Investors have been riding the wave of abundant liquidity in financial markets.
A spike in cash in the system has been driven by unprecedented actions taken by the Federal Reserve Board to shore up markets and stabilize the economy during the COVID-19 pandemic. The extra cash did its job: it’s been a key driver of stocks’ and bonds’ swift bounce back from the March lows. But with cash readily available, we’re noticing some heat in more speculative areas of the market.
It’s been a big wave: U.S. money supply has increased at a historic pace in this recession as the Fed and U.S. lawmakers have offered up monumental stimulus programs. In other words, we’ve seen the biggest increase of cash sloshing around in the financial system in recent memory.
To be clear, policymakers’ money moves were needed. In March, the U.S. economy basically shut down, and the powers that be needed to help businesses and consumers bridge the gap financially. In response, the Fed cut interest rates to zero and kicked off a comprehensive bond-buying program. Since then, they’ve bought $2.9 trillion in assets from Treasuries to corporate-bond exchange-traded funds (ETFs) to shore up investors’ confidence in markets by helping them to operate more efficiently.
That support is enticing companies back into the equity and debt markets to raise more cash, both to survive the economic shutdown and build up their own savings. Over 800 new issues of debt have been announced since March 16, more than two and a half times the dollar amount issued from the start of the year through March 16. The initial public offering (IPO) market also returned in full force. Nine companies have gone public this month (as of June 9), on pace to exceed May’s 12 IPOs and April’s 10 IPOs.
Low interest rates encourage companies and individuals to take on additional credit, theoretically stimulating investment in stocks as bond yields fall.
Today, the world looks a lot different, thanks to the Fed’s quick actions. Gauges of consumer confidence and job market health have started to stabilize, reflecting what could be the beginning of an economic recovery. Equity volatility has calmed from March highs and corporate spreads (measures of riskiness in company debt) have dropped back to lows. The S&P 500 climbed within 5% of a record high on Monday, just 11 weeks after hitting the lows.
Investors are also feeling unusually confident, to the point where we’re seeing them flock into more speculative parts of the market. Sectors like airlines and cruises have benefited from a surge in retail trading volume, even though the travel industry has been one of the hardest hit from the pandemic. Vroom and ZoomInfo Technologies — two companies that started trading on public markets in June – have more than doubled their share prices. Shares of Nikola, a vehicle manufacturer that’s forecasting zero sales for this year, increased six-fold from the beginning of May until June 8.
Companies are cashing in on this confidence. About half of the companies that have gone public since the start of April have been Special Purpose Acquisition Corporations (SPAC), which typically acquire companies with the money raised from their IPOs. Basically, they’re not your typical company, and the surge in popularity of SPACs shows more sophisticated investors may be taking advantage of the liquidity boom.
Shares of Hertz, a rental car company that declared bankruptcy, soared as much as 900% after it declared bankruptcy on May 24. Because of the recent jump in its share price, Hertz is reportedly planning to issue $1 billion in new stock to fund its restructuring efforts. That’s an unusual move at this point in the process, and while it could have a favorable outcome for the company, it may not be as favorable for the investor. There’s no guarantee these shares will be trading after Hertz’s restructuring, and equity investors are typically at the back of the line to get money back if a company does indeed shut down.
A rising tide may lift all boats (and cruise ships, rental cars and planes) but investors’ shift towards more speculative areas of the markets shows us the liquidity wave has encouraged what might be excessive risk-taking. That’s a concerning trend worth watching.
The tide turns.
Despite all the money in the markets, investors got a dose of reality on Thursday when the S&P 500 slid 6%. The day before, investors took issue with Fed Chair Jerome Powell’s June 10 comments, in which he painted a picture of a struggling economy after the Fed announced it would keep rates at zero and continue buying bonds at a rapid pace. Powell projected that the U.S. job market may take years to recover, and that “millions of people” may not be re-hired, while emphasizing that the Fed would support the economy until it’s well on the way to recovery. Fed policymakers also forecast the unemployment rate would stay above 5% through the end of 2022.
Powell’s grim comments were hardly surprising. U.S. companies have cut 19.5 million jobs since February, and the unemployment rate is still near a record high. Long-term economic damage looks inevitable at this point.
But combined with a surge in coronavirus cases, they served as a warning call to stocks. Stocks that investors piled into on the way up bore the brunt of the losses this week. The top-traded airlines and cruise lines among our customers slid as much as 30%. Nikola stock fell 24% from Tuesday to Thursday, while Hertz dropped 51%.
We’re firm believers that markets eventually catch up to economic reality, so the path could get bumpy from here as we navigate uncertainty. That said, the support of the Fed can’t be ignored and should help keep asset prices from falling as significantly as what we saw in March.
Longer-term, the risk of an over-inflated market shouldn’t be shrugged off given the increase in speculative trades. Remember, stock prices that have risen due to those types of trades are often the first and fastest to fall when the party is over.
The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.
Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.
Lindsey holds a passion for teaching individuals how to become successful long-term investors. She frequently shares her knowledge as a guest on national news outlets such as CNBC, CNN, Fox Business News, and Bloomberg News. She also serves on the board of Better Investing, a non-profit organization focused on investment education.