- The S&P 500 is now back to the level it was at the start of the year.
- Investors are looking past record virus numbers and are focusing on a potential vaccine.
- The Fed has helped to inflate the market bubble, but it might not last.
The S&P 500 just turned positive for 2020, despite record numbers in virus cases over the weekend.
COVID remains a huge problem w/cases, hospitalizations, and fatalities all climbing. The market continues to absorb all this information relatively well and this seems to be a function of vaccine hopes, lower fatality rates vs. Mar/April, the avoidance of wholesale lockdowns, and the lack of a resurgence in the Northeast (esp. NYC).
What Is Driving The S&P 500 Rally?
Hopes that a vaccine will soon be available is a reliable driver of the market rally. Pfizer (NYSE:PFE) and German biotech BioNTech SE (NASDAQ:BNTX) have obtained “fast track” designation from the FDA for two of the companies’ four vaccine candidates.
If ongoing studies are successful and the vaccine candidate receives regulatory approval, companies plan to deliver up to 100 million doses by the end of 2020 and potentially more than 1.2 billion doses by the end of 2021.
The S&P 500 is also rallying on hopes of a V-shaped recovery. In May and June, nonfarm payrolls recorded substantial gains. Other economic indicators, such as PMI and retail sales, also indicated a sharp recovery.
Corporate profits are expected to fall by 44% in the second quarter, which would be the most significant drop in quarterly earnings since the fourth quarter of 2008. The market could ignore the sharp decline in profits as long as companies signal recovery on the horizon.
The U.S. central bank has pledged unlimited purchases of financial assets to maintain market liquidity, increasing its balance sheet from $4.2 trillion in February to $7 trillion today.
While the vast majority of these purchases were limited to U.S. Treasuries and mortgage-backed securities, the Fed’s commitment to supporting the corporate bond market was enough to spark a frenzy among investors for bonds and stocks.
COVID-19 is now inversely related to the markets. The worse that COVID-19 gets, the better the markets do because the Fed will bring in stimulus. That is what has been driving markets.
Interest rates near zero and support for credit to large swaths of corporate America have drawn yield-hungry investors back to the stock market.
The Stock Market Bubble Could Pop Soon
Since its March 23 low, the S&P 500 has risen by about 45%.
According to a Bank of America survey released in June, 78% of fund managers think equities are overvalued. The S&P 500 forward price-to-earnings ratio is currently 21.5, a level last seen during the dot-com bubble 20 years ago.
Fed President Jerome Powell warned that the economic recovery would take a long time. The International Monetary Fund (IMF) has also issued a warning about the disconnect between asset prices and the economy.
Markets are caught in the middle. We have argued for months that a full recovery depends on three pillars, namely, sustained progress against the virus, the continuance of super-accommodative Fed policy, and consistent support from fiscal policy. Clearly, the first pillar has crumbled, and the third is now in limbo, with the Senate in recess until July 20. The Fed can’t do everything, so we’re not surprised that the S&P 500 has been range-bound since late May.
A. Gary Shilling, economist and president of A. Gary Shilling & Co., warned the stock market could fall by 40% over the next year:
Stocks are [behaving] very much like that rebound in 1929 where there is absolute conviction that the virus will be under control and that massive monetary and fiscal stimuli will reinvigorate the economy.
Although many economists expect a V-shaped recovery in the second half of the year, Shilling is much more skeptical:
This pandemic is likely to be the most disruptive financial and social event since World War II with equally long-lasting consequences. Many will no doubt restrain spending in future years to rebuild savings, especially since the crisis caught them at a time of high debts and short financial reserves.
At this stage, a crash before year-end seems highly likely.
Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com. Unless otherwise noted, the author has no position in any of the stocks mentioned.