Stock Markets Are in Fantasy Land – 3 Reasons Why

Stock Markets Are in Fantasy Land – 3 Reasons Why

The US economy is in a shambles, with over 40 million Americans having lost their jobs since the coronavirus-related economic shutdowns began. While the official unemployment rate is at around 15%, the real rate is probably closer to 25%. Second quarter GDP is expected to fall by as much as 50%, a bigger drop than during the Great Depression. And hundreds of cities across the country are seeing rioting, looting, and destruction of businesses. With all this as a backdrop, how would you imagine stock markets are doing?

If you thought all this negative news would negatively impact stock markets, you’d be wrong. Markets are up almost 10% this month, something that boggles the mind of anyone with any sense. How could stock markets look at all this negativity, not to mention the pessimistic outlook for the future, and keep on gaining? Here are three reasons why.

1. Federal Reserve Liquidity

The major driver of stock markets right now is the huge amount of liquidity that has been pumped into the financial system by the Federal Reserve. Over the past few months, the Fed has added nearly $2.8 trillion to its balance sheet. Much of that money has made its way to Wall Street, helping fuel the continued bull run in stock markets. But how much longer can the Fed keep it up?

President Trump wants stock markets to remain high through November, to help his reelection chances. But with the Fed having already created nearly $3 trillion in new money out of thin air, how much more money will the Fed have to create in order to keep stocks pumped up until then?

As with all stock market bubbles, when the monetary spigots close, the party will end. No one knows when that will happen, as the economy is still in poor shape and there’s a great likelihood of continued Fed intervention. But at some point the Fed will either slow its money creation significantly, or the effects of continued marginal money creation will be greatly reduced, and stock markets will start a long overdue decline.

2. New Buyers

The effect of new and inexperienced investors can’t be discounted either. Millennials are starting to buy stocks like never before, with apps such as Robinhood catering to millennials and offering free stock trades easily with a smartphone. But the problems with Robinhood are well known, at least to those observing the company from the outside.

The company sells data on purchase and sale orders to other firms, allowing them to front-run moves in the market. And the company itself has repeatedly had to resort to drawing on lines of credit, which makes it unclear what will happen to millennial investors and their stock holdings if the company ends up going out of business.

The tail end of every stock market boom features new, inexperienced investors rushing into markets just as everyone else is trying to leave. This time is no different, as millennials using Robinhood have piled into more and more bad stocks. They’re not doing their due diligence and are investing in big names they know, without regard to the financial position of these companies or their future performance.

Millennials piled into Hertz stock, even after the company declared bankruptcy. In their mind, Hertz was a big enough name that the company couldn’t possibly go under, so they purchased more and more stock as the price plummeted. But with coronavirus affecting travel so significantly, the likelihood that Hertz will be able to recover and return to business as usual is slim, so these amateur investors may end up losing all their money.

Millennial investors also love tech stocks such as FANG stocks (Facebook, Apple, Netflix, Google) and other tech companies whose products they use on a daily basis. The five biggest stocks on the S&P 500 right now are Facebook, Apple, Amazon, Google, and Microsoft, which collectively are up 15% this year, while the rest of the S&P 500 is down 8%. These amateur investors ignore the threats to these companies from competitors because they can’t imagine a world without these companies. Yet 20 years ago some of these companies either didn’t exist or were mere blips on most radar screens. And 20 years from now they could end up being eclipsed by new competitors.

These amateur investors don’t have unlimited financial means, so they won’t be able to influence stock markets for long. But as long as they’re buying, the stock market rally will continue.

3. Buying the Dream, Not the Reality

In general, investors today are buying into hopes and dreams about the health of the US economy rather than the stark reality. You read a lot about the resilience of US industry, the underlying strength of the US economy, and the ability of businesses to rebound from setbacks. But the reality is that there will be no V-shaped recovery, hundreds of thousands of businesses will shutter this year, and millions of Americans will remain unemployed even after the economy has fully reopened.

How long will it take for investors to wake up to the reality and realize that the Dow Jones won’t break through 30,000 points, or that the S&P 500 won’t break 3,500? Trillions of dollars of liquidity can paper over problems with the economy for a little while, but eventually investors will get wise to what’s really going on, and everyone will head for the exits.

A Note About Corporate Buybacks

A major component to the stock market bull run of the past several years has been corporate stock buybacks. But between the coronavirus lockdowns and new federal restrictions on buybacks from companies receiving bailouts, buybacks have come nearly to a halt. There’s a high probability that 2020 will see a significant reduction in stock buybacks, which definitely will impact markets. New investors and Fed liquidity are picking up the slack for now, but ultimately they won’t be able to keep up the same momentum that buybacks had.

What Will the Future Bring?

It should be clear that the combination of factors driving the stock market bull run over the past several years won’t be sustainable over the long term. Even over the remainder of the year, there is a greater likelihood of a major stock market crash than of continued gains. Investors who are able to position themselves correctly now in advance of the crash will be best protected once the crash actually occurs.

In many cases that means investing in gold, which protected many investors from the worst effects of the 2008 financial crisis. With stock markets due for a major crash as the economy continues to reel from the effects of the coronavirus shutdowns, gold is becoming an increasingly popular investment asset for those looking to protect their retirement savings. With a gold IRA, investors can even roll over existing assets from tax-advantaged retirement accounts without tax consequences. If you want to protect your investment portfolio, you should start thinking about investing in gold today.

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