A Booming Stock Market Could Come Back to Bite the Recovery

(Bloomberg Businessweek) -- If you were to look only at the stock market and nothing else, you’d probably have no clue that 21 million Americans are still out of work. You’d probably think everything in the world is fine. Great, even..After all, the S&P 500 just posted its fastest 50-day advance in nine decades, and the Nasdaq 100 hit a record high, putting the entire blow from the pandemic behind it. Maybe it’s all justified, and the markets have been right all along. But skepticism still exists, particularly among people who say the equity advance could lull the ruling class to sleep..The argument is that market buoyancy such as that on June 5—when a climb of 2.5 million jobs in payrolls sent the S&P 500 up 2.6%—will undo the urgency for more economic stimulus at a time when unemployment still sits above 13%. And while you always find bears who see the downside of everything, including a recovering economy, anything that weakens the flow of stimulus is of concern to investors in a rally as forceful as this one..“The market has been relying on another stimulus package coming,” says Kathy Jones, chief fixed income strategist for the Schwab Center for Financial Research. If the markets do well and continue to improve, the risk is that Congress may decide not to do more—or at least not to do as much as investors have been counting on..Not that that’s mattered to equities so far. The S&P 500 rose almost 5% the week of June 1, helped by the rally after the jobs report stunned investors and economists alike. The benchmark is about 1% away from erasing its 2020 losses..Some say there’s more room to run. According to Michael Purves, chief executive officer of Tallbacken Capital Advisors, the next stop for the S&P 500 could be 3,400—just above all-time highs reached in February. Nicholas Colas, of DataTrek Research, sees a potential pathway for the benchmark to 3,430, although economically sensitive sectors including financials and industrials will have to lead the way..The idea that a strong market could affect the minds and plans of policymakers is a risk investors know all too well after events of the last few years. The current presidential administration often wields the level of the Dow as a barometer of success, and it’s thought to have played a role in the dialing up and down of the U.S.-China trade war. The U.S. Federal Reserve, meanwhile, has been seen by some as making the equity market its “third mandate,” alongside jobs and price stability..With stimulus measures from Washington and the Fed so crucial to the stock market advance and economic revival, investors are forced to wonder, What happens next if a stock market recovery ends with less support?.That, in essence, is the biggest concern of Peter Tchir, head of macro strategy at Academy Securities. His bullish predictions came to fruition as the S&P 500 jumped 40% from its March lows. Now he’s turned outright bearish on equities, concerned the government will quickly lose interest in pumping more stimulus into the economy in the presence of a surging stock market..“There’s an inverse relationship between the level of the S&P 500 and willingness for policymakers to come together to arrive at some sort of solution,” says Willie Delwiche, an investment strategist at Baird. “If the market stays up, chances of deals in Congress this year are likely to go down and are likely to approach zero.”.Recent economic data illustrate an economy that’s improving, but still contracting and likely in need of more juice. Yes, data from the Department of Labor showed that hiring rebounded in May, but data on Thursday showed an additional 1.9 million Americans filed for unemployment benefits in the week ended on May 30. That was down from the prior week, but far from a halt. A measure of U.S. manufacturing showed it beginning to stabilize, albeit at depressed levels..“Every 1% the S&P 500 rallies reduces the chances that a stimulus bill actually gets passed,” says Tom Essaye, a former Merrill Lynch trader who publishes a markets newsletter. That’s all the more significant considering that the current unemployment benefit boost created by the CARES Act is due to expire at the end of July..To be sure, while Republicans in Congress pointed to the market’s big gains before the crisis as evidence of the strong economy under Trump, they haven’t suggested the recent rebound is a reason to delay further action on stimulus. As of now, talks of another round are ongoing. Administration officials see the next package unleashing as much as an additional $1 trillion in aid, Bloomberg reported. But nothing is set in stone, and that amount is already lower than numbers discussed earlier..President Trump has touted the stock gains, tweeting Wednesday, “Next year will be one of the best ever, and look at the Stock Market NOW!” In a Fox News radio interview, Trump said “the stock market is booming.”.Monetary stimulus set by the Fed has also played a critical role. Chair Jerome Powell has made it clear the central bank isn’t in a hurry to withdraw measures in place. However, high-profile market watchers including Scott Minerd of Guggenheim Investments and former New York Fed President William Dudley have expressed concern over the creation of a moral hazard in which excessive risk-taking prevails because of the perception that the Fed will help out..Now, with prices on riskier assets surging and the labor market apparently healthier than previously thought, there’s a concern that the Fed may pull back on its supportive measures. To Mohamed El-Erian, chief economic adviser at Allianz and a Bloomberg Opinion columnist, that’s one of the biggest dangers facing markets..“This may encourage the Fed to be less supportive of markets,” El-Erian told Bloomberg Television after the release of the jobs data, explaining that the first major risk is that the data is an aberration, sending a message the economy is recovering faster than may be true. “To the extent that the Fed feels that its job is done, that is the second risk.”.He added: “The third risk is that the urgency for stimulus goes out the window. Do people think you don’t need any more relief, the market is doing the heavy lifting for you, the economy is doing the heavy lifting for you, governments no longer need to worry about relief or stimulus?” —With Justin Sink, Laura Litvan, Erik Wasson, Claire Ballentine, and Vildana Hajric Read next: A Tech Founder Cashed Out and Bet It All on Apple and Wells Fargo.©2020 Bloomberg L.P.

A Booming Stock Market Could Come Back to Bite the Recovery

The S&P 500 just posted its fastest fifty-day advance in nine decades. Twenty-one million Americans are still out of work.

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