Welcome to the most expensive US stock market in two decades

The coronavirus pandemic has exposed a gaping disconnect between unprecedented economic pain on Main Street and extreme optimism on Wall Street.

The US economy is collapsing as never before. More than 30 million Americans have filed for unemployment. Millions of small businesses have requested forgivable loans to stay alive. And US GDP could decline at a breathtaking annualized rate of 40% during the second quarter.

And yet the stock market is racking up massive gains. Even after retreating on Thursday, the S&P 500 spiked 13% in April. It was the best month for US stocks since January 1987.

It’s common for Wall Street to price in a recovery long before Main Street feels it. The stock market is not the economy, after all. Investors look three to six months out into the future.

Yet the risk is that the slingshot in stocks leaves investors ill-prepared for the health and economic challenges that lie ahead.

“The market is pricing in something like a smooth-to-perfect recovery. But we shouldn’t expect it will go that way because the virus is a wildcard,” said Brian Nick, chief investment strategist at Nuveen, which manages more than $1 trillion.

Welcome to the most expensive stock market in 18 years

It’s not just that US stocks have raced back to life, catapulting 30% since the March 23 bottom. It’s that market valuations have become much more expensive, suggesting stocks are priced for perfection. The S&P 500 now trades at 21.7 times projected earnings, the loftiest level since May 2002, according to Refinitiv.

“We’re not expecting the market to just continue to melt up,” said Nick.

Part of that melt-up was driven by relief over Washington’s ferocious response to the crisis, which has lowered the risk of an economic depression. Congress and the White House enacted a $2 trillion stimulus package that includes forgivable loans to small businesses, direct payments to families and $500 billion in loans to distressed companies.

The Federal Reserve is racing to prevent a financial crisis by lending to cash-strapped businesses at an unprecedented pace, buying trillions of dollars of bonds and fixing broken markets.

“Central banks, led by the Fed, have gone to extraordinary lengths to backstop the financial system and shore up asset markets,” Jonas Goltermann, senior economist at Capital Economics, wrote in a report Thursday.

That’s why Goltermann said that even though “the worst is yet to come in terms of the economic data, we don’t think that this will necessarily stop risk assets from rallying further.”

‘Inevitable’ second wave looms

Investors are no doubt relieved that the rate of coronavirus infections has slowed enough to allow states like Georgia and Texas to begin to reopen their economies. Even New York and New Jersey, states at the epicenter of the crisis, have laid out plans to start their own gradual reopenings.

But Dr. Anthony Fauci, the nation’s top infectious disease expert, has warned that it’s “inevitable” that the United States faces a second wave of coronavirus infections in the fall.

“When it does, how we handle it, will determine our fate,” Fauci said Tuesday in an interview with the Economic Club.

That’s why the Federal Reserve said Wednesday that the health crisis “poses considerable risks to the outlook over the medium term,” a period that Fed chief Jerome Powell defined as “the next year or so.”

“How long will it take to get it under control? Will there be additional outbreaks? Will there be drugs that can either treat it or a vaccine of some kind?” Powell asked during a press conference. “All of that is very much shrouded in uncertainty.”

There’s also relief over progress in the fight against coronavirus.

Fauci said on CNN’s town hall Thursday that “if everything falls into place right” there could be a vaccine by January, though he also warned there are a “number of situations that could go wrong.”

Markets rallied this week after Fauci announced promising results for remdesivir, an experimental coronavirus treatment made by Gilead Sciences. However, medical experts and Wall Street analysts cautioned that remdesivir is far from a cure for the pandemic.

And yet the stock market is on fire. The Nasdaq posted its best month since June 2000.

“Over recent weeks, a path to our upside scenario, in which we see a sustained return to normality from June, has emerged,” Mark Haefele, chief investment officer at UBS Global Wealth Management, wrote in a report to clients.

Profound shifts in consumer behavior

He added that if a combination of testing, tracking and treatments brings about a “sustainable end to lockdowns,” then the central bank and fiscal stimulus could spark a recovery to pre-crisis economic output by the end of 2021.

But the real question is: If governors reopen, will consumers come? Until there is a coronavirus vaccine, Americans will likely remain reluctant to visit crowded sports venues, restaurants, conferences and airports.

“We’re not going to go back to life as normal,” said Laura Veldkamp, a professor at Columbia Business School. “I’ve learned that I like attending academic conferences from home. I like not slogging through LaGuardia and O’Hare.”

Such a shift in consumer behavior will have a profound impact on large swaths of the US economy, from hotels and airlines to Uber and Lyft.

Veldkamp co-authored a study that found that unprecedented events like the pandemic can lead to “belief scarring” — lasting and negative changes in consumer confidence. The persistence of those scars, the study concluded, will dictate the trajectory of the eventual recovery.

“The market is pricing in that all of this is resolved in the next 18 months, that there will be a very painful short term and then back to business as normal,” said Veldkamp. “I believe that’s too rosy.”

Cash hoarding, deflation risks

The optimism on Wall Street took a bit of a hit on Thursday. The Dow dropped 288 points, or 1.2%, after new reports detailing the damage to the economy.

The Labor Department revealed another 3.8 million Americans filed first-time unemployment claims in the week ending April 25. That brings the six-week total to a stunning 30.2 million jobless claims.

“The worst of the unemployment crisis still lies ahead,” Joe Brusuelas, chief economist at RSM, wrote in a report. “The distance between promise and reality for the working class of the economy has never been starker or more painful.”

The Bureau of Economic Analysis reported that the savings rate in the United States spiked to 13.1% in March — the highest level since November 1981. That cash hoarding reflects a deep level of nervousness about the economy.

Consumer spending, the main driver of growth, plunged by 7.5% in March. That’s the biggest drop on records going back to 1959.

The dreary numbers led some economists to warn of a disastrous deflationary spiral, a situation far more difficult to overcome than inflation.

“Extended deflation can wreak havoc on an economy, leading consumers and businesses to put off spending because they think prices will be lower in the future, weighing on asset prices,” Gus Faucher, chief economists at PNC, wrote in a note to clients.

Add that to the long list of risks that markets must contend with in the months ahead.