The Stock Market Is Propped Up By Day Traders & the Fed. How Long Until They Crumble?

The stock market’s valuation suggests that near-term gains are possible but that a correction will eventually tank share prices.
US stock market
Traders can thank the Fed and millennials for the stock market's impressive relief rally since April. But this recipe isn't conducive to long-term gains. | Image: TIMOTHY A. CLARY / AFP
  • The stock market is being propped up by the Fed.
  • Overzealous millennial investors are a driving force behind this unstoppable rally.
  • At some point, shares will have to trade on fundamentals, which are unlikely to support current levels.

Most stock market participants agree–this bull market is trading on the promise of an economic recovery and stimulus money. Low cost, commission-free trading brokerages like Robinhood made it possible for anyone to become a speculative day-trader. That has triggered a rally of epic proportions.

But is it sustainable? How much longer can the Fed and overzealous traders shoulder the burden of an overvalued market?

The Fed is Keeping the Stock Market Afloat

The Fed recently announced it would start buying individual bonds even though the bond market looked relatively healthy. The announcement helped investment-grade bond ETF LQD rise to all-time highs. As Bloomberg’s John Authers put it, the decision was unnecessary and has a glaring undertone: keep the stock market from crashing. 

 

stock market, federal reserve, stock market crash
The Fed’s intervention into the bond market appeared to be unnecessary. | Source: Bloomberg

Barstool Sports’ David Portnoy and his millions of followers saw their bizarre investments continue to rise. Portnoy’s running stock market commentary has become somewhat of a caricature of the current mood among today’s investors: buy anything with letters and it’ll go up. 

Dave Portnoy, stock market, Warren Buffett
Portnoy has been quick to proclaim himself as an “expert” despite only trading for a few months. |Source: Twitter

Portnoy even declared himself a better investor than Warren Buffett. The thousands of furloughed workers that plowed their stimulus checks into the stock market agree. That’s true for anyone who’s investment track record spans just four months.

Volatility Ahead

The dow, NASDAQ, S&P 500
With the stock market nearing all-time highs, it’s hard to imagine it’s fairly valued. | Source: Yahoo Finance

But Buffett’s experience is likely what’s keeping him on the sidelines. That’s because, eventually, share prices have to align with fundamentals. When that happens, it’s going to be a bloodbath. 

Peter Cecchini, a former Cantor Fitzgerald strategist, says the flood of new traders has created “an unholy speculative mix.” He noted that Portnoy and his followers seem to be convinced that stocks will always rise. That sentiment has been confirmed by the Fed’s commitment to propping up the market.

[Congress and the Fed have created] an unbreakable cycle of addiction to not only monetary policy but also fiscal policy. […] This may be the reason why David Portnoy just thinks stocks go up and up … can he really be serious?

Cecchini says that kind of risk-taking is evidence of a looming correction.

When Will the Stock Market Crash?

But the big question is when. For investors like Warren Buffett, who’s been looking worriedly at the lack of concrete data to trade on, this rally has been a missed opportunity. Some point to the most recent non-farm payrolls data as tangible evidence of a recovery.

But John Hussman, president of the Hussman Investment Trust, warned that the payroll data are simply a product of the government’s stimulus: 

What we are observing is not ‘recovery,’ it’s the impact of a government program that is paying the salaries of employees that are kept on payroll, whether they are actually working or not.

Hussman says his valuation model shows the stock market’s value is nearing dot-com bubble levels. By that metric, the S&P 500 could lose 66% of its value in the coming months. 

stock market, stock market valuation, stock market bubble
Hussman uses non-financial market cap versus non-financial corporate gross value-added to value the market. | Source: Business Insider

Despite that, Hussman says not to discount the power of Portnoy and his band of merry traders. In the near-term, the market could keep rising. Especially if the Fed continuously rewards speculators: 

Despite these headwinds, the repeated series of bubble-crash cycles of recent decades teach that there is no natural limit to the stupidity of Wall Street. When investors get the speculative bit in their teeth, it’s fine to be neutral, but it’s best not to fight the speculation by adopting or amplifying a bearish outlook

When Does Fear Outweigh Greed?

Now, investors have to decide when their fear of losing outweighs their desire to ride this rally. At the end of the summer, several potential downside catalysts could spark another selloff.

Warren Buffett, stock market, Dave Portnoy
While many believe Warren Buffett is ‘washed up,’ his investment theory could still prove to be true. | Image: AP Photo/Nati Harnik, File

This scenario is one that Buffet has preached for decades. Be greedy when the market is fearful and fearful when the market is greedy. Soon, investors will have to weigh whether or not share prices are based on reality or greed.

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.

Sam Bourgi edited this article for CCN.com. If you see a breach of our Code of Ethics or find a factual, spelling, or grammar error, please contact us.

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