns tomorrow. But low interest rates mean investors big and small can’t expect to make much money in less-risky investments like bonds. So they are betting that the market’s momentum will continue, whether passively through index funds or actively with a buy-on-dips mantra.
The mispricing of risk that flows from artificially low interest rates is, in effect, leaving investors with very few places to go for return. As any material yield has (all but) evaporated other than for the riskiest debt securities, all that’s left (to grossly oversimplify) for those chasing return in the markets are dividends, themselves “devalued” by rising share prices and, of course, the hope of capital gains from successful stock trading. Meanwhile, Joe Biden’s capital gains tax plans are still lurking, waiting to see how Georgia goes.
Most on the right are, by instinct, pessimists. I am no exception, and it is hard to imagine that the current round of malinvestment — because artificially suppressed interest rates can only end in malinvestment — is going to end well. My foreboding is not diminished by reading in that Journal report about an investor (who has — good for him — done well in the market). He has substantially increased his trading and has “began watching CNBC in the mornings while pedaling” his Peloton, language that (minus the Peloton) has more than a hint of 1999 about it.
In 2007, Chuck Prince, then the CEO of Citigroup (in)famously commented that “as long as the music is playing, you’ve got to get up and dance.”
We all know what happened next. That said, it is reasonable to expect that Janet Yellen will neither close down the band any time soon, nor, to use an older analogy, will she take away the punchbowl. The market’s reaction to the prospect of her appointment makes sense for now.
Yellen also has, to many investors, something else going for her: She is not Elizabeth Warren. Even though the chances of a Warren appointment were extremely remote — a Republican governor would have chosen her successor as senator — confirmation that she was not going to get the job must have come as something of a relief to the markets.
But Yellen’s appeal amounts to more than not being someone worse.
The genius of choosing Ms Yellen lies in the fact that people of all political persuasions can find some reason to cheer her appointment. That means she will almost certainly be confirmed by the Senate. Take monetary policy. Hawks point out that on Ms Yellen’s watch the Fed raised rates from near zero to 1.25-1.5%. Doves counter that hawks were over-represented in the rate-setting panel at the time, and that Ms Yellen did a good job of keeping them in check.
It is a similar story on fiscal policy. Shortly before Mr Trump became president, Ms Yellen argued that “fiscal policy is not obviously needed to provide stimulus to help us get up to full employment”. She is on the board of the Committee for a Responsible Federal Budget, an organisation that spends a lot of time warning people about the dangers of high public debt. Yet during the pandemic Ms Yellen has argued for “extraordinary fiscal support”. In June she co-signed a letter arguing that “Congress must pass another economic recovery package.”
Passing another stimulus bill may be her first big task. Republicans and Democrats have been unable to agree on a replacement to the bill passed in April, with particular disagreement on the size of the eventual package, even as it is now clear that the economic recovery is slowing. It is a lot to expect that the sheer force of one person could help break the deadlock, not least because Republicans are likely to retain control of the Senate for a while yet. But if anyone can do it, it may be Ms Yellen.
That overstates her powers of persuasion, but even if GOP senators continue their current “journey” toward greater fiscal rectitude she may be able to persuade them to agree to a deal that is larger than it would otherwise have been.
Some extracts that caught my eye below.
The first related to the financial position of the states, something that will be an enormous issue in 2021:
Congress should provide substantial support to state and local governments. The enormous loss of revenue from the recession together with the new responsibilities imposed by the response to the pandemic has put their budgets deeply in the red. To avoid the recessionary effects of major fiscal cuts by those governments, federal support should be substantial and conditions on the aid should not be overly restrictive. Following our advice would further increase the already record level federal budget deficit. With interest rates extremely low and likely to remain so for some time, we do not believe that concerns about the deficit and debt should prevent the Congress from responding robustly to this emergency.
The second speaks for itself:
One day in the future, we will have to get deficits, after this is over and the economy is recovered, we’ll have to deal with deficits and get them under control, but now is the time when I think it’s not necessary to worry about it.
Then there was this Reuters interview from October in which two of her musings stood out, and not in a good way:
There really is a new kind of recognition that you’ve got a society where capitalism is beginning to run amok and needs to be readjusted in order to make sure that what we’re doing is sustainable and the benefits of growth are widely shared in ways they haven’t been.
If there really has been “a new kind of recognition” that capitalism is “beginning to run amok,” more people need to be taking their meds. This is as bizarre a point of view as that held by individuals forever grumbling about “market fundamentalism” and (in the European context) “ultra-liberalism,” two phenomena noticeable only by their absence. That Yellen seems sympathetic to such talk is . . . not reassuring.
In a Capital Note last week, I…