With a tanking economy why is the market at all time highs?

Few had predicted the speed and scale of the post-pandemic stock market recovery in the US. The blue-chip S&P 500 Index took just six months to hit fresh highs. Meanwhile QQQ, the Nasdaq-100 Index ETF, required a mere 15 weeks to recover from its pandemic lows. What is going on?

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How can a tanking economy with increasing job losses co-exist side by side with a stock market making new all-time highs?

Three trends are taking place.

1. Financial markets and the underlying economy are diverging, as they occasionally did in the past.

‘Animal Spirits’ often dictate the direction of stock prices. Currently, this bullish sentiment is pushing prices to record levels. None exemplifies this speculative spirit more than Tesla, whose shares quadruple in six months (see below). Such bifurcating trends can be interpreted two ways: Either the stock market is overly optimistic or the economy is too bearish. With the real economic trend continuing to deteriorate, one executive from GMO pointed out “the current market seems lost in one-sided optimism when prudence and patience seem much more appropriate.”

GMG GUIDE: HOW TO TRADE INDICES

2. The market leadership is narrowing.

Leading the index higher are mostly tech and healthcare companies. The former is benefitting from the pandemic-induced trend of remote working and communication, while the latter is racing to find new vaccines for the coronavirus. For example, Zoom (ZM), Facebook (FB), Amazon (AMZN) have all surpassed their March highs as investors piled into their shares. The largest tech firm of all time – Apple (AAPL) – is now worth $2 trillion, a value larger than the entire FTSE 100 (see below).

Meanwhile, banks, insurance, property/REITS, travel, industrial firms etc are all under pressure. Some have already gone bust; many more are reporting growing losses.

A narrowing leadership during a bull market is not sustainable. When job losses pile up, aggregate demand will drop significantly. This will impact the tech sector sooner or later.

3. The Fed is continuing to pursue its ultra-accommodative monetary policy.

Last I checked, the Fed Funds Rate is now at 0-0.25%, the same level established in the depth of the 2008 Global Financial Crisis. A year ago, this rate was 2.25%. This sudden drop in borrowing costs is fuelling speculative trading activity. Furthermore, the Fed is engaging QE like there’s no tomorrow. Note this: in the second quarter (Mar-Jun) alone, the Fed increased its balance by a staggering $3 trillion!

Fed Balance Sheet Changes (source: Federal Reserve)

2007-2020        $700b to $4.1 trillion             +$3.2 trillion

Mar-Jun 2020 $4.1 trillion to $7.1 trillion    +$3 trillion

With such an aggressive QE stance, no wonder stock prices are rocketing into the stratosphere.

Money printing on such as large scale is also directing money into ‘hard assets’ like gold. It is no coincidence that gold prices jumped to $2,000 after a gap of 11 years (see below). As long as the QE is continuing, more upside in precious metals are not to be ruled out.

GMG GUIDE: How to Trade Gold

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