In March, the U.S. experienced one of the worst stock market crashes in modern history due to the economic turmoil caused by the coronavirus pandemic. Even though parts of the economy are starting to reopen and we’re learning more about treating the virus, we’re a long way off from gaining control over the situation. That has some investors worried that a second crash is imminent.
According to Craig Kirsner, a retirement planner, speaker and author, there was already what he refers to as the “central bankers’ bubble” before the coronavirus. Since 2008, government central banks have employed a number of easy-money strategies to boost their economies, including setting low or even negative interest rates and buying their own government bonds.
“The low interest rates we’ve experienced have allowed companies to borrow a lot of money, and a great deal of that money went into buying back their own company’s stock,” he said. As a result, stock prices surged higher, making consumers feel good about the economy and more willing to spend money and take on debt.
That bubble would seemingly have burst following the stock market crash. However, governments around the world pumped an additional $9 trillion (and counting) back into their economies in order to stimulate growth, which helped reinflate it.
“We’ve seen this movie before: sky-high real estate prices, sky-high stock market prices and a giant debt bubble,” Kirsner said. “We know how this movie is going to end, we just don’t know when.”
Others aren’t quite as pessimistic, though it’s generally agreed that what happens in the stock market is dependent on a largely unknown future. So what might we expect from the market as we work toward making it through the coronavirus crisis?
The Stock Market Crash Of 2020: How Did We Get Here?
Recently, we experienced the longest bull market run in history, which lasted from 2009 to 2020. That, however, came to a screeching halt after the coronavirus emerged early this year. As countries around the world (including the U.S.) imposed lockdowns to slow the transmission of the virus, we experienced major economic slowdown. Fears over how the pandemic would ultimately impact business and employment erased more than 30% from the S&P 500 Index between Feb. 20 and March 23 alone, according to Mindy Yu, director of investments at Stash.
Because the virus is brand new, there has been a lot of uncertainty surrounding what its effects could be ― and uncertainty rarely reflects positively in the stock market. Even so, the market seemed to be pricing in a much larger overall decline to earnings than what we are currently seeing, said Joe Favorito, a certified financial planner and managing partner at Landmark Wealth Management. “It’s not unusual for markets to overreact and price in the worst-case scenario in the face of the unknown.”
Many have compared the present crisis to the Great Depression in an attempt to understand how it might play out economically. However, Yu said there are a few key differences. For one, the unemployment rate during the Great Depression was greater than 20% for several consecutive years. Presently, unemployment sits at 14.7% ― a staggering figure for sure, and one that could potentially increase in the upcoming months. However, it’s unclear whether that high level of unemployment will persist for a long period of time. The Great Depression also resulted in several consecutive years of falling GDP ― a widely accepted measure of economic health ― the worst of which occurred in 1932 with a decrease of 12.9%. “Meanwhile, the International Money Fund is expecting a decrease of 5.9% in annual GDP for 2020, and a projected 4.7% growth in GDP for 2021,” Yu said.
“Uncertainty rarely reflects positively in the stock market.”
It appears possible the economy could be on the mend, and as a result, the stock market reversed its course. As of May 14, the S&P 500 was up more than 30% since the low point on March 23, though it’s still down about 12% for the year. Yu said that growth is partially driven by the handful of larger corporations included in the index, which have thrived during the pandemic and are seen as being sustainable for the “new normal.”
Recovery is also driven by the fact that the Federal Reserve has stated it’s willing to do whatever it takes to keep the economy stabilized, including further lowering interest rates and employing its quantitative easing program. Plus, the U.S. government enacted a $2 trillion stimulus plan, which provided direct support to the economy in various ways, including stimulus payments to individuals and low-cost loans to small businesses.
There have also been signs that the curve is beginning to flatten. “Other countries in the world have been slowly jump-starting their economies, with China showing a ‘V-shaped’ recovery,” Yu said. “This has restored confidence in states slowly reopening. All news seems to point towards a recovery.”
Is Another Crash On The Horizon?
Despite all this optimism, the truth is that the future is largely unknown when it comes to containing and treating COVID-19. And as Kirsner argued, all this stimulus funding is likely contributing to overinflated stock values and a false sense of security.
Just because investors are hopeful now doesn’t mean things will stay that way. “Equity valuations have remained high without strong fundamentals, such as earnings, to support this recent rally,” Yu said. “Much has been sentiment, based on the prospects of reopening the economy. There is still a lot of uncertainty in the market, which may remain for some time.”
Historically, market declines of the magnitude we just experienced usually do see a “retest” of the lows, though that’s not always the case, according to Favorito. “Considering the amount of liquidity the Federal Reserve has added to the economy rather quickly, it makes it less likely we’ll see those lows again,” he said. But that doesn’t mean it’s all up from here. Market volatility is not unusual, and we should expect to see more ups and downs.
Bert Brenner, director of investment and economic research at People’s United Advisors, doesn’t believe the March lows will be retested, though the market might give up some of its recent gains before moving higher. Even so, he said there are circumstances that could drive the market below the March 23 lows. “Whether that would play out in a sharp decline ― a ‘crash’ ― or through a slower erosion of values would depend on how the circumstances unfold,” he noted.
The most obvious of these circumstances are those connected with managing the coronavirus pandemic. The failure to come up with a vaccine or some sort of treatment for COVID-19 would turn investor sentiment against equities. “I think it’s fair to say that current valuations are betting that an effective vaccine will be developed and/or an effective treatment for the disease will be developed within the next 12 months,” Brenner said. “If we are disappointed on both scores, I would expect global equities to sell off to below March 23 levels.”
Another consideration is the health of the banking industry, which was in good shape before the crisis. However, Brenner said that if lockdowns cause more extensive loan losses than anticipated and at a magnitude that threatens some portion of the banking industry, we could see a reversal in the stock market. “The nature of the reversal would depend on the speed with which a bank solvency crisis happens, its anticipated severity and the extent to which the federal government could offer assistance,” he explained.
Domestic politics will also play a role, he added. Any disruptions to the fall 2020 elections, such as candidates falling ill or steps taken to control the spread of the virus compromising the fairness of the election, would be a cause of concern to investors.
On the international front, concern over a foreign state taking advantage of what may be perceived as weakness or distraction in the U.S. due to an extended battle with the coronavirus could cause a market sell-off. “Aggressive steps by China or Russia to extend their sphere of influence or actions by rogue states like North Korea or Iran could destabilize the international order and erode investor sentiment and confidence,” Brenner said.
Of course, these are just a few of many possibilities, and it’s impossible to predict what might ultimately happen. Though we’ve never experienced a global shutdown of this magnitude before, volatility is nothing new when it comes to investing. That means that you should avoid attempting to time the market and stick with the tried-and-true strategy of riding out the turmoil.
“Regardless of what is happening in the markets, we always recommend to our customers that they stay the course. Diversify your portfolio, continue to invest regularly and focus on the long term,” Yu said. “It is about time in the markets, not timing the markets.”
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