Only a few know, how much one must know to know how little one knows.
-Werner Heisenberg

A few weeks ago, I was reminded of a quantum mechanics principal named the “uncertainty principal.” This principal, introduced by Heisenberg in 1927, states that you cannot measure the exact position and velocity of a particle at the exact same time. In other words, you may know one or the other, exactly, but not both, or the more you know about a particle’s position the less you know about its momentum and vice versa. This principal reminds me of today’s economic environment.

The most recent economic malaise brought upon us from the COVID-19 pandemic was like no other. Most recessions, regardless of how deep they are or how long they last, are not known until after the fact. This recession was different. We knew exactly what caused it and when it happened. Having that knowledge is of little use in computing how quickly we will get out of it. In other words, we are seeing an economic “uncertainty principal” at work. Consequently, our present markets can also be defined by the word “uncertainty.”

That “uncertainty” will not be resolved any time soon, as the nation not only is trying to decipher what direction the US economy is heading, but it also struggles with social unrest and a presidential election. This creates huge dilemmas for investors trying to navigate the bond and equity markets. Then there is the Federal Reserve.  The following excerpt from Fed Chairman Jerome Powell may help you better understand the dilemma:

“Our principal focus though is on the state of the economy and on the labor market and on inflation. Now inflation of course is low, and we think it’s very likely to remain low for some time below our target. Really, it’s about getting the labor market back and getting it in shape. That’s been our major focus. I would say if we were to hold back because, we would never do this, but the idea that, just the concept that we would hold back because we think asset prices are too high, others may not think so, but we just decided that that’s the case, what would happen to those people? What would happen to the people that we’re actually, legally supposed to be serving? We’re supposed to be pursuing maximum employment and stable prices, and that’s what we’re pursuing.”

One effect of all the actions taken by the Federal Reserve has been a drop in interest rates across the entire bond market. This means that even non-government backed bonds, such as corporate bonds, have had a spike in prices. This is unprecedented during a recession where every part of an economy was shut down for a period of time. You would have expected the reverse as investors would have avoided debt issued by corporations whose businesses they knew would suffer. However, once again the Fed came to the rescue, as they promised to buy and did buy corporate bond ETFs (exchange-traded funds) to calm market participants. Needless to say,  the returns of corporate bonds since the Fed promised to buy funds of corporate bonds have been in the double digit spectrum, over 15%. And we know that the Fed will not hold back because asset prices are too high, so are asset prices too high? Are interest rates low enough?

More confusing is when the Fed tells us that they can expand their toolbox. What does that mean? Will they control rates along the entire yield curve like in Japan? Will they venture into the equity markets like other central banks such as Switzerland and Japan? We have certainly seen an enormous amount of corporate debt come to market because rates are so low and attractive for companies, and we all know that the U.S. Treasury is going to have to fund all of the forgivable loans, stimulus checks, and infrastructure goals. Are we to imagine that higher rates will make sense under that scenario?

One thing is clear: the economic turmoil and therefore market tumble was triggered by an unprecedented medical event that caused the government to shut down the economy on a known date.  All this is and was perfectly established. What comes next will be engulfed in volatility. And “uncertainty.”

Chief Investment Officer
Xavier Urpi