Sometimes, despite economic and political uncertainty, markets defy gravity. This happened recently, with stocks erasing the losses the indexes incurred during the March panic. The Nasdaq didn't just recover; it reached an all-time high on June 9, 2020.
The sentiment among economists, analysts, and significant investment figures is a mixture of bafflement and ridicule. Some point out that “the stock market is not the economy.” So, was the drop in stocks during the first quarter just a pause after a long period of expansion? Or was it something more?
- The drop in the market happened after the longest bull market in U.S. history. It began in 2009, right after the financial crisis. During this period, we saw a record low unemployment rate and rising buybacks among corporations. However, these two trends rapidly reversed after the coronavirus spread across the globe.
- In March, a global selloff, combined with many countries shutting their borders due to COVID-19, caused some worrying economic data.
- On April, 20 million Americans lost their jobs in one of the worst months since the Great Depression.
- Social unrest broke out across all 50 states following the death of George Floyd. This further disrupted the economy. Add further fears of a second wave of coronavirus as states reopen and questions about whether consumption and employment will return to normal, and investors have plenty to be worried about.
Why Markets Go Higher
With the pain of the March crash still fresh, few considered the idea of markets heading higher. Most expected economic damage to be similar to what happened 12 years ago.
However, the markets are forward-looking. Investors value what is going to happen more than what is currently happening. The extent of the damage caused by the coronavirus surprised investors. Still, they eventually digested the news, priced it in, and began to look forward to the recovery of the economy. Low commissions stock brokers such as E*TRADE and Ally Invest became very popular.
This would explain the divergence between the economy and the stock market.
- Investors look at the next step of the recovery before we have finished with the current one. This is quite common. A lot of the day-to-day movement in the market is determined by computers and investors who are trained to look ahead.
- Besides, the Federal Reserve steadfastly maintains its mandate of price stability in the markets, and thanks to its apolitical stance, it has been able to support markets unencumbered by the current political situation.
- Many believe that more bad economic data will simply prompt the Federal Reserve and government to inject more money into the markets. This creates a “bad news is good news” mentality. This is what happened in the years after 2008, when the Federal Reserve enacted its long-term quantitative easing plans.
- One reason that investors are looking ahead is that the economic damage has a very clear endpoint: a vaccine. Once a vaccine becomes viable, the source of much of the damage done will be neutralized. With so many companies rushing to create the vaccine, it is a question of when, not if.
March 2020 had 8 of the 15 largest single-day drops in history, so it isn't surprising that pessimism has been rampant. Old-timers like Warren Buffett sat out this move and remained cautious as to what the market may do next. Many market veterans see this as a classic bear-market rally duping less-experienced investors into giving away their hard-earned cash.
For those who are unfamiliar, a bear-market rally is a phenomenon that has been observed in every bear market since the 20th century. It occurs during a downtrend when the market temporarily rallies higher by 5% or more. This rally can last days, weeks, or longer. Most famously, a three-month bear-market rally occurred in 1929 before the market completely collapsed.
- The concentrated stimulus efforts of both the Federal Reserve and the U.S. government have ended up creating a huge boon for investors. Both have acted in unison, faster, and with much bigger packages than during the financial crisis in 2008. The Fed alone pumped in trillions of dollars within weeks. And the government applied the radical approach of sending stimulus checks across the United States.
- Additionally, the government made its stance clear that the most hurt industries, such as airlines and hospitality, would receive special guaranteed loans to stave off any fears of bankruptcy.
- Following this, Jerome Powell also made it clear that the Federal Reserve is willing to do whatever is necessary to maintain confidence in the markets. This is a strong statement from the most powerful central bank in the world.
These dramatic and efficient moves are assuring the market that a domino effect will not occur this time. This contrasts with the significant fear for the financial sector's safety after the Lehman Brothers collapse in 2008.
What's an Investor to Do?
The most important thing to remember during these times is that no one can predict the future. And no one can time the markets. It's crucial to have a long-term plan and stick to it. It could be that current investors buying into the stock market are wrong. Or maybe they are right. It's impossible to know.
There will most likely be more volatility in the days ahead, thanks to mass uncertainty. Investors can shield themselves by keeping their portfolios diversified with a mix of stocks and bonds, or by simple dollar-cost averaging and consistently investing whether markets go up or down. The help of experienced financial advisors can help you make difficult investing decisions. Paladin Registry is an excellent way to find 5-star financial advisors.
If the markets rally, remember that plenty could go wrong. If markets enter a bear market, remember that every downturn has an endpoint.