Why a Second Round of Stimulus Likely Won't Be Enough

The new 'gambling game' for millions of novice investors... A different definition of 'cheap' – and the allure of bankrupt stocks... Government stimulus worked, but now it's winding down... Why a second round of stimulus likely won't be enough...

Dayanis Valdivieso knew just what to do with her newfound 'wealth'...

She wanted to join millions of other novice investors in playing "a gambling game."

Before April, Valdivieso had never bought a share of stock. And like millions of Americans, the 22-year-old Kentucky resident had recently lost her job due to the COVID-19 pandemic.

But after receiving her $1,200 stimulus check from the government, Valdivieso believed it was the perfect time to try her luck in the stock market for the first time. As she told the Wall Street Journal in early June...

It was basically free money, so, you know, I decided to play around with it. You might lose some, you might win some. It's like a gambling game.

Valdivieso put part of her stimulus check into an account on Robinhood, the free trading app that many first-time traders have turned to this year. And she timed things just right...

The COVID-19 pandemic and related shutdowns sent stocks into freefall mode earlier this year. The benchmark S&P 500 Index fell 34% in a month from February into March.

But then, almost as quickly, stocks bounced back and returned to new all-time highs... From its March 23 low through its most recent peak on September 2, the S&P 500 soared from 2,237 to 3,580 – a 60% gain in a little more than five months. Take a look...

Through early June, Valdivieso had turned her initial $275 investment into $800 – a 190% return in a short span – by simply following the momentum higher. She told the Wall Street Journal that her investments included plant-based food producer Beyond Meat (BYND) and restaurant and arcade chain Dave & Buster's Entertainment (PLAY).

Of course, regular Digest readers know that this rally has been bolstered by the Federal Reserve pumping liquidity into the financial system... government stimulus to businesses and households... and expectations for a similarly quick, V-shaped recovery in the economy.

And as I (Bill McGilton) will explain today, this situation simply can't last forever... The Fed's efforts could allow the party to continue for a while, but the music will stop at some point.

When it does, unwitting investors like Valdivieso could lose everything almost overnight.

As we often say around here, though, you don't have to be a victim... While today's Digest will mostly serve as a warning, I'll also share what you can do to maximize your profits before the next storm arrives.

First, let's learn more about the wave of "gamblers" who discovered the markets this year...

Valdivieso wasn't the only one to gamble in stocks with her stimulus money...

Data-aggregation firm Envestnet Yodlee studied the bank transfer information of 2.5 million stimulus recipients. And as we first told you in the June 26 Digest...

Securities trading ranked as the second- or third-most-common use for stimulus funds in almost every income bracket. The data showed that Americans who earn between $35,000 and $75,000 per year increased their stock trading by roughly 90% over the week before they received their checks.

Folks with higher incomes used their stimulus checks for this purpose as well... Securities trading was the second-most-common use for households earning between $100,000 to $150,000 per year. And among this group, stock-trading activity increased 82% in the week after the checks were issued.

Altogether, trading volumes and new users across all the major online brokers surged after the stimulus checks started going out... Charles Schwab (SCHW), E-Trade Financial, and Interactive Brokers (IBKR) added almost 800,000 clients combined in March and April.

And as we noted in the Digest last week, Robinhood in particular benefited from the shift this year... More trades were placed on the trading platform in June than on Charles Schwab and E-Trade combined. And Robinhood's user base spiked from 10 million at the end of December 2019 to more than 13 million today.

The inexperience of these new entrants to the market is evident in the stocks they've been buying...

They've been chasing momentum stocks... In addition to stocks like Beyond Meat and Dave & Buster's, they've also bought into companies like electric-vehicle makers Tesla (TSLA) and Nikola (NKLA) – at least until fraud allegations surfaced in the case of the latter.

In many cases, these market gamblers have turned to stocks they view as "cheap" – not based on valuation like most experienced investors, but because their shares trade at a low-dollar figure. They take this approach for no other reason than they can afford to buy more shares... and potentially score bigger on any moves higher.

They've even turned to stocks of bankrupt companies – like department store JC Penney (JCPNQ) and rental-car company Hertz Global (HTZ).

Hertz is perhaps the most perplexing case, as these new investors can't seem to get enough of it. Take Thai Gaon, a 23-year-old salesman from San Francisco, for example...

Gaon used his entire life savings of roughly $50,000 to buy 35,000 shares of Hertz stock at around $1.43 per share on June 4 – less than two weeks after Hertz declared bankruptcy. As he told the Wall Street Journal at the time...

