Why did the stock market rise to record highs during the Covid-19 pandemic? Is it a bubble?

The timing of stock market gyrations are often hard to explain, and although the stock market crash at the beginning of the Covid pandemic is easy to understand, the dramatic rise later in the pandemic is harder to understand. Why would the stock market have risen much higher in September than it was a few months ago just before the pandemic started?


Most of the recovery in stock prices is a rational realization that the pandemic isn’t likely to be nearly as bad as the 1918 pandemic, but our current situation is still very bad and the market now seems to think the are no worries at all.  Why are investors ignoring the current economic fundamentals and uncertainty about the future?

One reason may be the dramatic rise in retail trading. Retail traders are individuals who are trading their own savings as a hobby. Many of them are ‘day traders’ who make such short-term trades that they often buy and then sell the same stock within a few hours the same day. Several news outlets have reported on this surge. One report suggested that retail trading has more than doubled compared with a year ago and basement speculators are pouring money into risky stock options like never before.

Why has retail trading surged? Because of the pandemic, most Americans suddenly found themselves with a lot more time as their entertainment options were curtailed and work was furloughed and they are turning to online entertainment like online gambling which has surged.  Surprisingly, the data also shows that Americans had a lot more savings than usual.  Here is the historic spike in the savings rate:

That is the highest the savings rate ever was since the government began collecting statistics in the 1950s. And why did the savings rate spike in the middle of the biggest 6-month contraction of GDP in recorded history? Because of the biggest 6-month monetary stimulus and fiscal stimulus in recorded history, much of which was funneled to households, some of which probably felt like it was ‘free money’ that people could gamble with and with Las Vegas essentially shut down by the virus, they put it in to retail brokerages instead.

Here is the size of the monetary stimulus:

That was more than double and close to triple the size of the monetary expansion during the financial crisis in 2008 depending on how you measure it. The Fed created new money out of thin air and lent it to the banks and to businesses and to the federal government.  The government then used the newly printed money to send out checks to all Americans, many of whom used the money to open retail brokerage accounts. Here is the size of the fiscal stimulus. It is absolutely enormous compared with the relatively minuscule stimulus bills that George W. Bush and Obama initiated during the Great Recession.

(Note that the vertical axis doesn’t start at zero, but it is still a dramatic increase in federal spending, nearly doubling the usual amount.)

A huge increase in the money supply should create inflation in theory if it is not hoarded. In this recession, there has been enough hoarding of the monetary expansion that there is no general inflation, but there has been some asset price inflation because some of the new money has poured into  stocks and bonds and bid up stock prices.

Most American households haven’t had the luxury to massively increase savings, so you might not know anyone who is doing this, but our high-income households are saving/hoarding a lot more than usual.  It is the well-off who are causing the spike in savings according to data gathered by a Harvard team and they are the most likely to also put money into stocks. High-income workers are also the most likely to have been working from home where the distractions of day trading are easier to succumb to than in the office.

Furthermore a lot of them are extremely optimistic about the economy.  Polls show that 67-70% of Republicans think that the economy is excellent now and indeed that it is better than it was four years ago. Republicans say they are extremely optimistic about the future, and if they are putting their money where their polls are at, perhaps that optimism helps explain why the stock market is also extremely optimistic about the economy.

There has been a growing partisan divide in how members of both political parties view reality and that includes how optimistic Americans are about the economy depending on which party controls the White House. Generally speaking, Democrats tend to be irrationally pessimistic about the economy when a Republican is president as is currently the case and Republicans tend to be irrationally optimistic. When a Democrat is in the White House, we see the reverse.

So both parties are guilty of irrationality about the economy, and whoever has their guy in the White House are more likely to irrationally say they are bullish.  That happens to be Republicans right now, but politics shouldn’t cloud our economic judgements. 

Personally, I’m guessing that stocks are in a bubble and I’m reducing my financial risks right now by pulling money out of stocks for a while because of the tremendous uncertainties I see in the next six months. I hope I am wrong and I miss out on a tremendous stock rally because that will mean that the economy is doing great, but if the economy staggers, at least I won’t lose a lot of money in the stock market. I think of selling off stocks as a way of buying a little bit of insurance against potential economic problems in the coming months.

I doubt there will be a repeat of the dramatic fiscal and monetary stimulus that surged into the stock market a few months ago and some of those retail investors might need to take some of that money back out of stocks to pay for living expenses at some point. That’s why I’m not optimistic about stocks in the next six months. 

Posted in Macro

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