The S&P 500 has rallied 32% since bottoming on March 23^rd, mainly thanks to the unprecedented levels of both fiscal and monetary stimulus. Optimism surrounding economic reopening and potentially successful vaccine & drug treatment discoveries has also helped propel stock prices higher over the past few weeks. However, there are plenty of reasons to believe that this is a bear market rally as opposed to the start of a new bull market, and investors should resist the urge to buy into this rally due to ‘Fear Of Missing Out’.

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Record stimulus is not a magic bullet

While the record stimulus measures globally may help alleviate liquidity and solvency problems to a certain extent in the short-term, we are inevitably confronted with a massive debt crisis worldwide. In terms of Corporate America, both small and large businesses will have high debt levels to repay once this pandemic passes amid a fragile national/global economy. Hence in the face of mass debt repayments, businesses are likely to be more financially conservative and cautious in terms of re-hiring workers.

In fact, various businesses are already filing for bankruptcy, demonstrating that regardless of the record stimulus efforts, not all businesses and jobs will be saved. Zombie companies, those with little/no revenue and high debt levels, employ about 2.2 million Americans. Hence, if these vulnerable companies go under, that would be a lot of job losses (that were perhaps keeping the unemployment rate artificially low prior to this crisis).

Many jobs that have been lost are likely to be permanent, not only due to bankruptcies, but also due to companies reorganizing in the post-pandemic era. In fact, the rate at which companies are embracing digitalization and artificial intelligence has been accelerating amid the pandemic, as they seek to become more cost-effective, productive and less-dependent on people. Automation was already expected to eliminate many jobs over the years to come, though the pandemic has given this trend an extra boost, putting many people’s jobs in jeopardy in a very sudden manner, such as in the call center industry.

As the unemployment rate remains elevated even once the pandemic passes, and revenues and earnings growth don’t recover as quickly as markets are currently pricing in due to weak macro conditions, market bulls will come to the realization that asset prices have become over-stretched, and another crash will be inevitable.

Valuation metrics

In fact, stock prices are already extremely stretched at the moment, with the S&P 500 trading at a forward PE multiple of 21x, which is even more expensive relative to the February peak in the index, when it was trading at 19x and analysts were a lot more certain about earnings prospects.

Furthermore, another important equities valuation metric, the Total Market Capitalization to GDP ratio, is also flashing red. The ratio currently stands at 139.3% (1.39), which reflects extremely overvalued conditions and stands at around the same level as at the peak of the dotcom bubble. Prior to this crisis, the ratio peaked at an all-time high of 152.70%, way surpassing the dot-com peak.

Stocks are trading at lofty valuations while the economic outlook and earnings prospects have rarely been this uncertain. This is not the time to wage bets on stock prices moving higher.

Retail investors are piling in: a classic sell signal

In the first quarter of 2020, Robinhood witnessed 3 million new broker accounts, Charles Schwab saw 609,000 new accounts, TD Ameritrade opened 608,000 accounts, and finally Etrade saw 363,000 new account openings. These numbers tally up to 4.58 million new brokerage accounts, as stock brokers reveal just how active retail investors have become in the market, believing this is the opportunity of a lifetime.

Retail investors piling into the stock market is a classic sign for professional investors, or the so-called “smart money”, to exit the market, as it signals the last phase of an asset bubble. The influx of retail investors is a strong confirmation of the fact that this is a bear market trap.

Bottom Line

With economic conditions unlikely to return to the ‘pre-coronavirus normal’ anytime soon even as the pandemic ends, stock prices at lofty valuations and retail investors piling into stocks, there is no doubt that this market is bound to take another leg lower as realism sets back into the markets. It is not advisable for long-term investors to allocate capital into the equity market in these conditions.