FAAMG may push higher but Fed holds the key

Business | Andrew Wong 24 Aug 2020

The S&P 500 hit a new high of 3,397 last week with the index seeming to reflect an economic recovery and expectations of a rebound in corporate profits.

But let's analyze this feat a little more.

Whenever US stocks fall from their peak, it is more often because of monetary tightening by the Federal Reserve.

The main reason why US stocks crashed in 1937 and the economy went into a recession was because the Fed had concluded monetary easing and had resumed monetary tightening.

Of course, the situation today is more complex than what it was in the 1930's, because the S&P 500 could still hit fresh highs since it is being driven the five biggest tech titans - Facebook, Amazon, Apple, Microsoft and Google - more popularly known by the acronym FAAMG.

But when you analyze the performance of the economy and corporate profits after excluding FAAMG, the 5 percent decline of the other stocks also does not properly reflect the poor health of the US economy.

So the Fed's monetary policy still gave a lot of impetus for US stocks, and it is believed that their peak will largely depend on monetary policy rather than the essence of performance.

In fact, the Fed's actions have had a significant impact on the performance of the US stock market over the last 100 years.

Then what about the performance of the economy and financial markets in Nazi-led Germany in the 1930's that I mentioned last week?

When Adolf Hitler came to power in 1933, Germany's unemployment rate was 25 percent but by 1938, unemployment was practically extinct, something that many would have found hard to believe.

However, by 1938, Germany's per capita income growth had hit 22 percent while average real GDP growth between 1934 and 1938 was 8 percent.

And though Germany's stock market did not rise as much as America's during that time, it nevertheless rose nearly 80 percent between 1933 and 1938, and the rally didn't end until the outbreak of the Second World War.

How did Hitler boost Germany's economy?

According to a study by Bridgewater founder Ray Dalio, Hitler boosted the economy in several ways, one of which was to refuse to pay "reparations" to creditors arising from the First World War while pulling out from the League of Nations, thus setting the stage for the Second World War.

Hitler's other push, in 1934, was to nationalize most of Germany's businesses, while encouraging corporates to borrow to invest.

In addition, through subsidies, Volkswagen and other enterprises were established to make cars and other goods more affordable to the common man. At the same time, more highways and other infrastructure were built, stimulating economic growth.

Hitler also forced banks to buy government bonds to fund the government's huge spending, which was eventually paid by the German central bank through an increase in money supply.

Though in different ways, both America and Germany relied on central bank monetary policy to drive their economies and financial markets. But what were the consequences? We'll talk this next week.

Andrew Wong is chairman and CEO of Anli Securities

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