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Portfolio > ETFs > Broad Market

Reasons to Be Wary About the Stock Market Recovery

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Coronavirus street sign Photo: Mipan/Shutterstock; Ffikretow/Shutterstock

The S&P 500 has recovered almost 33% from its late March low, but it may have gone too far too fast.

“Reopenings don’t mean recovery,” says Jeff Kleintop, chief global investment strategist at the Schwab Center for Investment Research. It’s also not clear that the countries with the biggest lockdowns will have the strongest reopenings, according to Kleintop.

He notes that defensive stocks have been leading the rebound in global stock markets, which is very unusual, suggesting that either global stock markets haven’t hit their lows yet or the economic recoveries will be long and slow.

How stock markets behave will depend heavily on how strong economies rebound from  lockdowns and whether new cases of COVID-19, which are likely to follow reopenings, will remain contained.

To understand those developments, Kleintop is following alternative data such as data on rush-hour commuting, air pollution, retail foot traffic and electricity usage in addition to the usual economic indicators.

His colleague, Liz Ann Sonders, chief investment strategist at the Schwab Center for Financial Research, says the U.S. stock market is not paying enough attention to “second-order economic effects” of the COVID-19 pandemic. 

U.S. stocks, for example, rose slightly the day the government reported that 20.5 million people had lost their jobs in April because it also reported that 80% of those job losses were temporary. But with a growing number of corporate defaults and bankruptcies at small and large companies, those temporary losses may become permanent, says Sonders, adding that such factors “need to be included in market expectations.”

The University of Chicago’s Becker Friedman Institute predicts that 42% of U.S. jobs lost through April 25 — or 11.6 million — due to the coronavirus will become permanent.

Sonders also notes that recent stock buying sprees are being propelled not only by quantitative and algorithmic buyers but also by small traders and individual investors, including sports bettors who are now turning to making stock bets, which adds another risk factor for the U.S. stock market.

Also underpinning the stock market recovery from the March lows — and the corporate bond market — is the Federal Reserve. It has been supporting the U.S. economy with near zero interest rates, asset purchases and multiple liquidity programs to backstop various bond market segments as well as Treasury programs to aid businesses, such as the Payroll Protection Program and Main Street Lending program.

Most of those programs haven’t even started yet, and those that have begun have used just a fraction of the money available, leaving the Fed with “lots of firepower” to do more, says Kathy Jones, chief fixed income strategist at the Schwab Center. “The Fed has even had success just by signaling what it can do,” says Jones.

Among bond markets, the municipal market especially faces challenges, says Jones. “State revenues are declining while costs are going up, much of it for health care” due to the COVID-19 pandemic and the economic shutdowns that followed.

The Fed has announced a municipal liquidity fund, which it recently extended to three years, to provide muni issuers bridge loans they desperately need, but ultimately more federal support will be needed, says Jones. “States can’t file for bankruptcy.”

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