Mike Segar/Reuters
- The stock market's rally from March lows overcame dismal economic reports, corporate profit warnings, and economist caution.
- As stock market investors pocket sizable gains, experts warn the uptrend is fragile and facing significant threats.
- "Gravity is taking over" as markets begin to assess reopening risks and a second wave of virus cases, said Marc Odo, client portfolio manager at Swan Global Investments.
- Recession aftershocks could arrive later in the year as businesses fail to stage healthy rebounds, other experts warn.
- Some strategists even point to indexes' heavy weighting of mega-cap tech stocks, cautioning that such crowding can drive as strong a downtrend as a rally.
- Visit the Business Insider homepage for more stories.
Bleak economic reports in recent weeks have been largely ignored by an unrelenting market rally.
The S&P 500 is up 28% from its late-March low, while the Dow Jones industrial average has climbed 27%. Just last week, the Nasdaq composite erased its year-to-date losses and now is less than 6% from record highs.
But as stock investors mint fresh gains, a growing number of experts warn the run-up isn't made to last.
One element they cite is overstretched valuations. By one measure, equities are historically expensive relative to profit forecasts. The S&P 500's price-earnings ratio rose to 20.4 times on Tuesday, the highest since 2002.
There are other troubling aspects surrounding the underlying economic environment. The unemployment rate soared to 14.7% in April as the coronavirus pandemic's fallout intensified. Corporate earnings forecasts are their gloomiest since the financial crisis. Federal Reserve chair Jerome Powell, who typically strays from exaggeration, recently classified the current recession as "without modern precedent."
That has experts questioning the strength of the stock market's recent rally, and wondering if such profits are under threat. Business Insider spoke to several experts to get their views, and the consensus was clear: recent market gains are vulnerable.
Wiping out on the second wave
Jessica McGowan/Business Insider
The prospect of rebounding COVID-19 infection rates isn't new to markets, but fears of such an trend are growing.
Equities faced new pressure throughout the week as economic and public health experts warned against prematurely reopening economies. Unbridled market optimism was shaken and investors enjoyed a preview of what may likely prolong the current recession, said Marc Odo, client portfolio manager at Swan Global Investments.
"What we're seeing this week is a little bit of reality coming in," Odo told Business Insider in an interview. "Eventually, gravity is taking over."
Where more optimistic commentators see deferred demand boosting the economy in the second half of 2020, Odo fears the pandemic's fallout presents serious obstacles to a recovery. Consumers will be more likely to avoid crowded spaces. Corporations may trade office space for telecommuting strategies.
Markets are largely underestimating how the once-in-a-century pandemic will prompt permanent change, Odo said.
The second-wave risk was also ignored for psychological reasons, according to Rich Steinberg, chief market strategist at The Colony Group. Investors trapped in quarantine saw hope in the prospect of reopening. Such hope fueled a spike in market optimism, but the upswing quickly showed "an element of complacency," Steinberg said.
"It's somewhat of a psychological response to be like, 'can we just get back to normal?'" he said. "The markets are acting like we're going to flip a switch and be back to normal. But the economic reality is not there."
The bankruptcy-layoff loop
AP Photo/Nam Y. Huh
Despite trillions of dollars in fiscal and monetary relief, not all businesses will last after their shutdowns. Economic damage across industries risks a recessionary aftershock and second market tumble, Seema Shah, chief strategist at Principal Global Investors, wrote in a Wednesday blog post.
"Markets may be right to look through Q2 numbers and look forward to a Q3 recovery," Shah said. "But it is entirely possible that there will be a Q4 reckoning, where a second wave of job losses & prolonged period of business failures tests equity sentiment."
Shah pointed to the air-travel sector as a prime example for companies facing deferred turmoil. Airlines clamored for government aid through March and saw travel activity almost completely freeze as lockdowns took effect. The firms have since said they don't expect travel activity to recover until 2022, threatening their ability to pay off relief loans.
With several companies punting risks down the field, the stock market faces years of "negative feedback loops" where fresh bankruptcies drive major layoffs, Shah said.
On the other side of the economic spectrum, the labor market is likely more tenuous than April's jobs report suggested.
While the 20.5 million erased payrolls highlight a dramatic job-market toll, the 18.1 million Americans who reported their job loss as temporary will serve as a critical indicator moving forward, Shawn Snyder, head of investment strategy at Citi Personal Wealth Management, said. If that population is unable to reenter the labor market, look for asset prices to react poorly.
"What's really important is that these businesses are able to successfully reopen, bring back those workers, and stay solvent," Snyder said. "If you see solvency issues, then that becomes something that I don't think is really, completely priced in."
The market make-up
Brendan McDermid/Reuters
The market's make-up
One of the market's biggest threats has little to do with the economy or the coronavirus. Several experts point to the breadth of indexes' rallies as the true sign of market health and blame surging tech giants for misrepresenting the broader market landscape.
The data supports their claims. The S&P 500 Equal Weight index is down 21% year-to-date, while its cap-weighted peer has declined roughly half that over the same period. Until the upswing is reflected among several other industries, investors may be turned off by the tech-fueled jumps and lessen their risk-taking.
"You probably need to see the beaten-up areas — real estate and financials — help create the next foundation to move forward," Steinberg said. "We need to test on the way down to see where investors' resolve is going to broaden out the rally."
The first place money goes in a crisis is where it was working before, he added, but that trend is now intensifying a previous threat.
Goldman Sachs warned in early February how crowding in tech giants was reaching dot-com bubble levels. With such concentration only swelling further, the market risks a major slide if those names disappoint.
"Concentration is not the sign of a healthy bull market," Odo said. "You want to look at the energy sector, real estate, and yeah, it's not pretty right now."
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See Also:
- 'We have a depression on our hands': The CIO of a bearish $150 million fund says the market will grind to new lows after the current bounce is over — and warns 'a lot more pain' is still to come
- 10 big money managers shared with us their favorite hidden gems in the market, and the contrarian trades they're making amid the pandemic
- Todd Ahlsten has dominated the market and his competitors for 2 decades. He lays out the 6 stock-picking decisions that reshaped his portfolio after the coronavirus meltdown.
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