Donald Trump is singing the stock market’s praises after one of the best weeks on Wall Street for almost 50 years. Unfortunately, while the President is optimistic about a V-shaped recovery, evidence suggests more pain could be ahead for the Dow Jones.
President Trump has taken every opportunity to inject some optimism into investors when the stock market has bounced, but previous efforts have fallen flat. Backed by some dramatic gains in the Dow and S&P 500, will he be right this time? It’s not looking good.
Currently trading above 23,000, the Dow Jones has risen like a phoenix from the ashes, after the coronavirus pandemic briefly knocked it into the 18,000 point handle.
While Trump is correct, it was the S&P 500’s best week since 1974; it was almost the best for the Dow since 1938. History has shown us these moves can be a strong indicator something is going wrong under the hood.
The S&P 500 has apparently been powered by optimism about the slowing of the coronavirus curve in the United States.
Adding to this, Fed-enabled denial about the impact of the shut-down on debt-laden corporate “zombies,” has created an obvious disconnect between fundamentals and price action. All this has stock market bears tearing their hair out.
Several key economic indicators are flashing some of the worst warning signs since the 1930s. First of all, unemployment is getting entirely out of hand.
More than 16 million Americans have lost their jobs in the last three weeks. And there doesn’t seem to be any end in sight to the lock-down.
Despite White House officials marveling at the flatness of the COVID-19 curve in California, LA County (the wealthiest and most populous county in the United States) has extended its shelter in place directive until May 15th.
To put the impact of this in perspective, if LA County were a country, it would be the 19th biggest in the world, and based on real GDP is more prosperous even than oil titan Saudi Arabia.
California as a whole is the wealthiest state by far, and its decisions tend to direct the other states’ decisions for nothing else than economic necessity.
This suggests that other regions will follow suit, and will make it harder for Trump to fulfill his dream of opening the economy with a bang.
Another economic engine, N.Y.C. is the worst-hit place in the country, and Governor Cuomo is unlikely to be in a hurry to re-open.
Is the Dow priced for a drawn-out battle? It doesn’t appear so.
Another major red flag for the stock market is plummeting inflation. Deflation looks to be here, and while that might sound like good news for the economy, it’s terrible news for a consumer-based economy.
U.S. households are the most powerful engine for growth in the global economy, and the idea that the Dow Jones could rev back up to record highs with consumers on the side-line doesn’t make sense.
So what do we need to see for Trump’s hope to come true? Probably a much more significant expansion of the Federal Reserve’s balance sheet. This is precisely what we are seeing, as Jerome Powell does his best to kill funding pressures amid a global scramble for U.S. dollars.
With record equity outflows seen last week, it’s obvious something pretty gigantic is going on behind the scenes.
Ritholtz Wealth’s Ben Carlson believes that the Fed’s interventions might be simultaneously removing the risk of monster stock market crashes while also lowering future returns, as he stated in recent research,
If the stock market during the worst economic contraction in 90 years can be smoothed out by government spending and Fed actions, does this change the risk-return framework in the stock market going forward? Said another way — if stocks don’t have the risk of a Great Depression-like crash on the table, does that mean expected returns should be lower going forward?
Combine this intriguing concept with the fact that ordinary life is off even after the blanket shut-downs are lifted, and the idea of reduced equity returns looks even more compelling.
Is it, therefore, realistic that the Dow Jones can emerge from the deep-freeze and smash to record highs? Of course not, but that doesn’t mean the Fed won’t do its best to smooth out the bumps.
Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com.