Will the Stock Market Burn Down the Real Economy?

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Riding a liquidity fueled mega-rally, the S&P 500 is back comfortably above 3000, having recovered more than 70 percent of what it lost earlier in the year. Some of that bump comes from Americans who put their stimulus checks to use by day trading.

If this does not worry you, it should. The money that is going into the stock market simply is inflating paper profits instead of shoring up a fragile economy where joblessness and the sharp drop-off in economic activity make the Great Depression look like a stroll in the park.

The market bubble is worsening the economic divide between the haves and have-nots at a time when social tensions are exploding. And it seems that the worse the economy and protests look, the more the market loves it.

The dangerous gap between the stock market and the real economy represents a lit match under a house of cards and a challenge that nobody cannot afford to ignore –for the sake not just of their own investment portfolios, but also for the businesses and jobs in their communities, and long-term for the market itself.

You’ll hear two schools of thought. One is that the low is behind us and we’re all set for a new rally. The other one is that a new crash is coming.

Quoting analysts predicting the S&P 500 will go up to 3,500 or close to it by year’s end, Bloomberg wrote about the “really big stock bull case” based on the idea that Fed stimulus stays. “Michael Darda, chief economist and market strategist at MKM Partners LLC, says it shows there’s more upside potential for stocks than downside risk,” reporter Sarah Ponczek wrote. “A measure called the price-liquidity ratio that plots the market cap of the S&P 500 versus total money supply shows equities actually look cheap, even as earnings collapse.” 

On the other side is Guggenheim Partners CIO Scott Minerd, who warned this week that a “day of reckoning” is coming not just for stocks and bonds, but for the very nature of our financial system and economy. He predicts a gut-wrenching $1 trillion in “fallen angel” corporate bond downgrades that take bonds from investment-grade to “junk” status in the eyes of rating agencies.

In the very short term, the bulls may prevail. But the day of reckoning most likely will come sooner rather than later for the markets.

Destruction of Price Discovery

The huge amount of Fed money pouring into the market has all but destroyed “price discovery” –that is, the process of determining what a security is really worth, which economists believe is important for channeling capital to the best use.

“What is driving markets is a bet investors believe they can’t lose: They win if—based on the notion that stock markets can see past the short term—the economy quickly returns to normal; they also win if it doesn’t, given that the U.S. Federal Reserve has repeatedly demonstrated that it is both willing and able to backstop markets,” Alianz chief economist Mohammed El-Erian told Foreign Policy. As compelling as this bet appears to many investors, it should be worrisome for those of us who care about longer-term inclusive prosperity, sustainability, genuine financial stability, and the broad buy-in by society that’s needed to support all this.”

Reverse Psychology

The great myth that policy makers have long used to justify pumping up stock prices is that a strong stock market reflects confidence in the economy and will encourage businesses to invest and consumers to spend.

Neither is true in this case. Investors are putting their money in the market because they rightly lack confidence in the real economy but they DO trust that the Fed will keep pouring money in.

With more than 42 million unemployment claims, investors are watching the market to see how many of those jobs come back as the economy re-opens. By some estimates as many as 4 in ten of those jobs are gone forever, especially as many businesses and consumers rightly fear a second wave of COVID-19.

Consumers are paying down debt and saving, with the US savings rate spiking from 12.7 percent in March to 33 percent in April –the highest rate since the Bureau of Economic Analysis started reporting in the 1950s. Personal spending fell by 13.6 percent ($1.6 trillion) during April.

Companies are not expected to fare well in this environment. In fact, analysts just lowered their estimates for second-quarter earnings per share for S&P 500 companies by a remarkable 36 percent –the largest fall since FactSet began tracking in 2002.

Then there is the spectre of corporate bankruptcies. In May, 27 firms owing $50 million or more sought bankruptcy protection, the highest since May 2009. And we haven’t even seen the worst of it yet. Standard & Poors reports that $4.1 trillion in corporate debt comes due this year. The International Monetary Fund, which has been warning for quite some time about the dangerously high amounts of corporate debt that companies are having trouble servicing, has warned again about financial fragilities.

What Goes Up Must Come Down

Citibank’s chief equity strategist Tobias Levkovich has warned that their “panic-euphoria” model is flashing “euphoria” and predicts an 80 percent chance that stocks will be down over the coming year.

Even CNBC’s Jim Cramer, not usually one to throw a bucket of cold water on the stock market, just warned young people that day trading in speculative stocks is “not investing.”

Some investors have shrugged their shoulders, calculating that as long as the Fed is pumping money into markets, that’s where they are going to put their money. This extreme short term view does not bode well.

The Fed cannot go on buying assets forever. When it pulls back, the markets will take it hard, as we’ve seen from past “taper tantrums.” And the longer it waits to take the markets off of their IV drip of gasoline, the worse it will be in the future. Prices will have even farther to fall, and the economy will be that much weaker because money that could have gone into productive activity instead will have gone to feeding ill considered speculation.

This article is part of my LinkedIn newsletter series, “Around My Mind” – a regular walk through the ideas, events, people, and places that kick my synapses into action, sparking sometimes surprising or counter-intuitive connections. 

To subscribe to “Around My Mind” and get notifications of new posts, click the blue button on the top right hand on this page. Please don’t be shy about sharing, leaving comments or dropping me a private note with your own reactions.

Michele Wucker
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About Author

Michele Wucker is a global thought leader and the author, most recently, of THE GRAY RHINO: How to Recognize and Act on the Obvious Dangers We Ignore (St Martin's Press, 2016). Learn more about her at http://thegrayrhino.com/about/michelewucker

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