Airline stocks have soared as they became individual-investor favorites, even as traffic remained light at airports including New Jersey’s Newark Liberty Airport.
Photo: Angus Mordant/Bloomberg News
From a high enough vantage point, this year’s move from boom to bust to boom looks much like a normal market response to an outside shock, only far faster. But examine it more closely and it becomes clear that the winners and losers have been twisted by the extraordinary power of money from central banks and governments.
Working through the super-quick bull market that will, all going well, mark its third month on Tuesday helps create a framework for thinking about how these powerful forces will develop. One conclusion: The most likely place for a bubble isn’t the beaten-up stocks day traders are punting on, but the big safe companies that have decent earnings even when economic growth is weak.
The S&P 500’s behavior has been “incredibly similar” to the average bear market caused by an outside event such as a war over the past two centuries, says Peter Oppenheimer, Goldman Sachs’s chief global equity strategist. In his new book, “The Long Good Buy,” he says the average event-driven bear market is shorter and has a smaller fall than bears triggered by ordinary economic cycles or structural declines, and has a faster recovery. Still, no other bear market has rebounded back into a bull market in only three days, which is all the S&P took to rise 20% from its March 23 intraday low.
“The thing that really differentiates [this cycle] is the policy response, which has been unprecedented,” he said.
Look under the surface of the bull run and the influences of stimulus from the Federal Reserve and the government becomes clear.
After an initial bounce in everything, investors concluded that we were having a repeat of the past decade. Easy money justified higher valuations, but only for stocks that could cope with a weak economy. Investors went for safety and growth, with producers of staples such as tobacco, canned goods and fizzy drinks beating the market in the first week of the recovery. Utilities and real estate led the way up as bond yields stayed stubbornly low.
During April and May, government stimulus arrived, and it became clear the stimulus would support an economic recovery. Cyclical stocks, which rise and fall along with the economy, finally took the lead and this month briefly jumped as optimism about jobs reappeared.
Take it as a given that the Fed and other central banks will step in again if the recovery starts to fade, and three plausible outcomes can be set out.
The bubble scenario is that growth stutters but the sheer force of stimulus keeps pushing up asset prices. Bond yields stay low, cyclical stocks are a no-go zone and investors pile into safety and innovative growth.
Something like this happened in 1998, after the Fed slashed rates in response to the Asian financial crisis and Russian default, argues Toby Nangle, global head of asset allocation at Columbia Threadneedle Investments. The low rates were designed to provide wider help to banks and an economy threatened by international trouble (sound familiar?), but for investors provided an opportunity to bid up the prices of the stocks that were unaffected. That helped to inflate the dot-com stocks, but often forgotten is that plenty of solid, safe companies were frothy then, too: Coca-Cola and Procter & Gamble traded at 42 and 33 times estimated earnings, respectively, in early 2000.
The equivalent of the speculative dot-coms of today are stocks such as Tesla, Beyond Meat and this month’s wonder, electric-truck maker Nikola, already with valuations that stretch credulity. Safe stocks aren’t cheap, but could easily rise to stupid multiples in a weak economy with plenty of stimulus.
Tesla and other speculative stocks currently have valuations that stretch credulity.
Photo: Mark Schiefelbein/Associated Press“When the Fed and not really the economy is underpinning [the market], it’s a fertile environment for misvaluation,” says Mr. Oppenheimer.
The day traders who have piled their stimulus checks into stocks have preferred to bet on the more hopeful second outcome: that all the money sloshing around will feed a rapid economic recovery, with higher growth and inflation. Put simply, that stimulus will work.
Beaten-up cyclical stocks such as airlines and even bankrupt Hertz Global Holdings soared as they became individual-investor favorites, prompting many to worry that they are creating a different kind of bubble. It is hard to see how this could become a true bubble in which higher prices lead to still higher prices, however; the reality of earnings and the economy is hard to hide for stocks so obviously dependent on a return to precoronavirus normality. Indeed, they rose and fell this month in tandem with bond yields and concern about a second wave of infections.
A third scenario is the worst, featuring the weak growth of the bubble scenario combined with the inflation of the growth scenario. Unlike the past decade, stimulus succeeds in pushing up inflation, but the economy remains stubbornly weak. Politicians and policy makers keep pumping in cash, but it appears only in consumer prices, not productivity. As in the 1970s, both stocks and bonds are losers as inflation erodes confidence and valuations fall back.
At the moment, the market is priced for a return to moderate growth and no inflation—ever. Investors are leaving themselves little margin for safety given the risks ahead, assuming that the Fed and other central banks will ride to the rescue if anything goes wrong. Even if that works out, investors still need to worry about the stimulus scenarios, given the winners are so different in each one—and the danger that stimulus might, finally, create inflation.
Write to James Mackintosh at James.Mackintosh@wsj.com
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