How Will A Stimulus Deal Affect the Stock Market?

Aside from the coronavirus, stimulus talks have been a major contributor to market volatility. Would more stimulus help boost the economy?

Oct. 29, 2020

Experts feel that the government’s original response to the outbreak – the CARES Act – gave the stock market a considerable boost, and feel another stimulus package is long overdue as the virus is still infecting record numbers in the U.S. and continues to hamper the economy. The stimulus package, passed in March, helped secure employment for many with its Paycheck Protection Program (PPP) and this helped boost the market. Additionally, many people invested at least part of their stimulus checks in the stock market. 

Schwab saw a record 609,000 new brokerage accounts opened and Robinhood saw daily trades increase 300% in March, year-over-year (YoY). Recently, President Trump announced that all stimulus negotiations must cease until after the election, causing the Dow Jones Industrial Average (NYSEARCA: DIA) to drop by 1.3% and the S&P 500 (NYSEARCA: VOO) to lose 1.4%; the market recovered after he partially reversed his position. He said he would consider a piecemeal plan that would help airlines, making airline stocks surge as high as 6% on October 7. When even rumors of another stimulus influence the stock market, can another cash injection help stimulate the economy or is it creating an unrealistic bubble?

Has the stimulus helped?

Experts at Bank of America agree that had the stimulus not passed, we would be in a different world today with the S&P 500 dropping to 1,720 rather than climbing to 3,400 as of October 27. That’s not taking into account the millions in furloughs and municipalities going bankrupt, so in the end, the CARES Act was a good thing for the economy. The stimulus helped sequential retail sales surge nearly 18% in May, way past the 8% forecast, and helped add 2.5 million jobs in the same month, again exceeding expectations of 8 million losses. Additionally, it helped boost manufacturing in the U.S. as verified by the ISM Manufacturing PMI increase to 43.1 in May from 41.5 in April, and it’s still climbing.

Unfortunately, only $30 billion of the relief, a little over 1%, was allocated for direct treatment and research of the coronavirus and that’s not a good thing as the economy will not fully recover without a viable vaccine. Federal Reserve Chair Jerome Powell fears that if another stimulus isn’t passed, household insolvencies and business bankruptcies will rise and have a negative impact on the economy.

Is it creating a bubble?

Whether you call it a stimulus or a bail-out, the government putting cash into society creates a huge potential for moral hazard and analysts are worried that that is what is happening. Before the pandemic and subsequent stimulus, roughly 20% of all publicly traded U.S. companies were zombies, or companies that earn just enough to continue operating and service their debt but unable to pay it off. That number grew to 32% during the outbreak as the Federal Reserve has no plans to raise interest rates and continues to purchase corporate bonds to ease credit conditions.

As the Fed continues lowering rates, zombies will grow and continue to negatively affect the economy, forcing the Fed to maintain lower rates or drop them further. This cycle is further accentuated by the Fed as it’s buying up junk bonds from sectors like energy, telecom, and health. Another stimulus will certainly boost the stock market but at what cost? The S&P 500 is already at a forward P/E of 24.19, eerily close to the 24.4 of 2000 right before the dotcom bubble burst. If another coronavirus bailout is issued, perhaps it would be best to fund the Fed with provisions to limit its rescuing of zombies. The proliferation of zombies only serves to inhibit growth and innovation in our economy and will impede long-term recovery.

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