I decided, you know, if I'm gonna do it, I should do it big, and I'll make a play and see what comes out of it.

And Gaon was far from alone in throwing risk out the window after Hertz went bankrupt...

Prior to the company's bankruptcy filing, 43,000 Robinhood accounts held shares of its stock. That number jumped to 73,000 in the first week of June... and peaked at 171,000 accounts in mid-June, according to Robintrack.net, a website that tracks Robinhood data.

The spike in Robinhood owners after the bankruptcy filing corresponded with an incredible two-week run for the stock... It soared nearly 900% from $0.56 per share on May 26 – the first trading day after it went bankrupt – to its highest close of $5.53 per share on June 8.

Like Valdivieso, Gaon scored big with his first gamble... He sold his Hertz shares at $2.76 on June 5 – almost doubling his life savings in a single day. According to Gaon...

I'm happy with doubling my savings overnight. Where else are you gonna find that?

That should sound like a potential case of "famous last words" to astute Digest readers.

While it paid off for Gaon this time, it's anybody's guess if the next gamble will work as well. At some point, you'd think his luck will run out... and wipe out his entire life savings, too.

Even worse, these market gamblers aren't just buying stocks. They're taking on a lot of risk in other ways, too...

Like trading options, for example... Investors can control more shares of a stock through options (at least, for a time). And that's exactly what many Robinhood traders are doing...

Confident from her initial success in buying stocks, Valdivieso decided it was time to take her new game up a notch... increasing her leverage by trading options. As she explained matter-of-factly to the Wall Street Journal...

You can make a pretty good amount of money in one day.

Of course, you can also lose a pretty good amount of money in one day, too.

Still, Valdivieso isn't the only one who has moved on to options – amplifying leverage, and therefore, amplifying risk... In July, for the first time ever, the volume of stock options traded by individual investors exceeded that of stock trading, according to investment bank Goldman Sachs.

Through June 23, an average of 28 million options contracts were being traded per day. That's almost 50% higher than the average of 19 million options contracts per day in 2019, according to data from clearing and settlement firm Options Clearing Corporation.

The stimulus checks have propped up the stock market and the economy for the time being...

These stimulus payments – including the $1,200 checks for adults and $500 checks for their children, as well as an additional $600 per week in unemployment benefits from the federal government – provided a "mini-wealth effect" for many Americans...

Personal income surged almost 11% in April. That's the biggest jump since the U.S. started tracking the statistic in 1959. Some folks received more in unemployment benefits than they could have made while working their regular jobs.

The net effect of all the stimulus was that it stirred up "animal instincts" in folks like Valdivieso and Gaon – making them more comfortable with taking on massive amounts of risk.

But now that the initial stimulus is winding down, the risks could start to catch up to many folks...

The stimulus checks were one-time payments.

And the $600 in weekly unemployment benefits from the government ended on July 31. Since then, folks could've received another six weeks of Lost Wage Assistance from the Federal Emergency Management Agency (at $300 per week). But that additional assistance is now ending, too.

It's not just the COVID-19 relief funds running out, either... Many of the mortgage, rent, credit-card, and personal-loan forbearance programs that went into effect at the height of the pandemic in March have already expired – or are set to expire soon.

One out of four Americans have taken advantage of at least one deferral plan, according to a recent study from financial-services firm Northwestern Mutual... That statistic includes around 4.7 million U.S. households (around 8% of all U.S. homeowners) that signed up for mortgage relief programs through late May, according to the Mortgage Bankers Association.

At the beginning of September, the U.S. Centers for Disease Control and Prevention – based on its authority under the Public Health Service Act – issued a moratorium (with specific criteria) on all rent evictions in the country. But it only lasts through December 31.

Although it's two months away, that day will come eventually... And earlier this year, in the wake of the COVID-19 pandemic, investment-research firm Amherst estimated that 28 million renter households in the U.S. were at risk of eviction.

A lot of folks simply aren't in good enough financial shape to start making payments on their mounting debt obligations again – especially if they don't have a job.

One of the main ways of keeping many Americans employed is wrapping up...

The Paycheck Protection Program ("PPP"), enacted by Congress as part of the COVID-19 relief efforts, funded 5.2 million loans for a total of $525 billion. The PPP provided these forgivable loans to businesses, incentivizing them to keep workers through their coverage period. It's credited with keeping as many as 51 million people working this year.

But the program is now closed to new applications. And since it's winding down, we're likely to see the number of new initial jobless claims stay at historically high levels...

