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Beware of the Stock Market Bubble: The Fed Won’t Save Investors Forever

Last Updated September 23, 2020 2:01 PM
Laura Hoy
Last Updated September 23, 2020 2:01 PM
  • The stock market’s valuation is based on nothing concrete; when Q2 earnings come out, it will be a wake-up call for investors.
  • Unless the Fed comes out with a groundbreaking stimulus plan, this rally will run out of juice.
  • Government stimulus isn’t enough to make people spend amid job uncertainty.

The U.S. stock market has defied gravity over the past few weeks as Federal Reserve funds boosted investor confidence.

Equity prices have risen more than 40% since crashing in mid-March despite a surge of new virus cases and increasingly panicked calls for caution. But can the Fed prop markets up indefinitely? Evidence suggests the answer to that is no. 

The Fed’s intervention may have inflated an epic stock market bubble threatening to pop at the end of the summer. The sudden comedown will leave thousands of exuberant first-time traders with hefty losses in their Robinhood accounts and exacerbate the economic hardships the pandemic has created.

Americans are Hoarding Cash

Data from U.S. banks suggest Americans have never been richer. FDIC data show that U.S. bank deposits have risen to a record-breaking $2 trillion  so far this year. In April alone, deposits increased by more than they did during the entirety of 2019. 

stock market, stock market crash, stock market bubble
America’s largest banks have seen a massive increase in deposits over the past few weeks. | Source: CNBC 

At first glance, that sounds like great news. People have a lot of money, and they’re ready to spend it. But that’s not the whole story.

Firstly, a massive chunk of that cash is corporate debt. Many firms drew down their lines of credit when the pandemic hit, leaving banks with substantial cash deposits in their corporate accounts. Payroll Protection Loans were also a source of the funds as many small businesses took on the government loans to stay afloat. 

Still, banks note that even their retail clients had higher than average account balances. Bank of America said that checking accounts with less than $5,000 balances saw an increase of roughly 40% following the pandemic. 

stock market, stock market bubble, stock market crash
Fed data show that people started flooding their savings accounts throughout March and April. | Source: Business Insider 

That’s a bad sign. It shows that while government spending has been able to spur on a considerable stock market rally, it isn’t stimulating the economy. Uncertainty is keeping people from making big purchases  that the economy needs. In other words, the government can give people money, but it can’t make them spend it.

Unemployment is About to Spike

A big reason many Americans are becoming more frugal is a loss of job security. Despite evidence of an improving labor market, the pandemic is likely to leave millions of Americans without a job. Some of those job losses have yet to materialize because of the Payroll Protection Plan loans.

The government’s small business loan program initially came with the caveat that businesses would need to spend the money within eight weeks. That rule has been relaxed, but the maximum loan size is two months’ worth of payroll. Anyone using their loan to keep staff on the payroll is likely about to run out of cash .

stock market, stock market bubble, fed stimulus
A pandemic-proof office like the one outlined here would require roughly $50,000 worth of kit.| Source: Business Insider 

Not only that, but reopening amid a global pandemic is no easy task, and it’s certainly not cheap. It’s estimated that companies large and small will have to spend roughly $300 per employee  to keep customers and workers safe. That’s a cost that many businesses, especially small ones, can’t shoulder. 

Consumers who are unwilling to spend, coupled with businesses that are strapped for cash, could result in a slew of layoffs at the end of the summer.

Beware of a Stock Market Bubble

The economy is rife with uncertainty and what-if cases, but the stock market continues to defy gravity. That’s a bubble.

Sky-high equity valuations are based mainly on–well, nothing. There’s the promise of an economic recovery, but most admit we have at least a year before demand recovers fully. 

Outside that, the stock market’s valuation is based on the Federal Reserve’s promise to continue expanding its balance sheet. But that euphoria is misplaced. Stock prices are based on earnings, and earnings are going to be terrible .

Second-quarter results will start coming in July, and investors will finally have actual data to use. That’s likely to be a moment of reckoning  for the overhyped stock market that could end badly for all the speculators placing risky bets on the back of Fed stimulus.

Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com. The author holds no investment position in the above-mentioned companies.