The United States is in a recession.
Wall Street hasn’t mirrored that fact at all in recent months, with the S&P 500 rallying nearly 50% from its March 23 lows through today. After the market’s record-setting 11-year bull run ended in the blink of an eye in March, a new rally sprang up almost immediately. But has the rebound been too jubilant? Will the stock market crash again?
Here’s a brief look into five risks that could possibly threaten 2020’s stock market gains. This article will briefly look to five potential risks facing stocks:
— A “second wave” of the virus.
— Prolonged labor market weakness.
— Inadequate stimulus.
— Market dynamics: high valuations and heavy concentration.
— Political uncertainty.
Before getting into these, it’s important to distinguish between a bear market, defined as a 20% decline from a previous peak, and a stock market crash.
“I have been in the investment management business for 36 years,” says Hank Smith, head of investment strategy at The Haverford Trust Co. in Radnor, Pennsylvania. “During this time, I have witnessed what I would describe as two crashes: The one-day crash on October 22, 1987, where the Dow fell 23%, and this year, when the S&P 500 fell 35% in 4 1/2 weeks.”
Smith emphasizes, “(Crashes) are caused by exogenous events otherwise referred to as ‘black swan’ events. By definition, an exogenous event is off of everyone’s radar screen.”
Since the risks above are fairly well-known, Smith feels they’re pretty unlikely to cause an all-out crash in the near future.
Still, the most prominent risks specific to these times should be well understood by anyone wondering about another imminent market downturn.
The highest-profile immediate risk to the economy is what caused the 2020 stock market crash in the first place: the pandemic.
“There’s a concern about the failure of the economy to snap back,” says Brad Cornell, emeritus professor of finance at UCLA and senior advisor to Cornell Capital Group. If “the virus problem becomes more serious or the vaccines don’t work or there’s a second wave,” the risk of more prolonged economic despair — and a hit to the stock market — will elevate, Dr. Cornell says.
Prolonged Labor Market Weakness
August’s employment report showed 13.6 million Americans out of work, up by 7.8 million from February. Although the number of unemployed has been falling in recent months, the percentage who expect to be out of a job for the next six months has been rising.
“The largest risk to the workforce is that furloughed or temporarily unemployed individuals suddenly become permanently unemployed,” says Adam Coons, certified financial analyst and portfolio manager at Winthrop Capital Management.
For months, Wall Street has been anticipating a second major round of virus relief from Capitol Hill, although the partisan negotiations have seriously stalled out in recent weeks as the gap between the left and the right appears increasingly insurmountable.
“If (a) further stimulus is not agreed upon in Washington, the reduction in consumption will begin to trickle through the overall economy,” Coons says.
“The Republican Party will find it increasingly difficult to have a two-sided message that the economy is in a strong recovery, yet we need more significant stimulus,” he says.
High Valuations, Concentrated Gains
One thing many analysts and investors like to see in a stock market rally is market breadth — broad participation across different sectors and companies that each perform well. That has not been the case in 2020, where one sector and a few large businesses within it have led the way. Big Tech has been the belle of the ball, with Apple (ticker: AAPL), Amazon ( AMZN), Microsoft ( MSFT) and Facebook ( FB) all easily outperforming the wider markets to date.
“Stocks at large, particularly technology stocks, are pricey by historical standards,” Cornell says.
A new generation of investors has also been introduced to the markets via free trading apps like Robinhood, which offers fractional share and commission-free trading. These features allow investors with less capital to participate in the stock market in ways that previously weren’t financially feasible.
“There’s what we call the retail enthusiasm,” Cornell says. “There’s been a surge in retail investment particularly in technology stocks. It’s been rewarded with rising prices, but if prices started to fall, could those retail investors all try to get out of the door at once?”
That, he says, is another risk to consider.
Uncertainty Surrounding the General Election
The last of the five highlighted risks that could trigger a market crash is political uncertainty. Investors know what to expect from a Trump administration, but the way equities would be impacted by an administration guided by Democratic presidential nominee Joe Biden is less clear.
Biden wants to raise corporate taxes from 21% to 28%, which is often the fear cited surrounding his election. At the same time, his plans for infrastructure and green energy could inject hundreds of billions more into the economy that may help shore up the labor market.
Not merely the unknowns of a Biden presidency, but the global geopolitical uncertainty should there be a contested or drawn-out election result is yet another, perhaps slightly overlooked risk.
So will the stock market crash again after 2020’s remarkable rebound? That’s hardly something that can be clearly seen by the masses. Some of the biggest risk factors facing markets can be seen, however, and anyone of them could be a major contributor to a looming bear market.
That said, there are mitigating factors many market watchers, investors and analysts believe will help prevent another all-out market implosion. The most frequently cited? The Federal Reserve.
Following the Fed’s recent policy statement that it was unlikely to raise interest rates through 2023, Wall Street is more assured than ever that the central bank will step in where necessary to assuage fears, boost confidence and inject liquidity.
“Never before in its history has the United States Federal Reserve made such an explicit long-term interest rate commitment,” says Nigam Arora, chief investment officer at The Arora Report.
“As a result of the Fed’s policy, traditional valuation metrics are obsolete, at least for the next year,” Arora says.
Arora is far from the only expert to emphasize the unrivaled commitment of the Fed these days. That said, the central bank can’t prevent every shock, crash or sell-off in a free market system — no matter how hard it tries. And fiscal stimulus can’t solve everyone’s problems, either.
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Will the Stock Market Crash Again? 5 Risk Factors to Watch originally appeared on usnews.com