Home How the pandemic drove massive stock market gains, and what happens next

How the pandemic drove massive stock market gains, and what happens next

How the pandemic drove massive stock market gains, and what happens next

Trader Peter Tuchman and specialist trader Michael Pistillo greet friends as they exit the New York Stock Exchange, (NYSE) wearing DOW 30,000 hats, in New York, U.S., November 24, 2020.

Brendan McDermid | Reuters

The pandemic turned 2020 into a year of unprecedented events — not the least of which was the swift crash and then record-fast recovery of the stock market.

The market’s race higher has been in stark contrast to an economy that has been growing slowly.

Many small businesses are struggling, and more than 10.7 million people are unemployed, according to Labor Department monthly data.

Even so, the market has powered higher, fueled by expectations of a period of strong growth after vaccines are widely distributed and the economy fully reopens.

Those same expectations have helped draw in a different cohort of investors, many of them young and new to investing. JMP estimates the brokerage industry added more than 10 million new accounts in 2020, with Robinhood alone likely representing about 6 million.

“One of the things that the pandemic has underscored more than anything else is that the stock market is a forward-looking mechanism,” said Michael Arone, chief investment strategist at State Street Global Advisors. “That’s been the tagline all year long as investors continue to scratch their heads wondering why the stock market could perform so strongly while the economy, labor market and earnings face such challenges. It’s more about future expectations than current conditions. It’s something that investors were loosely aware of in the back of our minds always.”

The market plunge and its rebound paralleled America’s response to the virus.

There was shock and fear, followed by hope for a recovery but with some setbacks along the way, as the virus continues to spread while investors look forward to the vaccine.

The year 2020 started off the way it was expected to, and then things went bad fast in late February and March as the pandemic spread and government officials around the world and in the U.S. shutdown economic activity.

“Usually it takes an unanticipated event to cause the market to get knocked on its ear, and nobody prior to the new year, that I can think of, said we’re going to have a problem with a virus in 2020, ” said Sam Stovall, chief investment strategist at CFRA. “Everyone creates their yearly forecast in early December, so if the market was still at an all-time high Feb. 19, obviously a majority of people continued to think it would be a good year and even with the virus in the background it would not be a world altering event — and oh, how we were wrong.”

The virus has thrown many trends that were already underway into hyperspeed.

“Everything was so fast. We went from peak to trough in 33 calendar days, which was three times as fast as the 1987 bear market. Feb. 19 was the record. It fell 34% in 33 calendar days,” Stovall said. “The Fed said we’re going to do whatever it takes, the market said you don’t fight the Fed and we got to breakeven on Aug. 18, which made it the fastest recovery on record and then we scored 19 new highs since then.”

Why a pullback could be lurking

The S&P 500 is up more than 65% since the March low, and nearly 16% for the year. The Nasdaq is 44% higher for the year. Stovall and other strategists say it would not be surprising to see a pullback in the early part of the new year, but he and others expect the market to end the year higher.

“Valuations right now are trading at a 42% premium,” said Stovall. He was referring to the premium above the average 12-month forward price-to-earnings ratio of 16.7 for S&P 500 stocks going back to the year 2000.

“There’s always a weird dichotomy between stocks and the economy except in the initial stages of a recession, when the economy falls sharply. The initial news that the economy is crumbling seems to crush the stock market, but the recovery is much longer for the economy than it is for stocks,” said Chris Rupkey, chief financial economist at MUFG Union Bank.

“The only difference in this stock market is the stock indexes have gotten to levels that are at values we almost haven’t seen before. … We haven’t seen valuations since before the internet sock market bubble in the late 1990s,” he added. “It’s OK for stocks to be here if companies are going to make a lot of money next year.”

Rupkey said investors point to the last recovery in 2009 and note stocks moved higher ahead of the economic recovery. But he noted that at the time, valuations were rising into the teens, not above 30.

The way investors look at the market has also changed, and that may be a direct result of how the pandemic has impacted the economy.

“Typically, when we go through economic downturns, people drift to consumer staples, utilities, and health care. … In a traditional downturn, you went defensive,” said Tobias Levkovich, chief U.S. equity strategist at Citigroup. Utilities are negative on the year, down about 5%; consumer staples are up 6.9% and health care is up 10%.

Levkovich also says it would not be surprising to see the rapidly rising market pull back in the new year. He said a 10% to 12% retracement is possible.

“The ‘defensive’ in the Covid world became who could grow in an economy where there is no growth,” said Levkovich. That would be like e-commerce, or Amazon, which is up 80% for the year.

“Defensive meant bulletproof balance sheets with free cash flow, and you ended up buying mega cap tech,” Levkovich said. The S&P information technology sector is up nearly 42% for the year, the best-performing of the major sectors.

“All in one fell swoop, mega cap was large cap, mega cap was defensive and mega cap was growth,” he said.

Stay at home vs. recovery

As the market climbed out of its pit, investors picked stocks that would do well as people worked from home and children attended school remotely. They punished stocks in businesses they could no longer enjoy — like airlines and cruise ships.

As vaccines became reality, they began to buy stocks that would do well in an economic recovery.

“We saw more small investors participate in the market, as did all of our competitors across the board, in a way that we’ve never seen before,” said JJ Kinahan, chief market strategist at T.D. Ameritrade. “We saw options usage increase and people understanding how to use options. … They’re defining their risk, which is something new. Retail investors tend not to do it.”

Kinahan said retail investors are also able to trade higher-priced stocks like Tesla and Amazon through the options market. He said many of the investors are young and new to investing and trading. At T.D. Ameritrade, millennials make up about 30% of its retail clients, an increase of 35% over three years.

As the stock market surged, there was also a massive boom in initial public offerings, the strongest wave of issuance ever. Investors have also levered their holdings and margin debt is at an all-time high, a potential contrarian warning.

“Right now there’s this great expectation. The downside is can we really live up to what everyone is expecting. What happens to the overall market?” Kinahan said. He said one question is can pandemic favorites Peloton and Zoom continue the growth they’ve had after the world returns to normal.

Levkovich said he also favors some areas that will recover with the economy.

“I think the most attractive bucket is probably that leisure, hospitality and entertainment. That’s where the massive demand that can’t get satisfied is,” he said.

–CNBC’s Kate Rooney contributed to this story. 

This article is auto-generated by Algorithm Source: www.cnbc.com


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