As the COVID-19 crisis continues, the financial ecosystem is experiencing a period of significant volatility. There is compelling evidence that economic recovery will take longer than expected and the current stock market is frothing well beyond fundamentals. As experienced investors take chips off the table, the armchair day traders are blithely ambling into the cave of a bear that is just waiting to pounce. The market could plunge by 30% over the next 12 months as unemployment levels remain at highs and travel, tourism, services, and real estate remain depressed.
We saw a panicky market in March rapidly replaced by a return of the bulls as spring marched forward. As we have moved into summer, many investors remain hesitant and the market is highly unsettled, with big reactive moves to the slightest of news and indicators. However, the underlying reality is hundreds of thousands dead, millions sick, and tens of millions unemployed across the globe. Coupled with social unrest and reallocations in consumer spending, this is hardly the recipe for robust economic growth.
The second wave of COVID-19 is still underway and, absent a miracle vaccine, a third wave is likely in the fall and early winter when the arrival of the flu season will add fuel to the seasonal fire of reduced immunity. At the moment, states that have reopened are busy hitting the pause button or reversing course altogether.
The election season adds another set of pins and needles to an already jumpy market, meaning that the next few months are going to be a bumpy ride. With Trump trailing and the news cycle hungry for something other than all-COVID all-the-time, there is going to be plenty of political fodder and October surprises to keep investors’ ragged psyches on edge.
One of the most impactful macroeconomic stress factors in the last few years has been the U.S.-China trade war, and with the microscope on China as a result of Bolton’s memoir and all eyes on Trump, this saga is going to receive added attention, with attendant reverberations in the markets.
There is also the uncertainty of the potential unemployment benefits extension for a lot of Americans and a possibility of the dreaded July 31st “fiscal cliff” if Congress does not reach a compromise. While Democrats have proposed an extension of the $600 weekly federal benefits through the rest of the year as part of a new stimulus package, Republicans have not been as enthusiastic about the extension. Largely convinced that unemployment benefits are not a key driver for pushing the economy forward, Republicans have remained cognizant of the fact that elimination of the benefits would be a vastly unpopular move three months before the election. Regardless of what agreement is reached in terms of another stimulus package, discussions around it have triggered investor uncertainty.
On the other hand, the Federal Reserve’s low-interest-rate policy has gone into overdrive during the pandemic, with the Federal funds rate being slashed to zero in the first days of the pandemic and fixed income yields hitting historical lows. This is forcing investors to stay in the equity markets, even though they know better, and contributing to the price schizophrenia we are seeing day-to-day.
We are also on the tail end of a decade of massive economic growth, including record earnings and capital gains that have produced a surplus of wealth that has to be invested somewhere. New money is often stupid money and has contributed to unhinging the equity markets from its fundamentals. The market will correct, the only question is when.
Some analysts are predicting a V-shaped recovery of the economy and the subsequent rise of the market, while others fear a prolonged crisis similar to the Great Depression. My crystal ball says that the recovery is going to be a process that extends well into 2021 and, likely, beyond. Caution is called for at the moment. More bottoms are ahead and you are better off being late on the upswing than plunging into the looming downswing.
About Jack Plotkin
Jack Plotkin attended the California Institute of Technology and began a career with Goldman Sachs after graduating from university. He was with Goldman Sachs for nearly a decade, where he developed innovative strategies for more than 100 Fortune 500 and sovereign government clients encompassing investment banking, equity, fixed income, and derivative products. Today, he is considered an authority on corporate strategy and investment in both public markets and private equity.