COVID-19 Fuelled Stock Market Rally Has Created a Bubble That Could Collapse

Global stocks have been on a tear from their March lows, up almost 30%. Despite the strong gains, many believe the recent rally has created a bubble that could result in a stock market collapse. Why? There is far too much optimism about a quick economic recovery from the coronavirus. In fact, fears of a second wave of coronavirus (COVID-19) in the back half of 2020 could derail any such hopes and impale corporate earnings.

Could the Stock Market Rally Collapse?

On Monday, May 18, U.S. stocks rebounded sharply after their worst week in two months on growing optimism that a vaccine for the coronavirus will be found. This buoyed investor confidence which put them in a buying mood. The S&P 500 advanced 3.5%. The Toronto Stock Exchange was closed for the Victoria Day holiday. That optimism spilled over to the following day though with the Toronto Stock Exchange rallying higher.  

North American stocks advanced after it was reported that a drug company announced encouraging results from an early test of an experimental drug used to treat coronavirus. Investors are also taking solace in optimism coming from the Federal Reserve’s Chair Jerome Powell, who expressed the U.S. economy could recover in the second half of the year and that the growth would be substantial.

The two go hand-in-hand. If a vaccine for the coronavirus can be developed, it could provide the kind of reassurance people need to get businesses open and the economy back on track. That’s a big “if” though. And it appears as though many believe the surprising rally off March lows has created a bubble that could burst.

One recent poll found a majority (68%) of investors are calling the stock market rebound a bear-market rally; which suggests a fast, short-term bounce before retracing to new lows. Just 25% of investors believe that stocks have entered a new bull market.

On top of that, just 10% of fund managers expect the economic recovery to be V-shaped, meaning, a quick, sharp rebound. By comparison, a whopping 75% are predicting a U-shaped or W-shaped rebound, which would take a lot longer.

The U.S. and Canadian economies are starting to reopen, which is a good sign. But is it too soon? A second spike in infections would certainly curb consumer confidence and could result in another lock down, which would cobble corporate earnings, and lead to another stock market collapse.

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