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U.S. stock market indexes trade above pre-pandemic levels even though the economy is about 3% smaller and nearly 13 million Americans are out of work (7 million more than pre-pandemic). Weekly unemployment claims continue at around 750,000 compared with approximately 220,000 pre-pandemic.
We are now grappling with a health crisis, an economic crisis and a racial equality crisis, which weren’t in evidence a year ago.
Many sectors of the economy are a long way from being back to normal including restaurants, movie theaters, commercial real estate, live entertainment, sports, education, cruise, vacation, leisure and business travel. Some of these areas may never return to normal. For example, a recent study estimates that more than one-third of business travel probably will never return.
Small businesses have been crushed. As of September 2020, about 100,000 small businesses have permanently closed, according to Fortune. About 20% of all small business owners don’t believe they will survive until year-end. Keep in mind that small businesses are the backbone of this country.
Kastle Systems data shows that only around 25% of all office workers have returned to their offices. This has significant implications for the health and vibrancy of large American cities. Even if the majority of office workers return to their city center offices, many businesses that depended upon office worker traffic, will fail. Most are not structured to survive on 60% or 70% of pre-pandemic revenues.
The National Women’s Law Center reports that 2.2 million women left the workforce between February and October, many presumably to care for their children.
Heavy Thanksgiving travel has caused epidemiologists to predict a surge in COVID-19 infections.
Given these facts, it is puzzling to many why U.S. equity markets continue to set record highs. Following are some thoughts on why this is happening.
Why is The Stock Market so High?
Many believe “there is no alternative” (TINA) to stocks – it is the only game in town. The Fed continues to subsidize speculation in the equity markets via low interest rates. With interest rates close to zero, many investors feel that fixed income investments don’t make sense.
2. No country looks better to invest in during times of crisis
Another boost to U.S. equity markets comes from the feeling that in times of crisis, the safest place to invest is the good ol’e United States. It is still probably true that when the U.S. gets sick the world gets a cold. The corollary to this is also probably still true: the U.S. won’t necessarily remain ill if the world is sick.
3. The stock market discounts the future
The stock market is a leading indicator. That means it is looking roughly six months ahead and valuing companies based upon what they are likely to earn then. What it appears to see is a bright future. Theoretically, much brighter than pre-pandemic levels.
4. Many more traders (buyers)
The advent of the brokerage firm Robinhood and the creation of fractional shares may have induced as many as 13 million additional retail participants into U.S. equity markets. Most of these individuals appear to be traders rather than buy-and-hold investors.
It certainly is time to jump on the equity markets bandwagon, especially for small investors. They tend to pile into equities when markets are setting record highs because of the fear of missing out (FOMO).
I can’t recall a more compelling stock market FOMO time during the last decade.
6. Discounting a Goldilocks future
The market’s resilience when bad news comes out is very strong right now, leading observers to believe that participants have a strong conviction that the future is going to be much better than the present.
With the prospect of divided government in Washington, the rollout of a number of vaccines, the eventual end to winter and the dawning of warmer weather and pent-up demand for almost everything, six months down the road looks very appealing.
Why The Stock Market May Crash
As the unemployment, economic and COVID-19 statistics show, we aren’t out of the woods yet.
1. Inflation from all the stimulus
With maximum (or close to maximum) stimulus around the world, isn’t it just a matter of time before inflation returns? Also, embracing Modern Monetary Theory (MMT) may prove to be more inflationary than anyone believes.
2. Vaccine rollout problems
How can there not be unanticipated glitches? Billions need to be vaccinated as soon as possible. Non-healthcare people think the vaccination rollout means the end of the virus. Healthcare workers know better.
And news that hackers sponsored by unfriendly governments are targeting the vaccine distribution process is worrisome.
The pandemic may last longer than most think.
Remember when China was the markets greatest concern? As we gain control over the pandemic and the economy recovers, friction with China may again threaten market gains.
4. The Fed
The Fed has rarely pulled the right levers at the right time for a sustained period of time. Typically, the Fed stays with a policy too long eventually creating unpleasant unintended consequences. Can it continue to remain lucky?
In addition, a change in Fed policy at what appears to be an appropriate moment but turns out to be the wrong time could be a buzz killer for U.S. equity markets. Inflation above acceptable levels could force the Fed to act sooner than it wishes.
5. A double-dip recession
The facts right now are not very encouraging (see the initial paragraphs). It isn’t hard to visualize another period of shut-downs for the U.S. economy.
Keep in mind that enhanced unemployment benefits are set to expire at the end of the year as well as the moratorium against evictions and utility disconnections.
To help understand what might be happening, consider how many of us have children learning virtually right now. In my school district we oscillate between in-person and virtual learning. This back-and-forth struggle we are fighting with the virus in my district is probably representative of what is happening in the overall economy.
6. Way overbought and not broad-based
Much has been made of the fact that a few tech companies have boosted the stock market to record levels. It is true that the rally from March lows has not been the result of a broad-based rise in the value of most shares. Will the rally in tech shares end? Will a rollover from tech to value happen? Are markets priced for perfection and therefore priced for failure?
The U.S. stock market is expensive. Market data show that the P/E CAPE of the S&P is over 31 (15 – 17 is average). So there either has to be a significant fall in the prices of stocks (the “P” in the equation) or a massive increase in earnings (the “E”) for the P/E ratio to return to normal. Reversion to the mean will happen. The question is when.
We have lived through an interesting 2020. It appears that 2021 may be just as challenging.
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton is an award-winning 401(k) investment adviser with over 30 years of experience. He has consulted with many Fortune 500 companies, including: Aon Hewitt, Apple, AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Corporation, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or email@example.com.
Lawton Retirement Plan Consultants, LLC (LRPC) is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to employer retirement plan sponsors. The firm specializes in Socially Responsible Investment (SRI) strategies for retirement plans and is a pioneer in the field. LRPC currently has contracts in place to provide consulting services on nearly a half billion dollars in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or firstname.lastname@example.org or visit the firm’s website at https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
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