Frothy Markets: What’s the Harm in an Ever-Rising Stock Market?

Unless you’ve been living on a deserted island somewhere in the South Pacific, you know the equity markets have been on a tear since late March 2020. The S&P 500 alone made a gain of approximately 89% earlier this month to around 4230, up from approximately 2230. And while insurance agents don’t normally bring up stats regarding market action, there are products that we do use that have a connection to these markets. That and the fact that, as a former Investment Advisor, turning completely away from what was a daily exercise is difficult, to say the least. I should also note that while I cannot give advice regarding investment accounts, I can opine and give commentary regarding my views of the equity markets, as well as the economy in general. So, here we go…

Back in March 2020 with the equity markets in free fall due to Covid and subsequent lockdowns, the first of three stimulus payments was issued to most Americans, a product of the $2.2 Trillion CARES Act signed into law on March 27, 2020, by President Donald Trump. Approximately one year later, President Joe Biden signed into law another Covid relief plan, dubbed The American Rescue Plan, with a price tag of $1.9 Trillion. Included in this plan was another round of stimulus payments, along with relief for businesses, small and large, as well as increased vaccination efforts. Think massive liquidity injections into the economy.

Not long after the signing of this plan, the S&P 500 began its ascent, first recovering the losses from this past February, then surpassing that high to race to the all-time highs referenced above. Why did it suddenly reverse course and take off to these highs? In my opinion, there are three major reasons: first, many moderate to higher earners may have used their stimulus payments to invest in the equity markets. If someone didn’t actually need the payment(s), putting it to work is an efficient way to maximize growth from it. Secondly, since interest-bearing accounts pay practically nothing (with the Federal Reserve holding rates at historic lows), what better vehicle to utilize than the stock markets where there’s a chance to get a better return than approximately 1%? Thirdly, no fear of the Fed. Jerome Powell has stated that, for the near term, the Fed has no plans to raise interest rates until inflation averages over 2%. This means that not only does inflation have to reach 2%, but in order to hit that average, it has to surpass it. This gives investors, both individuals and entities, virtually no incentive to invest in fixed income, which are bonds or cash equivalent accounts.

So the question now becomes, what’s the harm in an ever-rising stock market? In my opinion, there are a few factors that pose a danger. One is looming tax increases on the horizon. It’s clear the Biden administration wants to raise both corporate and high earner individual taxes. While there are opinions galore regarding if the wealthy pay too much or not enough in taxes, it’s undeniable that their spending power has an impact on the economy. Removing some spending due to higher taxes could certainly have a negative impact on corporate earnings. But even if you’re not considered a “high earner” by definition, corporate tax increases are typically passed along to all consumers in the form of higher prices. Increased price(s) (inflation), makes the cost of living more expensive and also garners the attention of the Fed (previous paragraph). If inflation rises and unemployment remains low (healthy economy where demand is strong) the Fed will start becoming concerned about inflation and could raise interest rates. Rate increases in such a scenario may not have too much effect initially, however, if rates are continually raised, it will have the effect of throwing cold water on the recovery, thereby possibly lowering revenues. Alternately, if the recovery stalls or is uneven, reduced spending (with or without an interest rate increase) would have a negative effect on revenues as well.

In either scenario of reduced spending, earnings will probably constrict, leading investors to question if a company’s share price is justified. And (per The Motley Fool 4/23/21), since the current S&P 500’s price-to-earnings ratio (a ratio for valuing a company) is approximately 35 (whereas the average over the past 150 years is 16.8), negative S&P 500 corporate earnings could well lead to a correction. When, how long or how deep any correction may be is truly unknowable at this time, but odds are that one will occur, eventually.

If you’d like to talk about if it makes sense to remove some potential volatility for your peace of mind, please contact me at d.babecki@db3insuranceservices.com or give me a call at (941) 704-3134. As always, thank you for reading and let me know if I can be of service.

The above article reflects the opinions and thoughts of David J. Babecki. The information contained in this material is believed to be reliable, but not guaranteed. It is for informational purposes only and is not a solicitation to buy or sell any products which may be mentioned. It is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation.

Please note: all guarantees and/or promises are based on the claims-paying ability of the respective insurance company.