The Fed Has Inflated the Mother of All Stock Market Bubbles

• Analysts at Citigroup are starting to worry about a potential stock market bubble.
• Traders are continuing to pile into financial markets despite worries about the economy.
• Without the Fed, this rally would collapse, but with the Fed, it’s becoming out of control.

The U.S. stock market took a much-needed breather on Wednesday morning as investors reassessed the strength of the market’s epic rally over the past few months.

The whirlwind recovery has been based on central banks’ willingness to keep injecting money into the global economy and build a bridge into 2021. But data show investors’ optimism has gone beyond the promise of stimulus—traders are now betting on a sharp V-shaped recovery.

The Stock Market has Outpaced Stimulus Spending

Data from Bloomberg show that the market rally has surpassed the amount central banks have spent trying to prop up financial markets. The global market cap has gained more than $20 trillion since plummeting in March. That’s nearly double the projected outlay from central banks in the U.S., Europe, Japan, and the U.K. combined. 

That indicates investors are not only leaning on central bank backstop—they’re betting on economic recovery.

Economic Recovery in Question

That recovery is going to have to be a steep one, according to the Organization for Economic Cooperation and Development (OECD). The organization is expecting the global economy to decline by 6% this year , and that’s a best-case scenario. If the pandemic worsens again in the Autumn, the decline would be closer to 7.6%.

Possible Return to Lockdown This Summer

The worst-case scenario is starting to look more likely, according to data from the U.S. Some states like Arizona and Arkansas have seen an increase in new virus cases of more than 100% in the past two weeks. To make matters worse, many states that are seeing a surge in cases also have very few ICU beds available to new patients.

The data indicate some U.S. states may reinstitute lockdowns—a move that would almost certainly spook the markets. Many had been hoping that the virus would subside in summer . Reduced cases also meant more time to find a viable vaccine before flu season begins in the Autumn. 

Stock Market Bubble Reminiscent of Dot-Com Bust

The one-two punch of bad news has reignited worries that the U.S. stock market is starting to look eerily similar to the dot-com bubble of 1999. In a note to clients over the weekend, Citigroup’s Tobias Levkovich said there are some signs of trouble ahead .

Citigroup’s Panic/Euphoria Index has risen significantly in recent months, taking it to an 18-year high. Levkovich pointed to growing FOMO (Fear of Missing Out) pressure on investors to jump into the market or miss out on gains as a reason to be cautious. 

[We] are concerned that such thoughts have been sidelined by the pressure to partake or be left behind […] People are ignoring joblessness, trade friction, social unrest, and risks that loom including possible [virus] reinfections, the end of bonus supplemental unemployment checks and the upcoming elections.

What’s Next

The market is undoubtedly in dangerous territory. Data from trading app Robinhood show retail investors have driven prices up significantly in the aftermath of the March stock market crash.

Lots of speculative traders that lack commitment is a recipe for disaster in terms of market stability. It is, as Citigroup alluded to, precisely what happened in 1999 when the dot-com bubble burst.

But as a note from Rabobank put it, the Fed’s stimulus has added another dimension to this stock market bubble :

If everyone is holding stocks just to pass on to the next greater fool, and if the greatest fool is a central bank with infinite liquidity to buy them, then, yes, prices will keep going up.