Is a new stock-market bubble being formed right now?
My answer to that question is YES! All we know right now is there are huge unknowns in the economy and the path ahead is widely uncertain, making any prognostic is quite dicey.
However, is pretty clear is that the economy is experiencing
an epic collapse of economic activity that has set in motion problems that will
play out over many years.
We are in the most severe recession in a century and we will
experience a halting recovery with a potential second wave of the virus
coming up.
So, is the stock market going nuts? Allow me to pinpoint some facts that shore up my sentiments that the market has entered a Bubble.
1. Index Consumer Sentiment
The consumer index is a well-know indicator that measures
how optimistic consumers feel about their finances and the state of the
economy.
If the consumer has confidence in the near future and his finance,
then the consumer will spend more than save. When consumer confidence is high,
consumers make more purchases. When confidence is low, consumers tend to save
more and spend less, setting aside money for rainy days.
In the U.S, consumer spending accounts for incredibly 70% of
the GDP. Consumer spending usually drives growth during economic
recoveries.
Consumers create demand in the market and producers produce goods and services accordingly.
2. The Industries being hit hard by the Covid-19
There are some industries being devasted by the virus. The most
exposed are: Restaurants and Food Services, Airlines, Hotels, Movie Theaters, Live
Sports, Oil and Gas, Automakers, Gyms, and Entertainment.
Altogether, they represent a big chunk of the GDP. The 2008 financial crisis showed how interconnected is the globalized economy, and the struggles in
those industries could have a devastating impact on the overall economy. The economy is this enormous machine in which
one person’s consumption spending generates someone else’s income.
Business Capital, State and Local budgets are suffering cuts
and are likely to weigh on growth for some time. A hotel, for instance, isn’t
going to invest in new furniture or reservation software right now.
After months of staying at home, we are seeing some resurgence
on the travel industry. Some in the industry say the recovery is already underway.
Some destinations, like Florida and national parks, are seeing a significant rise in demand.
However, this is just the beginning and it is clearly not
enough to bring back this business to the game. Generally, a flight or hotel
needs to be about three-fourths full to turn a profit.
3. Stocks buyback
Companies hit the pause button on share buybacks. Companies
in the SP&500 stock index spent more than $2 trillion buying back their own
stock over the last three years. Buy-back is a corporate action in which the company buys back its share from existing shareholders usually at a price higher
than the market price, which in turn putting pressure on the share price.
Buyback might shrink for the foreseeable future because companies
would rather save their cash and do not want to be singled out for criticism by
politicians.
As you can see in the graph below, the correlation tells a
strong relationship between two variables and the buyback programs have contributed
to the market’s advance over those years. The S&P500 bounced back to early
march levels without buyback programs pushing the prices up.
In addition, many companies have been funding their buybacks
though debt on the back of low-interest rates and easy access to the credit market.
Rising debt issuance amid a recessionary environment could eventually lead to high defaults and prolonged declines of corporate credit.
4. Employment
Is the stock-market a forward-looking indicator? Investors expect that employment will bounce back as the economy reopens
The forward-looking nature of the stock market is one of the reasons why stocks have surged in recent months, even as the economy has collapsed.
While jobless claim spiked in April and May, some investor
expects the employment will bounce back later this year as the economy starts to
reopen.
Most investors are pinning their hopes on positive
developments toward a COVID-19 vaccine, which would speed up the economic recovery,
and health care news right now could be more important the economic data and earning.
And that could be the case for a while because this is a pandemic that will
end as we feel comfortable going back out into the public.
The market tends to benefit from signs the economy will
improve even if it’s not happening right away.
And that was what causes the surge in the stocks after the
latest job data were released, even though knowing that the majority of jobs
added was heavily buffered by the government stimulus and tens of millions are
still out of work.
5. Aggressive stimulus from the FED and Congress.
The government has tried to keep the demand for goods and
services at the pre-crisis level. And the federal government’s relief program and stimulus
from governments and central banks in Europe and Asia have given the economy a
boost.
It remains to be seen how far the Central Banks will be
comfortable in baling out industries that take on debt to engage in buyback
programs instead of making long term investments in their companies and their
workers, those same companies are now are in desperate need of government help.
6. A Second Wave
There is a huge real risk of a second coronavirus wave as the
virus is still presenting among us. Extreme social distancing has helped so
far, but the moment we start mixing again, that is a great chance that the
transmission will restart.
If we go back and take a look at some history’s worst pandemic, we will see a clear common trend among them. Pandemics always have occurred in waves.
1918 – Spanish Flu
The Spanish flu was an influenza pandemic that spread around the world between 1918 and 1919, It ultimately caused at least 50 million deaths worldwide with about 675,000 deaths happening in the U.S.
Asian Flu
The "Asian Flu" began in East Asia in 1957. Of the
1.1 million people who died of the Asian flu worldwide, 116,000 of them were in
the United States.
Swine Flu
The "swine flu" occurred in 2009, the virus was actually first detected in the US, and spread quickly across the US and the world. The CDC estimates 575,400 people died worldwide
It is clear that markets have not accurately priced in the risk
of a second wave at the same time they are only slowly starting to realize the huge
economic consequences of the pandemic.
In general, the market ever quite accurately price risks,
the market tends to swing from being very risk-averse and thinking at the end of
the world to be wildly optimistic, and markets are at the optimistic stage right now.
A coronavirus second wave is not a matter of if but when. If I were you, I would get ready for the second wave of economic pain, thus, a market crash.
7. United States presidential election
Does the market get influenced by a presidential election? There
have been 22 elections since the S&P 500 index began. In these elections years: 18 of 22 years, or 82%, provided positive performance.
Another interesting fact is that an above-average annual
return in the S&P 500 index may indicate that a Republican is more likely
to be elected president.
History shows the market has a tendency to trade higher
during presidential election years, the volatility of monthly returns tends to
rise sharply in July and August.
Given the nature of this year, this could lead the markets above
historical levels even while the economy collapses.
No doubt that a year from now we will see if the market is accurately priced.
8. USA Global Trade Policy
Economic and political tensions the U.S and China also remain high, establishments of new tariffs could further complicate the recovery for large corporations as well as the global economy.
Such tensions should re-emerge on the debates from presidential elections in November.
The trade war has an immense negative impact on American
exports because tariffs increase the prices for specific exported goods making
them undesirable or difficult to sell in foreign nations. As prices for American
goods increase, companies’ profits begin to decrease.
New tariffs would complicate the future of small business
as the cost of business would swell as American supply chains are heavily
reliant on Chinese manufacturers
The global economy is much less apt today to absorb new tariffs and that could lay even more pressure on the already disrupted economy.
The tough question is: what would new tariffs do to the stock market?
In conclusion, the path is pretty dubious. However, the stock market is clearly overvalued in a bullish mode and is not taken into consideration a lot of big ifs.
The stock market is looking ahead to a rosy outcome that is too far away to happen.
Don't forget to share this post!
Comments
Post a Comment