Wall Street to the Pandemic: “What, Me Worry?”
The stock market’s surge, despite the worsening pandemic, reminds me of the catchphrase of Alfred E. Neuman, the gap-toothed mascot of Mad magazine: “What, me worry?”
Today I’ll shed light on this disconnect and explain why a day of reckoning is around the corner. I’ll also steer you toward smart plays now that can simultaneously protect your portfolio and help you build wealth.
It’s probably the most frequent question that I receive from readers: What accounts for the stock market rally, despite the economic and personal suffering caused by the coronavirus pandemic?
Monetary stimulus is a key factor behind the market’s upward trajectory. The Federal Reserve is pumping trillions of dollars into the financial markets, with a pledge to do what it takes to keep equities afloat.
What’s more, the stock market is heavily weighted to a handful of companies that are positioned to become even more dominant than they were before the crisis. Their stock prices have been rising in anticipation of that bright, shining post-COVID future.
TINA (There Is No Alternative) also plays a factor. With bond yields at record lows, investors don’t have appealing alternatives to stocks as places to put their money.
Socioeconomics plays a role as well. The wealthiest Americans own stocks and their livelihoods are best-equipped to weather quarantines. Even including 401k’s and Individual Retirement Accounts, only 55% of Americans are investors in the stock market, according to recent studies.
It’s also important to remember that the sector of the economy the worst affected by the pandemic, small businesses, are not represented in the main stock market benchmarks such as the Dow Jones Industrial Average or the S&P 500. These indices track global behemoths, not small employers.
But what about corporate earnings? Aren’t they projected to be negative for the rest of 2020? It’s true, stock prices are based on expectations for future earnings and this year will prove terrible for profits. But investors are looking toward next year, when corporate report cards are expected to improve.
Hence the disconnect between Wall Street and Main Street. In a minute, I’ll explain why the bubble can’t last and what you should do about it.
The rally continues…
Stocks last week closed mostly higher for the third week in a row on coronavirus vaccine hopes and positive economic reports. The tech-heavy NASDAQ, which has been on a tear, took a breather.
The Commerce Department last week reported that retail sales rose 7.5% in June after jumping 18.2% in May. The consensus of economists had forecast retail sales climbing 5% in June. Consumers started visiting stores again, as states reopened their economies.
In further good news, the Federal Reserve reported last week that industrial production rose 5.4% last month, the second consecutive monthly gain after a 1.4% rise in May. Last month’s production number was the biggest monthly gain since 1959 and represented another surprise on the upside. However, despite the increases in May and June, industrial production dropped at a 42.6% annual rate in the second quarter. The fact is, a crisis is brewing, with no sign of a remedy.
Enhanced unemployment benefits run out at the end of July and Congress is gridlocked on whether to extend them. Expectations of an imminent vaccine are (in my view) a pipe dream. And coronavirus cases are surging by alarming levels, prompting states to roll-back re-openings.
In the meantime, though, investors over the past week preferred to accentuate the positive (see chart).
Volatility is likely to continue in coming months, as the pandemic rages and the presidential election heats up. As a buffer against rapid changes in sector leadership, make sure your portfolio is properly diversified.
The road back to pre-pandemic levels of consumer spending and economic output is likely to be protracted, with stock market dips along the way. Don’t bet on a “V-shaped” recovery. According to the non-partisan Congressional Budget Office, it will take nearly a decade before the economy recovers completely from the COVID-19 outbreak.
According to data from Johns Hopkins, last week the U.S. hit a new high in the number of new coronavirus cases (72,045 reported), with the seven-day average up 20% from the previous week. The worst outbreaks are occurring in the South and Southwest, triggering returns to lockdowns.
Keep in mind, the data from June is backward looking and doesn’t account for the resurgence of coronavirus in July. Economic data indicate that consumers are indeed spending again but continue to avoid industries the worst affected by the virus, such as restaurants, travel and hospitality.
Technology and services sectors are benefiting the most from recent consumer trends shaped by the persistent pandemic, as quarantined people increasingly shop online, stream their entertainment and news, and embrace Internet services to stay connected socially and professionally. That’s good news for certain tech companies, especially those involved in the roll-out of innovative wireless capabilities.
Another positive trend is the greater breadth of the rally, as small-cap stocks pick up the pace. Historically during recoveries, small-cap companies have outperformed their large-cap brethren. Since the March 23 low in stocks, the Russell 2000 has outperformed the S&P 500, returning 42.8% compared to the S&P 500’s gain of 39.9%.
Furthermore, small companies tend to be “disrupters” that operate in new markets where competition is initially low. They consequently enjoy the ability to raise prices easier than large caps, which paves the way for high profit margins.
It’s a truism that small companies form the heart of the country’s job creation. They also generate breakthrough technologies that provide multi-year momentum for their share prices.
And yet, beneath the stock market rally, if you listen carefully, you can hear the ticking of an economic time bomb.
The coronavirus is killing exponentially greater numbers of people, the unemployment rate remains staggeringly high, millions of workers will soon run out of expanded unemployment benefits, and schools face a highly uncertain path to reopening in the autumn.
Anxious parents around the country face the likelihood of home schooling, without childcare assistance. This household stress is sure to dampen consumer confidence and spending.
Roughly 70% of U.S. gross domestic product is comprised of consumer spending. The nation’s unemployment rate is currently 11.1%, an increase of 7.6 percentage points from February and still higher than any level it had reached from 1948 through March 2020. Investor wealth is increasingly concentrated at the top but even the wealthiest multinational blue-chips can’t thrive when a high percentage of consumers are unemployed and too broke to buy anything.
The woes of Main Street will eventually make their way to Wall Street. The market crash of 1929 is a prime warning from history, when the struggles of farmers and consumers finally brought the rally of the Roaring Twenties to a halt.
By temperament I’d rather be on the bullish bandwagon, but my job is to deal in the facts and not deception. Hope is not a wise investment strategy. You should stay invested, but with your eyes open. Further sell-offs are probably on the way.
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The great disconnect between Wall Street and Main Street will eventually hurt investors, but only those who are complacent and unprepared.
John Persinos is the editorial director of Investing Daily. Send your comments and questions to email@example.com