Recently, a significant event occurred in the stock market: instead of climbing, stocks experienced a dramatic downturn. On Thursday, the S&P 500 plummeted by 5.89 percent, with some companies suffering even steeper losses—Gannett Co. fell by 29.5 percent, Noble Corporation dropped 25.51 percent, and Denbury Resources slipped by 23.65 percent.
This leads us to a pressing question in today’s tumultuous market: should you buy the dip?
To answer this, we need to step back and consider the broader context, particularly within the retail sector.
The reality is that the music has stopped for American retailers, yet investors appear unfazed, continuing to engage in buying despite major challenges. The pandemic and subsequent economic downturn haven’t deterred them.
According to Bloomberg, May saw the highest rate of bankruptcies since the Great Recession, with 27 companies, all having at least $50 million in liabilities, declaring bankruptcy. Noteworthy among these were J.C. Penney, Neiman Marcus, and J. Crew.
Melanie Cyagnowski, a former bankruptcy judge, predicts that “we’re going to continue to see filings of at least the level we’re seeing for a while.” Amid government-imposed lockdowns, retail revenues have diminished dramatically. This inability to generate income has forced many retailers to seek court protection to negotiate their debts.
Still, retail investors seem disconnected from the grim realities of bankruptcy. After its closing price of 26.29 on March 23, the S&P 500 Retail ETF (XRT) has surged by over 55 percent, even after Wednesday’s drop of 5.46 percent. Shockingly, it appears that a wave of retail bankruptcies might be seen as a positive sign for retail stocks.
Conventional wisdom suggests that in bankruptcy proceedings, shareholders rank at the bottom of the priority list, trailing behind bondholders when companies undergo liquidation. Their chance of retrieving any investment is minimal—more often than not, they receive only negligible returns.
But it seems retail investors are more attuned to a different melody. They are likely responding not to the music of companies struggling to stay afloat but rather to the relentless churn of a money-printing machine, driving their decisions and enthusiasm.
Follow The Money
The Federal Reserve has been aggressively expanding its balance sheet, injecting about $3 trillion into the economy this year alone. This influx of digital money is effectively an electronic creation that fills gaps left by the economic downturn.
A significant portion of this Fed credit has been channeled into the Treasury via the acquisition of Treasury notes. Subsequently, the Treasury redistributes this borrowed capital throughout the economy through various means, such as corporate bailouts and stimulus programs. This mechanism allows for what seems like limitless growth in national debt.
Additionally, purchases of Treasury notes by the Fed help keep interest rates low, ensuring continued liquidity in credit markets. This excess liquidity often winds up in the stock market, resulting in a dichotomy where the economy deflates, but the stock market appears to inflate.
For anyone attentive, the correlation between Fed credit and stock market activity is unmistakable. Following the money trail invariably leads back to the Fed and its digital printing press.
Despite this connection, many investors display a misplaced confidence in the Fed’s ability to prop up the stock market. They’ve observed the rapid rebound of stocks since March 23 and are determined not to miss out on the perceived wealth generated by free money, continuing their involvement even when the music has ostensibly ceased.
However, the stock market isn’t merely a mechanical entity. Investors inject the Fed’s monetary influx into the market, hoping the party will persist. When faith in this system erodes, as it inevitably does, a rush for the exits ensues, often leaving many in dire straits.
Should You Buy the Dip?
Prior to Thursday, investors were largely riding the highs of the Fed’s expansive monetary policy, some cautiously eyeing the exit while others fully immersed in the buoyant market. The prospect of rising stocks was enough to keep spirits high, as was the knowledge that the Fed would continue its interventions.
At a press conference following the recent FOMC meeting, Fed Chairman Jay Powell reiterated his commitment to maintaining the aggressive monetary support: “[The Fed will] do whatever we can and as long as it takes to provide some relief and stability, to ensure the recovery will be as strong as possible and to limit lasting damage.”
However, the lasting damage Powell aims to prevent may have already been incurred. According to a recent assessment by Coresight Research, up to 25,000 store closures could be announced this year, signaling a downward trend for retail and, by extension, commercial real estate.
For instance, Gap Inc. reported a staggering loss of $932 million for the quarter ending May 2, and mall owner Simon Property Group is pursuing Gap for three months of unpaid rent, amounting to $65.9 million, due to lockdowns affecting their stores.
It remains unclear how Powell envisions that flooding financial markets with credit will foster an economic recovery. What is apparent, however, is that he has established a moral hazard that far exceeds the risks associated with Alan Greenspan’s dot-com bubble.
Could Thursday’s sell-off be indicative of a psychological shift? Perhaps faith in the Fed has waned, prompting both investors and speculators to hastily exit the market.
This brings us back to our original question: should you buy the dip?
The answer largely hinges on your sense of luck. If you’re inclined to take risks, you may choose to invest in stocks, equating it to a game of chance. However, it’s crucial to recognize that feeling fortunate right now might border on recklessness. Historical patterns of moral hazards fueled by the Fed’s policies have shown detrimental outcomes.
Ultimately, it’s wise to proceed with caution.
Sincerely,
MN Gordon
for Economic Prism
