The Stock Market Is About to Plunge. Here’s What Will Save It
The current environment points to a stock market crash, but that won't happen as long as these three things hold true.
With the U.S. stock market showing signs of fragility, the Federal Reserve could be planning its most ambitious stimulus yet. | Image: Tasos Katopodis/Pool via AP, File
- The stock market has several downside catalysts ahead.
- A stock market crash won’t happen if the Fed can keep markets afloat.
- Earnings and an additional stimulus package should help maintain this rally.
The post-Covid-19 stock market rally has been dubbed ‘the most hated rally in history’ because of the number of doubtful bears.
Jani Ziedins of the Cracked Market blog said it best last week:
If this market doesn’t want to breakdown, there is no arguing with it.
Ziedins says the bears’ arguments for why the market ‘should’ crash are valid, but obsessing about the negatives while the market focuses on the positives is a terrible strategy.
Either [the stock market] does [go up] or it does not. Anyone trading ‘should’ is losing a lot of money right now.
On Thursday, the S&P 500 began a decline that saw the index finish the week 2% below its mid-week highs. Now the question is whether this decline will turn into a correction.
It should, but it’s unlikely as long as these three key events play out as planned.
The Stock Market Depends on Stimulus
The lynchpin holding the stock market’s rally up is unwavering government support through stimulus spending.
Several government aid programs will expire this month. Now, Congress is mulling over extending unemployment benefits and sending out another stimulus payment. Without that stimulus, a sharp pullback in consumer spending is likely as incomes dry up.
The Trump administration is widely expected to announce additional stimulus, which will keep the economy, and the stock market, afloat.
The Fed Could Eventually Buy Stocks
A stimulus bill isn’t enough to keep the stock market on track. Investors will also be keeping an eye on the Federal Reserve for confirmation that the central bank won’t retreat anytime soon. The Fed has employed almost every tool in its toolbox; its only remaining options are bringing interest rates below zero or buying equities outright.
Negative rates have been hotly debated, with many pointing to their detrimental effect in Japan as a reason to avoid them. Buying equities, on the other hand, would be a direct injection of strength into the U.S. stock market.
This year, the Fed bought corporate bonds for the first time in history, buoying investor confidence. If the central bank shows a willingness to buy stocks as well, we could see the stock market rally continue even higher.
China Tension Remains in the Background
As the U.S. and China shut down each other’s embassies and double down on harsh rhetoric, it’s surprising investors aren’t more concerned. Last summer’s simmering tension between the two nations didn’t come close to the level of hostility seen in recent weeks, and the stock market plunged in response.
Covid-19 has dominated the headlines, keeping investors more focused on case numbers and vaccine news. In a way, that’s a good thing as many believe the two sides will eventually work things out to avoid economic fallout. But if the tension between the two parties grows into something bigger, the stock market could be in for a rude awakening.
The U.S. has blacklisted Huawei and put pressure on allies to do the same. According to Ed Yardeni from Yardeni research, if Beijing responds with similar actions, it would command the attention of U.S. markets.
It certainly looks like a Cold War has started, and it isn’t clear there is any path for de-escalating. At some point, China might up the ante by doing something similar to an American company, and that is when the market will pay attention.
Some of the stock market’s biggest players depend on China for growth—Tesla (NASDAQ:TSLA), for example, is heavily dependent on the Chinese EV market.
Earnings On Tap
The final piece of the puzzle is earnings season, which hasn’t spooked investors so far.
Perhaps the most telling results will be those of stay-at-home stocks that have seen exponential growth. Many believe that the pandemic will cause a permanent shift in consumer behavior, boosting these stay-at-home names in the long-run.
As Netflix’s results showed last week, some of the enthusiasm surrounding stay-at-home stocks has been overdone. Other popular names like Peloton (NASDAQ:PTON), Zoom Communications (NASDAQ:ZM), and Teledoc (NYSE:TDOC) need to meet expectations to prevent a mass exodus from the group.
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 securities.