"It is indeed beautiful to see a person put out to sea with the fair wind of hope; one may utilize the chance to let oneself be towed along, but one ought never have it on board one’s craft, least of all as pilot, for it is an untrustworthy shipmaster." ~ Soren Kierkegaard
The stock market just completed its best 2 weeks in 82 years, even as US job losses reached 22 million. Why? The short answer is hope. The longer answer is that the stock market is a forward-looking mechanism. Stock prices now generally reflect where the investor herd expects the economy to be within about 3-6 months.
In different words, the recent market rally is being driven by expectations that the economic shut down will end quickly and the US economy will be strong and healthy by November. But hope and expectations do not a recovery make. Although there's nothing wrong with hoping for a recovery, it's arguably not wise to expect one in the short term and certainly not to bet money on it. In hindsight, buying stocks in late March was probably a good idea. But buying stocks in mid-April? Probably not.
Here are just a few reasons why April's historic rally will likely turn negative again:
The Stimulus Is Not Enough to Save the Economy
The most recent bottom of the coronavirus bear market was March 23, 2020, when the $2 trillion stimulus package was beginning to look like a reality (President Trump signed it into law on March 27). Since then, through April 17, the S&P 500 index jumped nearly 30%. But does the $2 trillion justify a new bull market for stocks? Probably not, when considering that US GDP in 2019 was $21.7 trillion.
There Will Be No V-Shaped Recovery
Investors are hoping for a V-shaped recovery. But when the economy begins to open up again, employers won't immediately hire back 100 percent of their furloughed employees and consumers aren't going to return to their pre-coronavirus spending. People like to plan.
Businesses won't hire and redeploy capital if they can't forecast demand for their products and services. Consumers won't buy much more than the bare necessities if they're not confident about their financial future. And until there's a vaccine for COVID-19, it's not likely that people will be planning vacations, eating at restaurants, going to the movies, or attending sporting events -- at least not like they did before the coronavirus.
The Interdependence of a Global Economy
COVID-19 is a global pandemic; the virus has hit economies hard all around the world. Investors should remember that the U.S. is part of a global economy. There's no full economic recovery until most of the world has been normalized, especially leading economies such as the U.S. and China. On April 17, China announced a shrinking economy for first time in nearly 50 years, as Chinese GDP fell by 6.8% in the first quarter of 2020. This and other economic headwinds around the globe won't normalize soon.
Corporate Earnings Haven't Been Factored In Yet
The April rally in stocks occurred before a majority of U.S. companies announced their Q1 2020 corporate earnings. If investors have assumed prices were "a bargain" in early April, they'll be unpleasantly surprised when poor earnings are reported throughout the months and are factored in with today's higher prices.
For example, the price-earnings ratio or "P/E ratio" is widely regarded as a relative value of a company's shares. The calculation is the stock's price divided by the company's earnings per share (EPS). If the numerator (the price) goes up and the denominator (the EPS) is goes down, you end up with a higher P/E, which then translates into a stock price that doesn't look like such a bargain anymore.
It's Too Early to Bet on a Treatment for COVID-19
Two big drivers of stock prices in recent weeks have been news of potential COVID-19 treatments, including the Malaria drug, chloroquine, and the Gilead Sciences (GILD) drug, Remdesivir. Neither of these drugs have been approved by the FDA as treatments for COVID-19. Chloroquine's efficacy has been mixed and some side effects, such as abnormal heart rhythm, are severe.
On its surface, the news about Remdesivir looks more promising, with a recent COVID-19 clinical trial showing rapid recovery in some patients. But after looking beneath the surface, the results are questionable. The clinical trial did not include a control group, which is crucial in experiments to show results of individuals who do not receive treatment. Also, this trial was sponsored by Gilead, which introduces biases in favor of positive outcomes and places a cloud of doubt over the entire trial.
Bottom Line
Consumer activity is roughly 70% of the U.S. economy. If consumers aren't confident about their respective financial futures, they generally don't spend money on products and services they don't need. Businesses are the same: they don't hire more employees or invest more of their capital if they don't see better times ahead. This is why economic recoveries can't be suddenly turned on like the flip of a switch.
I like hope; it's what drives the human spirit when there's nothing left to drive it. Hope can help you survive but it can't make you live. This holds true for the stock market. Hope can be a powerful force but it's not a sustaining one in the long run. Hope can produce the best two-week rally for stocks in 82 years. But it won't create an economic recovery. I hope I'm wrong. But I don't think I am...
Be well, my friends.
Kent Thune is a philosopher who happens to be a Certified Financial Planner (TM) and owner of Atlantic Capital Investments, LLC, a registered investment advisory firm located in Hilton Head Island, SC. Mr. Thune is also a freelance writer published on multiple investing and finance websites, including MarketWatch, Yahoo Finance, Kiplinger.com, InvestorPlace.com, The Balance, and The Motley Fool.