One of the few really bright spots in the economy is the stock market. Since the crash earlier this year, it’s trended upward, and more recently has been making new highs regularly. This is great news for governments, which will enjoy increased tax revenues, and also for many investors, who will reap additional income.
All of the major indexes - the Dow Jones Industrials, S&P 500, and the NASDAQ Composite - made new highs in November. And each of these also gained sixty percent or more from their lows in April.
Why are investors so exuberant? After all, the virus is raging across the country, entire industries are on the ropes, many businesses remain closed, and millions of people are quarantined or are restricting their activities.
Following are the views of respected market observers about why stocks have been so frothy and also some reasons why going forward investors should be aware of risks. Hopefully, these insights will give readers a better understanding of the developments unfolding on Wall Street and in the economy.
According to Stephen Moore, a former Senior Economic Advisor to President Trump, there are several explanations for the big rally.
“The economy is in the midst of one of the greatest economic recoveries in history,” he said. “The unemployment rate is declining and 20 states essentially are already back to normal. Also, we’ve seen really strong gains in housing and construction, and manufacturing has bounced back sharply.
“Add to this the vaccines, which are scheduled to become available any day and which will be a game changer with respect to COVID. Hopefully by early next year the economy will bounce back to where it was before the pandemic and that would be a wonderful thing. President Trump’s Operation Warp Speed has accelerated vaccine development and will have brought it to the public in less than one year.” New vaccines usually take five years until they get to the marketplace.
Moore added that treatments for people who come down with the virus also have improved vastly; their chances of recovering have increased significantly and the recovery period has decreased. President Trump, for example, became sick with COVID in early October but recovered quickly and was back on the campaign trail just several days later.
A Solid Pick
There are still other explanations for the huge rally. One of these can be attributed to Janet Yellen’s selection as the new Treasury Secretary.
Yellen has played an important role in shaping US economic policy for many years. She served as Chair of the Federal Reserve from 2014 until 2018 and as Vice Chair from 2010 until 2014. During her term at the Fed, the economy grew steadily, had very low inflation, and the stock market boomed, so Wall Street is very comfortable with her selection. Even Moore, a Republican, acknowledges that Yellen is a solid pick for Treasury Secretary. Apparently, Wall Street remains very confident in Yellen’s abilities.
These points help explain the rally on Wall Street. But will stocks remain strong? A report by Bloomberg concludes that they will, and specifies low interest rates as one of the reasons why. “While stocks are expensive, they actually look cheap when you compare them with US Treasuries, with the 10-year now yielding close to 1%. When discounting future profits back at such low interest rates, equity valuations get a significant boost.”
The Bloomberg report also cites the massive “stimulus policies from the Fed that have driven the money supply sharply higher. Some of that money has been invested in the stock market and historically money supply growth and stock prices have moved in tandem. So, while the underlying economy is weak…don’t be surprised if stocks continue to hit record highs.”
Bears, Too, Have Their Say
Knowledge Leaders Capital, an advisory that analyzes highly innovative companies that generate excess returns in the stock market, came to this conclusion. “There could not be a greater bullish cocktail of recent news, with three COVID vaccines showing strong promise against a backdrop of zero interest rates, a record fiscal deficit and an uber-dove - Janet Yellen - in charge of it all.” These factors have led to “extreme euphoria, the likes of which surpass even that of the dot-com bubble.”
At the same time, “The November rally was clearly a short-covering rally. The most shorted stocks were up 28.48% since November 2, while the S&P 500 is up about 11.1%.”
Investors love sharp rallies, but at some point, these can be too much of a good thing.
As of late November. call volumes were four times the normal levels. “Call buying now represents about 40% of NYSE total volume. This is the highest reading in history.”
At the same time, the put/call ratio (the number of put options traded divided by the number of call options traded) is at multi-year lows, which suggests too much enthusiasm for stocks.
Another indication of this: 92.5% of S&P 500 stocks are now trading above their 200-day moving average. According to Knowledge Leaders, this points to “extreme euphoria, the likes of which surpass even that of the dot-com bubble.” And by some market measures the euphoria exceeds that of 1929.
Investors may remember that in the past, periods when the market was “irrationally exuberant,” were sometimes followed by very intense and painful bear markets.
No one can say for certain what trends lie ahead on The Street, but savvy investors should prepare for all possibilities. Like they say, you never know.
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