Up, Up and Away: Stocks Defy Gravity

I was watching the 1939 classic The Wizard of Oz with my twin toddler grandsons over the Christmas holiday and the scene with the gas balloon made me think of the stock market rally. (It’s an occupational hazard; I see financial metaphors everywhere.)

A gas balloon rises because it has buoyancy. Buoyancy is the upward force that is exerted on the trapped gas (e.g., helium or hydrogen) that’s lighter than the surrounding air. If buoyancy is greater than the force of gravity, the balloon will rise.

Pandemic-caused economic damage can be viewed as gravity, exerting downward pressure on the stock market. However, certain forces are currently strong enough to offset this pressure and keep stocks buoyant. Let’s examine how long investors can continue defying gravity.

The major stock market indices soared Monday after President Donald Trump’s belated signing of a long-awaited $2.3 trillion omnibus spending bill that contains more than $900 billion in pandemic relief. Stimulus measures in the bill underscore investor optimism about economic recovery.

On Monday, the Dow Jones Industrial Average rose 204.10 points (+0.68%), to reach a new high. The S&P 500 climbed 32.30 points (+0.87%) and the tech-oriented NASDAQ jumped 94.69 points (+0.74%). All 11 S&P sectors closed higher, with financial and energy stocks leading the charge.

In pre-market futures trading Tuesday, the three major U.S. stock market indices were poised to extend their gains and open higher.

In an abrupt 180-degree reversal Sunday night, Trump retreated from his threat to block the hard-fought spending bill, restoring unemployment benefits to millions of Americans and averting a federal government shutdown. To make up for Trump’s delay, the U.S. Treasury Department is rushing to send one-time stimulus payments to millions of Americans by the end of this week.

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Under the COVID relief portion of the omnibus bill, individual adults with adjusted gross income on their 2019 tax returns of up to $75,000 a year would receive a $600 payment, and heads of households making up to $112,500 and a couple (or someone whose spouse died in 2020) earning up to $150,000 a year would get twice that amount. If they have dependent children, they would also get $600 for each child.

Legislative haggling and symbolic votes for bigger checks of $2,000 are continuing this holiday-shortened week in Congress, but the political posturing is likely to go nowhere.

Will stocks fall to earth?

In the meantime, the stock market keeps going up, up and away. In the U.S., the coronavirus has killed more than 300,000 people, thrown millions out of work, and closed businesses from coast-to-coast. And yet, Wall Street has been euphoric.

The S&P 500 index is up about 15% year to date, with valuations nearing levels last seen in the run-up to the dot-com bust of 2000. In another parallel with that frothy year, initial public offerings (IPOs) are enjoying their busiest year in two decades, even though many of the newly public companies aren’t turning profits. According to data from Dealogic, more than 447 new share offerings worth in excess of $165 billion have been raised so far in 2020.

Much of the upward impetus has come from an influx of new and inexperienced individual investors and therein lays risk. Many of these investors are newbies engaged in day trading to stave off the boredom of quarantine. They’ve been making dubious bets on “story stocks” and hot IPOs. If these stocks stumble, the neophytes could run for the exits, accelerating a broader market sell-off.

Regardless, there’s considerable justification for continued bullishness. Notably, the Trump drama ends on January 20. That doesn’t mean Wall Street is enamored of Democrats; it simply means that the financial community is eager to see less political turmoil.

Arguably, the head of the Federal Reserve is more important to Wall Street than the occupant of the White House. In Fed Chair Jerome Powell, investors have a steadfast friend. Powell has vowed to do whatever it takes to nurture the economy and shore up the markets. As long as interest rates remain at rock bottom levels, the bull run will have plenty of fuel.

Another major source of investor optimism is a projected return to healthy earnings and revenue growth. Fueling the stock market’s buoyancy are steadily improving forecasts for 2021 earnings and revenue, which analysts have raised in 10 consecutive weeks. According to research firm FactSet, the S&P 500 is projected to witness robust rebounds next year on the top and bottom lines (see chart).

To be sure, the coronavirus pandemic isn’t behind us. However, the distribution of new vaccines tells us that the end of the COVID nightmare is at hand.

In another sign that investors expect faster economic growth in 2021, small-cap stocks have been outpacing the broader market.

The post-election rally has recently gained breadth, with small-cap stocks in the vanguard. I see a secular bull market taking shape in 2021, as investors push their cash stockpiles into risk-on assets, especially small caps.

The Russell 2000 index is up nearly 20% year to date, a clear indication that stocks will continue to enjoy gravity-defying buoyancy in the new year.

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John Persinos is the editorial director of Investing Daily. You can reach him at: mailbag@investingdaily.com. To subscribe to John’s video channel, follow this link.