Is a Hopeful Market a Vulnerable One?

As of yesterday, the markets spiked again, taking the major indices back close to new highs. The S&P 500 closed at 3,534, less than 2 percent below the all-time high of September 2, just before markets tumbled. The Dow and Nasdaq results were similar. Clearly, the markets think everything is awesome.

Is Everything Awesome?

Yet, when you look at the data, everything is not awesome. Risks from the pandemic continue to rise, with several states now showing case growth levels that put their health care systems under serious strain. While the economy continues to recover, job growth has slowed substantially even as layoffs remain very high—and we are still only halfway back to pre-pandemic employment levels. In the markets themselves, we have seen significant volatility around the news cycle: the prior high, in early September, was followed immediately by a decline of almost 10 percent as the medical news worsened.

So, What’s Driving the Markets?

In a word, hope. As the election starts to look less uncertain, markets are hoping for a clean and fast resolution—and for another round of federal fiscal stimulus shortly thereafter. As COVID treatments improve and as a vaccine gets closer, markets are hoping that the pandemic will end soon and the country will reopen. And as corporate earnings improve, markets are hoping that companies will be moving back to normal sometime early next year as the country reopens.

To summarize, markets are now hoping for (and trading on) a smooth election, a big stimulus, the end of the pandemic, and the economy being back to 2019 normal early next year. If all that happens, then current prices, based on interest rates staying low, appear supportable. If all that happens, then we might well see markets move even higher. If all that happens, everything really will be awesome. If all that happens.

Right now, it seems like some of the good news might not happen. The pandemic news continues to deteriorate. The virus is still under control in many states, but it is not in control in many more. While the economy continues to recover, more damage is pending as multiple industries are now facing deadlines to downsize and as more and more people exhaust their savings and earlier stimulus payments. And while the vaccine and treatment news is good, we still don’t have anything approved, and obstacles continue to appear.

Are the Markets Vulnerable?

In other words, there is a lot of hope in today’s markets, which could well leave them vulnerable to bad news.

We saw this vulnerability at the start of September, with that 10 percent drop as the virus started to gain ground again. We saw it in early June on earlier adverse medical news. And, of course, we saw a major drop when the pandemic first came to the U.S. When bad news hits, the markets tend to react; the higher the hopes, the bigger the reaction.

Right now, hopes are high. But, so far, the news is supporting them. So far, so good. As investors, though, we have to be prepared for more bad news and the inevitable market reaction. Volatility shouldn’t be too scary, if we can see it coming. Right now, we can. Watch for more volatility the next time the headlines change.