State-Led Capitalism

State-Led Capitalism

Private markets are no longer primarily determined by the actions of private buyers and sellers. The State now controls private markets as the primary mover. Guessing the timing, scale and duration of massive fiscal and monetary programs has superseded if not largely replaced fundamental analysis. That’s not to say that fundamentals do not matter, but they clearly have taken a back seat to State programs. Like Frankenstein’s monster, the State means well (so it says). Yet like the monster its actions do more harm than good.

State actions have always influenced capital markets but not to this degree. Born out of “necessity”, the Fed introduced Quantitative Easing (“QE”) and bank bailouts to “save” the economy during the 2008 financial crisis. Perpetual QE has become the norm over the past 12 years. A coordinated fiscal and monetary effort temporarily thwarted the negative economic impact that COVID inflicted upon the economy. A combination of unprecedented fiscal and monetary actions loosened credit, inflated debt and equity valuations, created zombie companies, crowded out private capital and created mass moral hazard. The State is feeding pure sugar to the diabetic.

The Fed is primarily to blame in our view. It is supposed to act as a check against irresponsible fiscal policy that has subsidized an entitlement culture with debt and taxes (primarily the former). It is supposed to ensure that the credit markets are functioning properly and that the banking system is stable. Instead, the Fed is both complicit and disruptive. It funds fiscal deficits with its expansionary monetary policy and provides lax bank oversight (seriously, no leverage ratio tests?). Further, the Fed’s perpetually low interest rate policy simultaneously encourages over-leveraging (making it difficult to raise rates), and makes investors’ quest for yield a quixotic one. This scarcity of yield motivates bankers to create inherently risky securities (or are they risky if the Fed is going to back stop everything?), such as CLOs where underlying high yield credits are regularly packaged as AAA-rated securities.

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How long can the Fed afford to subsidize money-losing day-to-day fiscal operations while continuing to spend approximately $120 billion per month purchasing government paper to maintain narrow credit spreads? That’s to say nothing of the various fiscal stimulus programs it is executing on behalf of the Trump Administration/ Congress/ Treasury. You may have noticed on Monday that the Fed announced its program for purchasing individual credits in the primary market (this is in addition to its secondary market actions). I never thought I would see the day when the Fed took action on corporate fixed income securities, whether in ETFs or as individual securities.

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What bridge(s) has the Fed yet to cross? Investing in equities and the pursuit of negative interest rates are on the horizon. If you wait long enough you are likely to see these “not in my lifetime” Fed actions become reality.


Milton Friedman to Frankenstein’s Monster.