Stimulus Spending Is Why The Stock Market Is Booming…And Why It Will Continue
The pandemic is costing the economy billions, yet the stock market is about to hit an all-time high. Why?
Quick! $1,200 can buy you 80% 0f one share of Tesla!
Back in the pre-COVID days of early 2020, things were looking cautiously positive for America’s economy. In February, The Dow Jones Industrial Average index hit an all-time high of 29,551, marking 11 years since the start of the longest bull market in history. 11 years of gains meant valuations were beginning to feel uncomfortably high, but a series of interest rate cuts and an easing of trade tensions were fueling investor confidence and stocks continued to climb upwards.
That all abruptly changed when, two weeks later, the novel Coronavirus ripped across the globe and brought America - and the stock market - to their knees. By the time the US declared a national emergency on March 13, the Dow had plummeted 30%, unemployment had climbed above 15%, and the government had embarked on the largest stimulus package in American history in an effort to avoid an economic Armageddon worse than the Great Depression of the 1930s. Stocks went into tailspin, although many analysts argued the market was overheated and the pandemic had merely accelerated a long overdue realignment of stock prices with earnings.
Fast forward to the present. The US economy is still at a standstill, unemployment is still in double digits, and a reliable COVID-19 vaccine is still not available. Rising levels of infections continue to hamper America’s return to ‘normal’ operations, with some industries - air travel, tourism, education - still incapable of reopening. The Trump administration continues to buffer the pandemic’s economic impact with injection after injection of new cash, via loans, stimulus payments and other programs to individuals and businesses, and there’s more to come. An estimated $6 trillion of new money has been created, with little talk of what all this new money may do to the future health of America’s balance sheet and the short and long term values of the US dollar. Other topics for another time.
Meanwhile, stocks are enjoying a wildly prosperous summer. Both the Dow and S&P500 indexes hit new highs this week, as investors pile in and ride the wave of upward momentum. Gold and other medals are also hitting record highs. Where is all this positive sentiment coming from, and what does it mean in terms of the stock market’s ‘value’?
The stock market usually performs similarly to the economy and has long been considered a barometer of the country’s economic health. Nothing could be further from the truth in today’s current market. A stock’s price used to be tied to potential earnings, which helped gauge its value. So how is it that companies are reporting staggering drops in earnings, yet the market seems nonplussed? If Q2 results are anything to go by, most of America’s largest companies look worse than back at the start of 2020 when valuations were already worryingly high. Traditional measures of value - P/E, EV/E, even Y-O-Y revenue - have all been thrown out the window. What’s going on?
The simple answer is the current stock market rise has nothing to do with an increase in value. The government’s unprecedented injection of trillions of dollars of new money is the main driver behind the market’s momentum: More money in the system means more money for investing. Add to this an aging investor population, whose future monthly incomes are now more integrally tied to the stock market’s health than any previous generation, and it’s no wonder flashy companies like Tesla, the new-age carmaker, has seen its stock price quadruple since March. The company is now valued at nearly $300bn - more than Ford, Volkswagen and Toyota combined - despite the fact its electric vehicles account for only 1.3% of the cars on America’s roads.
Tesla’s stock has quadrupled since March, and the company is now valued at $300bn, despite accounting for only 1.3% of the car market in the US. Source: Marketwatch.com
The other driver of stock market pricing is the advent of new trading platforms like Robinhood (one of my favorite apps, and blog topics) that make stock market investing easier, cheaper and more accessible to individual investors. Robinhood and other low-cost trading platforms (Schwab, E*trade) have seen an explosion of new users since the start of 2020, especially Millenials and app-savvy younger investors who spent their lockdown months learning the ins and outs of day trading. Robinhood investors are a tiny slice of the stock market’s investor base, but they can marginally influence pricing, especially ‘hot’ stocks like Tesla, one of the site’s most actively-traded stocks. Robinhood’s no-minimum, fee-free trading platform has dramatically promoted the fractional ownership of shares and has expanded stock investing to include smaller, inexperienced investors who, collectively, will continue to play a larger and more influential role in stock movements in the future. .
Not like the old days: Share ownership in the digital age means investors can quickly and easily trade fractional shares of stock
On the other end of the investor spectrum are the big hitters: The pension and institutional investors. With interest rates now around 0%, pension funds have little choice but to plough their investors’ cash into equities if they’re going to earn anywhere near the expected returns required to meet their investors’ promised payment calculations. Bonds no longer offer anywhere near the 8% return they once promised a generation ago, and that means, going forward, the stock market is fast becoming the nation’s investment vehicle of choice for future income. With a massive portion of America’s wealth locked up in the pension system, pension fund managers have a lot riding on a continuously healthy stock market. There’s so much wrong with this scenario on a long-term basis, but again, that’s a story for another time.
Whatever the reasons for the current market surge, what’s clear is there are plenty of people, and lots of new money, working hard to keep it going. Whether that’s reason to be bullish or not is unclear, but with another stimulus package in the works and more money flooding the market, there’s little reason to believe the good times are coming to an end.