You don’t need me to tell you these are some crazy times for the stock market. Stock prices hit new record highs on the last day of trading in 2020 and have topped those peaks in the New Year. All of this has occurred despite a worsening coronavirus pandemic, amid mounting concerns about the economic recovery. Previously, we covered The Importance of Financial Literacy During the Coronavirus Pandemic. In the months that followed, we have seen a substantial recovery since the initial economic lockdown last spring.
However, has that improvement really been substantial enough to warrant the massive rebound we’ve seen in the stock market? I’ve been saying for years that stock values have become detached from economic realities and are artificially inflated, thanks largely to the Federal Reserve’s overuse of quantitative easing ever since the Financial Crisis. Has the stock market become so detached that reality no longer matters? Can Wall Street just keep on running while Main Street only crawls? What does it all mean for everyday investors?
Historically, any number of issues can weigh on the stock market—limiting its growth, triggering a correction, or in the worst-case scenario, ushering in a long-term bear market. Typically, a flat or down-trending market goes hand in hand with a recession. When investors are focusing on fundamentals, the market will start rising again once the economy shows clear signs of coming out of the recession.
The market recovery will always outpace the economic recovery because the stock market is forward-looking, and investors are betting on future growth, not reacting to current growth. However, they’re not just looking at economic factors. Social and political issues that could disrupt growth are also considered, along with the potential for a major event like a war or, of course, a pandemic. These are all just some of the fundamental issues that influence the financial markets, normally. To a certain extent, they still do.
Though over the past decade, as artificial stimulus and suppressed interest rates have become the norm, these fundamental factors have had progressively less impact. The ability of the financial markets to shrug off socioeconomic and political influences has increased dramatically.
Yes, we did see investors panic, and we watched the market drop by almost 40% when the coronavirus first hit last March. However, Wall Street began bouncing back soon after the Fed lowered interest rates to near-zero (as they did in response to the Financial Crisis) and announced open-ended quantitative easing. Long before 2020 ended, all three major market indexes had surpassed their pre-pandemic peaks and hit new record highs.
That’s partly due to certain sectors of the market—especially the tech sector—actually benefiting from the pandemic, but it’s mainly due to the Fed’s actions and to the release of record levels of economic aid by Congress.
It’s important to understand that although these measures taken by the Fed can be defined as artificial, their impacts are very real. That’s especially true when it comes to suppressing interest rates. Mathematically, stocks are worth more when interest rates are low. That’s just one way in which the Fed’s artificial measures have real impacts, but the important point is that they also disrupt the market’s relationship with socioeconomic realities.
Have Things Improved Since the Start of the Pandemic?
As I noted, the economy has certainly recovered to a large degree since the start of the pandemic, when a nationwide lockdown resulted in historic GDP shrinkage during the second quarter. However, even though unemployment numbers have steadily improved since last May, that improvement has slowed and job numbers have more recently shown signs of moving back in the wrong direction. What’s more, the pandemic is still raging, with Covid-19 case numbers worse than they’ve ever been and expected to get even worse before the end of winter.
Although we do now have two promising vaccines available, the effort to distribute them is moving slower than expected. Even though President Biden has said he has no plans to order another nationwide lockdown to combat the spread of the virus, that could change if case numbers continue to outpace the vaccine rollout. Can Wall Street continue to ignore these realities if they escalate?
What Does This Mean for you as an Everyday Investor?
At the end of the day, nobody really knows just how stable this artificially-based stock market formula really is. As I’ve been saying for years, it’s essentially one big lab experiment being conducted by the Fed and other central banks around the world. As with any experiment, the end result could be a groundbreaking success or an epic failure.
Either way, the most important thing for everyday investors right now is to be sure your financial strategy is aligned with your risk tolerance and designed to help protect your investments from downside risk. Now is an ideal time to discuss the matter with the right financial advisor, because I believe the markets are in a “sweet spot” for investors to take action. It is a great time to answer questions, such as How Much of My Income Should I Invest for Retirement?
Since all the major market indexes are still hovering near record highs, investors can help reduce their risk while following one of the most fundamental principles of good investing: “sell high.” At the same time, certain investors with the right risk tolerance can arrange their portfolios to take advantage of potential new buying opportunities in the coming year.
How the Elections May Impact Wall Street
Along with the coronavirus recession, the biggest fundamental factor that could potentially halt the seemingly unstoppable stock market is the political picture. So far, Wall Street has had an overwhelmingly positive reaction not only to Joe Biden winning the presidency but also to Democrats taking control of the Senate as a result of the Georgia runoff election on January 5th. Normally, Biden’s win and the Democratic sweep in Georgia might have triggered a selloff, not a rally. However, the market hasn’t really behaved normally for about a decade.
Wall Street has been celebrating because having the Democrats in full power improves the odds that more coronavirus relief and stimulus is on the way. For modern-day Wall Street, it’s all about the stimulus—so much so that big investors are able to ignore all the scary factors driving the need for stimulus and stay focused on hope instead of fear. Could that change? Perhaps, and many market watchers believe it probably will by mid-year. By that time, big investors may start to shift their focus away from what a Biden presidency means in the short-term and toward his longer-term economic policies, which include things like increased regulation and raising the corporate tax rate.
The Stock Market’s Performance in 2021
On the other hand, with low-interest rates and artificial stimulus here to stay, some believe the stock market will maintain its ability to focus on these things while basically shrugging off political and socio-economic fundamentals. They believe that—at least as far as 2021 is concerned—an artificially overvalued stock market will continue to be part of the new normal, along with things like masks, Zoom meetings, and online shopping. More new record highs could be in store, although it seems unlikely that stock values could continue climbing much higher without real corporate earnings starting to catch up in a big way. Could that start to happen by the end of this year? Possibly. There are many genuine reasons to be optimistic as the year begins: vaccines are being delivered, the political picture is clearer, and more economic relief is on the way.
However, there are also still plenty of major challenges ahead, any one of which could quickly undercut investor confidence and send the markets back into correction territory. Some analysts believe another correction is possible by mid-year due to political issues. It probably wouldn’t be as steep as the one that occurred last March, but it will likely be significant enough to potentially impact your retirement plans if you’re not prepared for it. Now is the perfect time to take action by meeting with the right advisor to make sure your financial strategy is geared toward greater protection and retirement income, aligned with your personal risk tolerance, and (for certain investors) designed up to help you take advantage of potential new buying opportunities in the year ahead!
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