In One Word: Why the Market Keeps Going Up (and What Will Make It Fall)

55 million Americans have filed for unemployment benefits, 10% of the workforce remains unemployed, and there is historic civil unrest in our nation. But stocks have jumped 50% since the market's bottom in March. Whether you're all in with stocks or you're 100% cash (or something in between), you're likely wondering two things now: 1) Why does the stock market keep going up and 2) What would make the stock market crash again? 

The answer to both questions can be boiled down to just one word: Vaccine. Here's how and why...

Using the '5 Whys' to Explain Today's Stock Market

Now other questions may come to your mind: You can see how a coronavirus vaccine (or the anticipation of one) can make the stock market go up. But how and why would the vaccine make the market go back down? Wouldn't stock prices just keep climbing after we get an FDA-approved vaccine? Also, aren't the market gains primarily due to fiscal and monetary stimulus? What does the vaccine have to do with this? 

To answer these questions, let's enlist the 5 whys, which is a problem solving method most notably used by Toyota Corporation. The idea behind this philosophical method is that asking "why" just once is not sufficient to find the root cause of a problem. But asking "why?" 5 times can reveal the real answer:

Why the Market Keeps Going Up

1. Why does the stock market keep going up? Trillions of dollars in monetary and fiscal stimulus, along with the belief that this stimulus will continue as long as it is needed.
2. Why the stimulus? The underlying fundamentals of the economy are weak and would be devastating if not for the stimulus.
3. Why is the economy weak? Because of historic unemployment, among multiple related challenges.
4. Why do we have historic unemployment?  The short answer: Covid-19 continues to threaten the economy. The longer answer: Businesses are shutting down or reducing services, due to government mandates to prevent the spread of Covid-19, consumer fear of the virus, and because of uncertainty over the degree of negative economic impact from ongoing government shutdowns and restrictions. 
5. Why does Covid-19 continue to threaten the economy? There's no vaccine.

Why Might the Market Crash Again?

1. Why might the stock market crash again? Traders and short-term investors will believe the best gains have been made and they will begin selling to lock in gains. Thinking that the anticipated crash has arrived, herd-selling would ensue, creating a self-fulfilling prophecy.
2. Why might investors lose confidence? The Federal Reserve and government end their stimulus.
3. Why would the stimulus end? There's no incentive for the Fed and government to continue borrowing and spending.
4. Why would there be no incentive to continue the stimulus? Because the threat of negative impact from Covid-19 would be significantly diminished.
5. Why would the threat of Covid-19 be diminished? Because there's a vaccine.

In summary: The lack of a vaccine is the fundamental reason for continued stimulus; thus, it is the fundamental reason that the stock market keeps going up. Upon the announcement that a vaccine has been approved, especially if this occurs after the presidential election, there would be almost zero expectation for stimulus to continue; thus, the stock market is left without support. All bets are off and the market enters into a downward spiral.

Buy the Rumor, Sell the News?

There's a saying among investors: Don't fight the Fed. In translation, this means that, if the Fed is stimulating the economy, stocks are the place to be. The Federal Reserve has explicitly stated that the "economic recovery will depend significantly on the course of the virus." This is why bad news has consistently been good for stocks. It translates into more stimulus.

But because the Fed has made it clear that they have investors' collective back as long as there's no vaccine, they've made an implicit statement that the market is on its own when the vaccine arrives. When the primary reasoning for the stimulus is removed, the Fed will then remove the proverbial punch bowl and the party is over.

To use another colorful bit of phrasing, traders and other short-term investors may see the coronavirus vaccine as a "buy the rumor, sell the news" type of event. The idea is to ride prices higher, as the rumors of the event continue, although the fundamentals of the economy remain weak. Expecting that the news of the event will herald the short-term peak for stock prices, traders will sell shares to lock in their short-term gains.

Put simply: stocks go up on the rumor of a vaccine; stocks go down on the news of the vaccine.

Bottom Line

While the downside potential for stocks post-coronavirus vaccine may not be immediate, a stock market correction is almost inevitable soon after FDA approval of a vaccine is announced. Post-vaccine, more attention will turn to the fundamentals and many over-priced stocks will be sold off. Put simply, when hope, fantasy, and the political will for stimulus are all removed, investors are faced with the cold hard reality of a weak economy. The uglier that reality looks, the harder stocks will fall. 

But it's great to be a long-term investor! As I stated in my recent post, Rational Investing in an Irrational Market, long-term investors can have their cake and eat it too by remaining allocated to stocks, somewhere between 30% and 70%, with the remainder mostly in cash (keeping in mind that bond prices have almost zero upside potential when the Fed ends stimulus). This tactical asset allocation strategy enables the investor to participate in the upside, then buy more shares on the downside.

Above all: Stay focused on the things in life that are much more important than money.

Kent Thune is a philosopher who happens to be a money manager and a Certified Financial Planner (TM). Kent is owner of Atlantic Capital Investments, LLC, a registered investment advisory firm located in Hilton Head Island, SC, serving clients all around the U.S. Kent 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.