Is it Time for a Market Crash?

The stock market has repeatedly reached new all-time highs over the past weeks, and while new highs are essentially inevitable over long periods, there is considerable risk when those highs are reached without good reason or in good time.

Are Investors Too Optimistic About a Vaccine?

The coronavirus has ravaged the world, not only in lives lost but economically. In November we finally received much needed good news in a year that has found it lacking. Three pharmaceutical companies each announced that they had developed and tested highly effective Covid vaccines and approval for use in the United States is expected in a matter of days. Millions of doses are expected to be administered by the end of the year.

The vaccine announcements left investors dreaming of a return to normal by this Spring. In fact, the Dow Jones industrial average shot up over 1,000 pts during intraday trading before calming to a more modest 834 point gain at closing the day Pfizer announced their first vaccine’s success rates.

While the development of an effective vaccine is incredible news, it doesn’t mean the pandemic and its effects on the economy are over. Lieutenant General Paul Ostrowski, director of supply, production, and distribution for Operation Warp Speed(the government’s accelerated vaccine development program) says that any American who wants the vaccine will be able to get one by June 2021. Given that about 60% of Americans say they are willing to get vaccinated and roughly 10% of Americans already have antibodies to the virus due to prior infections, those numbers would start getting us close to the minimum 70% “herd immunity” scientist say we need to consider returning to normal.

Still, if everything goes right and we do achieve those numbers, it won’t likely mean a quick return to normal. Notably, the vaccine will not be 100% effective and those people who are immunocompromised may only receive limited protection from the vaccine. Additionally, most of the world will not have access to vaccines as quickly and in such numbers as the United States. These factors mean mask-wearing, social distancing requirements, and travel restrictions should extend much longer than this coming June. If we’ve learned anything over this last year it’s that every optimistic projection about the end of the pandemic has badly missed the mark.

We should be expecting retail stores, restaurants, hotels, entertainment, construction, and more to continue struggling for at least the first six months of the new year.

Why a Return to Normal Isn’t Enough

Global corporations have taken on nearly $1 trillion in additional debt in 2020 a 12% increase to debt levels that were already concerning before the pandemic even started. Typically corporate debt is used by companies to make improvements and upgrades that will result in more profitability down the road. In 2020 however, we’ve seen most companies deciding to put off major projects and instead of upgrading, they’re using debt to finance operating expenses like paying rent or salaries and pouring money into pandemic-related operating expenses like setting up temporary outdoor dining or installing plexiglass dividers.

Even if everything went back to normal tomorrow, many businesses will find themselves buried deep in debt and much worse off than they were twelve months ago. A return to pre-pandemic profitability will not be possible if companies only return to the amount of business they were doing pre-pandemic, especially if we consider another six months of debt accumulation.

To dig out of the hole, businesses will need a monumental surge from consumers. While this might be possible due to pent-up demand, there is a limit to how many times people can really go out to eat or travel to theme parks or go on a cruise no matter how much they miss doing those things. The move to online shopping was remarkably accelerated since the pandemic’s beginning and while many retailers were able to pivot to online options fairly easily(although at significant additional expense), it’s hard to imagine brick and mortar retail stores should expect any type of post-pandemic surge.

Stimulus Infatuation

Stock market investors have been counting on a new stimulus deal for months and many are even anticipating multiple stimulus deals. At least one deal looks close to happening and a big part of what’s driven the market’s climb has been the fear of not being invested when the next stimulus passes. With coronavirus cases skyrocketing and new lockdowns being announced weekly, additional protections and benefits are badly needed for Americans to weather the storm. The first stimulus deal sent out direct payments to most Americans, boosted unemployment coverage, and provided massive funding for businesses at a cost of about $2 trillion.

Despite the large price tag of the first stimulus deal, over 20 million Americans remain unemployed or underemployed and countless businesses have permanently closed or filed for bankruptcy. Future stimulus deals will be less generous and therefore less effective at shoring up the economy and businesses(let alone bringing several states back from the brink of financial ruin thanks to lost tax revenues). While the additional stimulus is needed and will help, we’ve already seen that even multi-trillion dollar deals are not enough to keep the economy running at full steam and the current $900 billion proposal will fall far short of of being able to do that.

At best, the previous stimulus and the most recent proposal are enough to keep the economy limping along instead of falling flat on its face, but they certainly aren’t enough to create a booming economy which is what the current stock market seems to be signaling.

The Disney Stock Case Study

At the end of Disney’s third-quarter in 2020, it was announced that the company lost $4.7 billion over the three-month period, or roughly $52 million per day. Their fourth-quarter results were much better due to some parks being allowed to reopen under limited capacity and a number of cost-cutting measures like laying off 28,000 workers. Still, the company lost $700 million that quarter(nearly $8 million per day). Ultimately, Disney chalked up an annual loss of $2.8 billlion, its first annual loss in 40 years.

It’s important to note that Disney does not operate on a calendar year. Its 2020 fiscal year actually began in October of 2019 which meant their first quarter saw no pandemic effects and their second quarter was only minimally impacted. Still, the company reported a large loss for the year. Analysts are predicting another loss for the quarter ending 12/31/20(though it doesn’t take an analyst to figure that out). However, most analysts are also projecting a return to profitability starting as early as January, but that seems far-fetched given that new virus waves have forced them to re-close the majority of their parks at least sporadically around the world and there is no hope that their California parks will open within their first two quarters.

Like many companies, Disney increased its debt to $55 billion in 2020 up from $38 billion in 2019 and $17 billion in 2018. Additionally, Disney announced they would no longer pay their semi-annual dividends which helped keep their stock attractive. Investors would likely point to the much better than expected subscriber numbers for Disney+ to justify the stock’s price, but even with the boost in subscribers, Disney’s streaming segment lost $2.8 billion over the last year and is not expected to profit until 2024. Despite their continuing losses, Disney’s stock is currently at an all-time high.

What Does It All Mean?

For the most part, investors are overly optimistic, if not desperately optimistic that the pandemic is ending. With effective vaccines coming soon, there is light at the end of the tunnel, but that light is still in the distance and any potential negative news on those vaccines will push that light even further out. Imagine a virus mutation that leaves the vaccines far less effective than testing has shown. Probable gatherings at Thanksgiving and Christmas most likely mean that the worst of this pandemic is yet to come. A spiking virus will not only mean more mandatory closures, but it will also heighten fear in people already cautious about venturing into public to spend their money.

The stock market is booming, but the economy is not. Disney’s stock could be considered a microcosm of the stock market as a whole. Major portions of its business model are being decimated, yet Disney’s stock price doesn’t reflect it at all. One way of measuring the reasonableness of current stock market prices is by dividing the current market capitalization(total value of stocks) by the country’s Gross Domestic Product(economic output). Current stock market prices are valued at over 180% of GDP, the highest percentage since just prior to the Dot Com crash in 2000, when market prices were around 160% of GDP.

Does this mean a market crash is imminent? Possibly. The market is never predictable, but it’s apparent that current values indicate elevated risk. Additionally, when the pandemic hit, millions of people began staying at home and many of them, buoyed by stimulus checks and extra time, became amateur day traders(stock market speculators). Shortly after the market crash in March, it was hard to find a stock that wasn’t a a winner. In fact, it was relatively easy to double or triple an investment in a very short period. Speculation by those traders has played a role in driving prices to where they are now, but the fun can’t last forever.