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RCU Investment Review

The Bull Market Is Back... Will It Keep Charging?

Jan 23, 2021
man thinking at computer in office

On August 18, 2020, the S&P 500 set a record high for the first time since COVID-19 ushered in a bear market on February 19. The cycle from peak to peak was just 126 trading days, the fastest recovery in the history of the index, erasing losses from an equally historic plunge of almost 34% in February and March.1

Based on the traditional definition of market cycles, the new record confirms that a bull market began on March 23 when the index closed at its official low point. This also confirms that the February-March bear market was the shortest on record, lasting just 33 days.2

Although the strong comeback is good news for investors, there is a striking disconnect between the buoyant market and an economy still struggling with high unemployment and a public health crisis. The market is not the economy, but the economy certainly affects the market. So it may seem puzzling that the market could reach a record high not long after the largest quarterly decline in gross domestic product (GDP) in U.S. history.3

Furthermore, stocks jumped to new record highs at the end of December after President Trump signed a pandemic relief package into law. The S&P 500, the Dow, and the Nasdaq closed the day at record highs as investors saw the stimulus relief as a boost to economic recovery

 

Steep Fall, Rapid Recovery S&P 500 Index graphic 12/31/19-8/18/20

Optimism vs. exuberance

Whereas GDP measures current economic activity, the stock market is forward looking. The rapid bounceback suggests that investors believe the pandemic will be controlled at some point and that business activity will return to normal. The current economic situation remains tenuous, but there are hopeful signs. With a vaccine available investor optimism rises and economic confidence returns. In the meantime, the virus continues to suppress business activity amidst the holiday spike.

Nowhere else to go

Low interest rates make it easier for businesses and individuals to borrow, but they have reduced bond yields to the point that many investors are willing to take on greater risk in equities in order to generate income. Money that might normally be invested in the bond market has poured into stocks, driving prices higher. This situation has its own acronym: TINA, There Is No Alternative to Stocks.11

Big tech at the wheel

While the S&P 500 is generally considered representative of the U.S. stock market as a whole, the recovery has centered around technology companies, which have helped provide goods and services throughout the pandemic. The Big Six tech stocks — Apple, Facebook, Amazon, Netflix, Microsoft, and Alphabet (Google's parent) — were up collectively by more than 43% for the year through August 18. By contrast, the rest of the companies in the S&P 500 were down collectively by about 4%. The Big Six tech companies now represent more than one-fourth of the total market capitalization of the S&P 500 and thus have an outsized effect on index performance.12

Are stocks overvalued?

The most common measure of stock value is price/earnings (P/E) ratio, which represents the stock price divided by corporate earnings over the previous 12 months or by projected earnings over the next 12 months. The projected P/E ratio for the S&P 500 on August 18 was 22.6, the highest since March 2000 at the peak of the dot-com bubble. Big tech stocks were even higher, trading at 26 times their projected earnings, and the Big Six were higher still at more than 40 times projected earnings.13-14

In considering these valuations, keep in mind that these are extraordinary times, and traditional expectations and measures of value may not tell the whole story. If nothing else, the extreme volatility and rapid market cycles of 2020 have illustrated the importance of maintaining a diversified all-weather portfolio and the danger of overreacting to market movements. While new records are exciting, they are only signposts along the road to achieving your long-term goals.

The return and principal value of stocks and bonds fluctuate with changes in market conditions. Shares, when sold, and bonds redeemed prior to maturity may be worth more or less than their original cost. Investments seeking to achieve higher yields also involve a higher degree of risk. Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss. The performance of an unmanaged index such as the S&P 500 is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is not a guarantee of future results. Actual results will vary.

1, 3, 6, 8, 11, 13) The Wall Street Journal, August 18, 2020

2) CNBC, August 18, 2020

5) U.S. Bureau of Labor Statistics, 2020

7) The Wall Street Journal Economic Forecasting Survey, August 2020

12, 14) The Washington Post, August 20, 2020

Categories:
  • Stock Market

*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. The credit union has contracted with CFS to make non-deposit investment products and services available to credit union members.

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