It’s like the bear market never happened. And maybe not.
The stock market had another good week, with the S&P 500 index ending up 0.6% to 3372.85; the Dow Jones Industrial Average up 497.54 points, or 1.8%, to 27,931.02; and the Nasdaq Composite gained 0.1%. The S&P 500 gain was good enough that the index ended the week 0.4 percentage point off its February 19 high.
But what if the market hasn’t experienced a bear market? By the traditional definition, that was obviously: the S&P 500 fell 34% from February 19 to March 23, far more than the 20% needed to meet the requirement. But there are other ways to tell if a drop is really a bear market. For example, a typical peak-to-peak recovery takes 1,542 trading days, on average, according to Dow Jones Market Data, so the speed of the rebound alone would suggest that something else is happening.
A bear market should also mark a clear break from what came before. This was the case during the financial crisis of 2007-09, as banks shifted from the top performing sector to the lag, and during the dot-com collapse, when tech stocks suffered massive losses but that the value investors have fled like bandits.
Instead, Michael Shaoul, CEO of Marketfield Asset Management, likens the drop to two other big drops, one officially a bear market and the other not.
The first came in 1987, when the S&P 500 fell 34% from its all-time high, including Black Monday’s 20% drop, still the largest single-day drop recorded. The second occurred in 1998, when the emerging market debt crisis and the explosion of Long-Term Capital Management hedge fund caused the S&P 500 to fall 19.3%. In both cases, the rebounds, spurred by the Fed’s largesse, were rapid and ended up creating bubbles – in Japan in the first, technology in the second. And in Shaoul’s opinion, another bubble is inflating.
“Under the current circumstances, the chances of central banks being ‘lucky for the third time’ seem slim, and we increasingly believe that we are heading towards some form of ‘bubble problem’ along the way,” writes Shaoul.
You don’t have to take his word for it. Take the example of Bank of America analyst John Murphy (ticker: TSLA) Tesla Friday morning upgrade – which earned 295% to $ 1,650.71 in 2020 – from sell to custody. It’s not that Murphy suddenly changed his mind about Elon Musk’s company. Instead, he cited Tesla’s unfettered access to cheap capital earned by its endless rise in its stock.
“It is important to recognize that the more the upward spiral of [Tesla’s] stocks disappear, cheaper capital becomes to fund growth, which is then rewarded by investors with a higher price, ”writes Murphy.
Think about it for a minute. Murphy describes a positive feedback loop, which is almost guaranteed to lead to a price well above what the fundamentals suggest. And that same dynamic is at play in many segments of the market, says Jason Brady, CEO of asset manager Thornburg. The market is led by companies that have gotten stronger from the coronavirus, may offer growth at a time when the Federal Reserve has pushed interest rates well below the level of inflation. It’s a good story, he says, but maybe it’s starting to get pushed too far.
“This is where things get a little silly,” Brady says.
So if the market is in a bubble, what could cause it to burst? BTIG strategist Julian Emanuel offers some potential catalysts. A vaccine could cause investors to buy economically sensitive stocks over those that benefit everyone working from home. Interest rates could rise, causing financial stocks to rise and inflated multiples to contract. Continuing tensions with China could also cause problems for high-tech stocks.
“Or will there be no catalyst, because bubbles tend to be identified with hindsight, as was the case in 2000,” writes Emanuel.
And maybe then we’ll have a real, genuine, honest bear market with God.
Write to Ben Levisohn at [email protected]