In the week ending October 17, there were 787,000 new jobless claims in the U.S.

That's a big improvement from the 6.9 million new jobless claims in the week ending March 28 – at the height of the pandemic. But it's still a long way from "normal" times...

New weekly jobless claims are three and a half times more than the average of 220,000 leading up to the pandemic. And they remain far above historical levels recorded over the past 50 years. The following chart gives you an idea of what we're talking about...

On the same note, the official unemployment rate has improved from the 14.7% in April... But it remains elevated at 7.9%. The last time we saw an unemployment rate that high was in 2012 – following the last financial crisis. Take a look...

The Fed expects the unemployment rate to stay high – in the 7% to 8% range – for the rest of 2020. And it forecasts unemployment to gradually decline in the years ahead... But it doesn't expect unemployment to fall to pre-pandemic levels of 3.5% to 4.4% until 2023.

Though improving, it's clear that the economic fallout from the pandemic isn't ending anytime soon...

Various restrictions remain in place across most states, limiting businesses from reopening their doors and preventing economic activity from bouncing back... Plus, many folks are still afraid of the spread of COVID-19, so they're wary to go out in public and spend money.

We can see this reluctance to return to normal through the continued lack of business at U.S. restaurants... The number of seated diners was an average of 42% below last year's levels over the past seven days (through yesterday), according to restaurant-reservation firm OpenTable.

It's also evident in airline passenger volumes... They were down 63% in the U.S. and 78% internationally for the week ending October 20, according to industry trade group Airlines for America.

And it's true in movie theaters, too... Only 23% of adults feel comfortable returning to these closed-in venues, according to a recent poll from data-intelligence firm Morning Consult.

At this point, the Fed estimates that U.S. GDP will fall around 4% in 2020... and then recover by around 4% in 2021. That would take the economy back to 2019 levels by the start of 2022.

However, that's an optimistic forecast. It assumes that the pandemic won't worsen to the point where a new round of stay-at-home orders becomes necessary.

Reduced stimulus, continued high rates of unemployment, and a struggling economy mean consumers will cut discretionary spending and stop paying their bills.

When folks stop paying their bills, it will make an already bad situation much worse...

As we've noted in the Digest before, serious delinquencies on auto loans and credit cards were creeping higher in the years leading into this recession... And that was in a strong economy.

The percentage of auto debt delinquent by 90 days or more bottomed near the end of 2014 at around 3%. Since then, serious auto-debt delinquencies have kept pushing higher... As of June 30, the percentage of auto debt delinquent by at least 90 days was roughly 5%.

It's a similar story with credit-card debt... The percentage of delinquencies of at least 90 days bottomed toward the end of 2016 at around 7%. And it has moved higher since then... As of June 30, credit-card debt delinquent by at least 90 days was again approaching 10%.

With COVID-19 aid programs and forbearances set to expire soon, delinquencies will certainly trend higher in the months ahead. It remains to be seen how high they'll go.

Despite the continued optimism in the stock market, we're looking at a tough road ahead...

The driving factors include the COVID-19 recession, high levels of unemployment, and a record $14.3 trillion in household debt. Combine these factors with banks tightening lending across the board, and it's a recipe for a prolonged downturn...

You see, banks create money when they lend. When they stop lending (and as money gets paid back), less money is available in the economy.

Then, it's up to the Fed (through its low interest-rate policies) and U.S. Treasury (with its stimulus programs) to step in and try to inject money into the economy artificially to make up for the lack of bank lending.

The chart above tells us that banks are seeing so much risk today that they don't want to lend – making businesses and consumers across the board more dependent on the Fed and the government policies. It's a vicious circle...

Ultimately, it points toward a constrained economy ahead. And that's really bad news for around half of all Americans who are living paycheck to paycheck...

With free-market lending mechanisms pulling back, and with the Fed and government stimulus as the driver, the plights of these folks will only get worse.

To keep propping things up, the government will need to come up with something big...

Negotiations continue in Congress about a new round of stimulus for everyday Americans.

However, Democrats and Republicans can't agree on anything... And even if they do eventually, the second round of stimulus is expected to be far more modest than the first round.

That likely won't be enough to offset the coming downturn...

Dr. Lacy Hunt, an economist at Hoisington Investment Management, is the smartest guy in the room when it comes to the Fed and U.S. economic policy. During his third-quarter outlook, Hunt said he believes the lift from the stimulus will only last one to two quarters... and worse, all the debt accumulated for the stimulus will restrain growth going forward.

