The stock market continued one of the more extraordinary rallies in recent memory on Monday, with the major indexes gaining more steam less than two months after one of the most precipitous selloffs in history.
Despite historic unemployment and evidence that the U.S. Economy has been in a recession since February, Wall Street remained almost giddy as sectors of the U.S. Economy slowly started to reopen. Whatever shape the post-coronavirus recovery looks like, markets that have rebounded more than 40% from their March lows—effectively wiping out their losses—would lead one to believe that the worst is behind us and the recovery is well underway.
But for some investors, it may be too good to be true. Rupert Thompson, chief investment office at London-based wealth management firm Kingswood Group, warns that the markets are “now well ahead of the economic reality” and warns that “a correction remains on the cards over the coming months.”
Thompson points to last week’s surprisingly optimistic jobs report and additional fiscal stimulus efforts in Europe as having fueled some of the market’s recent bullishness, with investors eager to get in on the rally while they can.
“Fear of missing out—and quite a few investors have missed out, as the sharpness of this rally has caught most people by surprise—could yet carry equities higher near-term,” Thompson says.
Still, he notes that unemployment “remains higher than it ever reached in the global financial crisis,” and that it remains to be seen “how easily the newly unemployed will find jobs again even if lockdowns continue to be relaxed.” With generous unemployment benefits slated to expire in the coming months, Thompson cautions that “the real test for the economy will come as government support programs are wound down.”
Meanwhile, underlying metrics continue to indicate an equities market in which valuations are detached from underlying fundamentals. According to Kingswood, the global forward price/earnings ratio now stands at 17.5x, a 16-year high.
“Even if one looks through the sharp hit to earnings this year and focuses on next year’s likely rebound, price/earnings ratios now look high,” Thompson says.
That raises a conundrum for those debating whether to hitch a ride on the current rally or exercise caution. As Marc Chaikin, founder of quantitative investment research firm Chaikin Analytics, puts it: “Investors are now faced with the unenviable decision of whether to jump on a moving train or risk missing out on further advances in stock prices.” While the S&P 500 closed at more than 3,232 points on Monday, Chaikin believes the S&P’s rally should meet resistance at between 3,280 and 3,300 points.
Equity strategists at Bank of America are among those skeptical of the market’s ability to sustain its rally, as well as its reflection of the economy at large. They forecast a year-end level of 2,900 for the S&P 500 (up from a previous target of 2,600) and say the run-up has been mostly driven by growth stocks in the tech sector, which have helped take the Nasdaq composite to an all-time high.
“If the rally were from economic recovery inklings, the distressed, GDP-sensitive cohort of the [Nasdaq] would have led—a subset that has not rebounded until recent weeks,” BofA Global Research said in a note Monday. “Instead, liquidity looking for a home settled mostly into secular growth/stay-at-home beneficiaries.”