This has been a crazy year for the stock market. In January and February, most investors did not take the reports of a new virus in Asia seriously and kept pouring money into the stock market, with the market reaching all time highs in late February. Very few investors bet that the virus would spread and shorted the market (also a few Senators with top secret briefings sold their stocks). But in March, when the virus started spreading in the U.S., stock markets overreacted and people anxiously pulled out more of their money from the market than was necessary. While the stock market hit a low in March, since then the stock market has had one of the fastest growth periods in history. By the end of August, stocks had regained almost all of their lost value from the pandemic, yet the world remains in a deep economic downturn that will likely take years to fully recover from and companies have decreased sales and persistent lost value. In this article we will try to answer the question of what has fueled the crazy swings in the market and discuss scenarios for what will happen next.
Stock Market Recovery
By August 2020, the stock market had recovered all the losses suffered during the pandemic fueled selloff that had occurred in March. The quick turnaround of investor sentiment can be attributed to four factors; the impact of the virus on the economy was less than feared, many corporation’s profits remained robust, Congress and the Federal Reserve propping up the economy, and the low interest rate environment left people with spare cash and few other places to park their money. We’ll explore each in a little more detail.
Impact on economy: This may seem counter-intuitive, since the world is seeing the worst economic decline in nearly 100 years, yet many feared it could have been worse and the initial stock market reaction reflected this. China and several major economies have the virus under control and have nearly returned to normal. Most U.S. corporations, that make up the stock market, are global in their supply chain and sales. Even as the U.S. expects to see a significant decline in GDP much of the world has nearly recovered.
Corporate profits: The virus is hurting small businesses harder than most corporations, except for the travel and entertainment industries where the pain is hitting small and large businesses equally. Looking at profits numbers from the second quarter, companies in the technology sector, and even some manufacturing, banking, and retail are at or above their profit numbers for the same time last year. This quicker than expected recovery in corporate profits helped push stock prices higher.
Government support: Congress acted quickly in the weeks after the virus hit to spend trillions of dollars to support the American economy. This spending put money in the pockets of the majority of American families, prevented foreclosures, and kept millions of Americans on the payrolls of businesses that would have otherwise laid them off. The Federal Reserve also took decisive action to lower interest rates to near-zero percent and provided lending to businesses both large and small at extremely low rates. These actions provided confidence for investors that businesses would not go bankrupt and that the government would not let the economy crater.
Investors with spare cash: Americans are spending less on travel and entertainment and most safe investments offer little return because the Federal Reserve has lowered interest rates to almost zero percent. Savers are get almost no return from keeping their money in a bank account. With extra cash and few other options offering a return on their money the stock market has seen a large influx of cash from individual investors, helping to push the indexes up.
While investors putting money is a factor in the stock market recovery, it has had the smallest impact. Far more important are the recovering corporate incomes and the aid provided by Congress and the Federal Reserve. This is why those predicting another coming market crash could easily be wrong and the government continues to promise additional support for struggling families and businesses.
I will predict with some certainty that the market will go up, but I don’t know how long it will take or what will happen between now and then. It seems like most people predict this fall will be a tough time for the market. The biggest questions relate to the factors that caused the stock market to recover; what will the virus look like in the fall, will the US government provide more support to families and businesses, and if businesses start doing poorly will all the same investors who have been pouring their savings into the stock market start quickly pulling their money out?
Return of the virus: Scientists agree that there is going to be a fall wave of the virus in the northern hemisphere. How severe it ends up being depends on the preventative measures that governments and people take. A large flare up would worry markets and likely cause another dip but if the virus gets under control that could assure markets.
Government support: The markets have been doing alright without additional government spending since Congress passed the last relief in May. The worry is more about what starts happening as a tenth of the American workforce remains on long-term unemployment, evictions increase, and Americans begin to default on loans. Economists believe that without another round of stimulus funding from the government we could see a prolonged economic downturn. This will depend on how long families and small businesses can hold out for another round of stimulus, either after the election or in the new year with a new Congress and a potentially new President.
Investor sentiment: This last point is more what could drive a stock market that is already balanced precariously over the edge. If there is some really bad news (e.g. a delay in the vaccine, a large spike in case, company bankruptcies) it could be investor selling that drives the stock market down. This could drive what would have already been a dip in the market into a even larger downward spike.
My advice through good times and bad remains the same: ignore what is happening in the news and instead setup reoccurring investments, based on your paycheck schedule into an index fund. The only time I would adjust these contributions is if you have more disposable income and can afford to increase your contributions. If you have seen a decrease in your income do your best to keep making contributions, but it’s alright to put investments on hold — just make sure to restart them when your income returns.
I strongly believe this is the best strategy. The problem is that you will constantly be told about people who bought stocks at the rock bottom, or who know what stock is about to explode. There are shows and articles proclaiming that they know the best stock to buy. For every one of those people there are ten more that timed the market poorly and lost more money than they made, or at least didn’t make as much as they would have just buying an index fund. By investing regularly and at spaced out intervals you will smooth out the markets big swings and you’ll make a sustained income The market has always gone up and it most likely will continue its jerky march upwards.
In a few years there will likely be articles written about people who invested wisely during the economic turmoil caused by COVID-19. Just look back at similar writings following the crash from the 2008 financial crisis. Investing smartly is the best way to ensure financial gain in the years to come.
I have written several other articles on smart investing that I hope are helpful to you:
- This story explains how to Get a Tax Break For Selling Your Stocks, something that people with stock market losses will find helpful
- I wrote a post called Rich People Don’t Keep Money in a Bank Account, You Shouldn’t Either
- Another is called Taxes on Savings are Unfair, Here’s How to Fix it
- 401(k)s are the Worst form of Saving, Except for All the Others
- Lastly, here is an important one called Did you Receive a Smaller Tax Return? Next Year Will be Worse