It makes you wonder if a new round of stimulus will become a permanent fixture, every six months or so, as an alternative to negative interest rates on U.S. Treasury bills.

After all, the Fed and Treasury want inflation... And banks are pulling back on lending. So to get inflation, the Fed will have to push interest rates even lower in an effort to stimulate economic activity... And the Treasury will have to provide more stimulus.

But it's a fine line... They must perform a balancing act between helping financially strapped Americans in a debt-saturated economy and hurting the purchasing power of the U.S. dollar.

Eventually, when you make too much of something, it becomes worth less. The U.S. dollar is not immune... It's why gold is up around 30% since mid-March.

Down the line, action from Congress might not even be necessary...

That's because the Fed is working on its own "solution."

A month ago, Cleveland Fed President Loretta Mester gave a speech at the Chicago Payments Symposium titled "Payments and the Pandemic." In it, Mester discussed options that the Fed was working on... to hand out money directly to millions of Americans.

Mester discussed legislation being proposed that would require each American to have an account at the Fed. Then, in an emergency, the Fed could deposit "central bank digital currency" into these accounts. This currency would have the same value as a U.S. dollar but with some potentially big differences...

The Fed money wouldn't be anonymous and may have an expiration date. And the central bank would create end-user digital wallets and bypass the current banking system in the process.

Mester went on to say the Fed has a digital-currency laboratory and has been testing these options out for some time. It appears that Fed Chairman Jerome Powell and the rest of his cohorts are getting prepared to expand the powers of the Fed to provide direct stimulus.

This will give the central bank a greater ability to control – in other words, cause – inflation by getting money directly in folks' hands – which will increase the turnover of the money.

So if that happens, the Fed may finally get the inflation it wants. But then, that leads to a bigger question... How does the Fed contain inflation?

If you think things have been moving fast already, buckle up... They're about to move a lot faster.

However, as we've seen, the Fed will do whatever it takes to keep the party going as long as it can...

Because of that, you can still make a lot of money before it all comes crashing down.

That's why my colleague Dr. Steve Sjuggerud continues to encourage everyone to get in on U.S. stocks right now. He believes it's still one of the best ways to make money today.

While COVID-19 threw a wrench into his "Melt Up" thesis, it's back in a big way as the Fed keeps propping up the markets and a new wave of market gamblers enters the fray...

Many of these gamblers are making a killing as the good times keep rolling. But the thing is, they're also likely to hang on too long and lose a ton of money when things turn south.

That's where Steve can help you to be different from the crowd... He can show you all about the best investments to make right now to take advantage of the Melt Up – and also guide you along the way as you aim to protect your wealth from the inevitable Melt Down.

If you haven't checked out Steve's latest Melt Up event, you should do so immediately... This FREE video replay remains available for a limited time. Get all the details right here.

New 52-week highs (as of 10/26/20): none.

Today's mailbag includes a note of "gratitude" for Ten Stock Trader editor Greg Diamond. After reading it, you might be interested in learning more about Greg's work – which you can do on our website right here. Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Greg, I just wanted to take a moment to express my gratitude to you for enabling my wife and me to benefit from your expertise. Several years ago, I retired from the Army without any real financial knowledge other than having developed the ability to live off a budget and put a little money away in a mutual fund account. I had no knowledge or skill of actual investing and/or trading.

"When I came across Stansberry Research about a year ago, I wasn't really sure I should spend money on such a product without knowing any of the 'real' details or people involved. Ultimately, my wife and I made the leap to become an Alliance member... and I am so glad we did!

"Through our Alliance membership, I stumbled across your newsletter. In all transparency, I do not fully understand or appreciate the technical side of trading, but I know we have benefitted from your recommendations and I am trying to learn as much as possible. 'AMD' and the 'VXX' trades are but just two examples of your impact upon our finances.

"I guess I am just a 'sponge' trying to soak up as much as I am able so I can then pass that knowledge onto my children, helping them beyond anything I received growing up. As I read your posts, I see the dedication, time, effort, energy, and family sacrifice you put into helping people like me achieve more with their money. You clearly go way above anything required to mentor and support your readers.

"While my wife and I may never become financially rich, you (and your Stansberry colleagues) have made us rich beyond our imagination or expectations. Thank you for what you do for us, the passion for your trade, and the tenacity you demonstrate to us all. You clearly set an example worth emulating." – Stansberry Alliance member Alex H.

Regards,

Bill McGilton
Kyiv, Ukraine
October 27, 2020