The S&P 500 is close to an all-time high after selling off earlier in 2020 and some are seeing early signs of a bubble.

The S&P 500 is close to an all-time high after selling off earlier in 2020 and some are seeing early signs of a bubble, according to Barron's.

The stock market has recovered from a record sell-off in March when the coronavirus pandemic emerged in the US. Last week, the S&P 500 posted a 0.6 percent gain to 3372.85, the Dow Jones Industrial Average gained 1.8 percent rising to 27,931.02, and the Nasdaq Composite gained 0.1 percent. The S&P 500 is now within 40 basis points of its February 19 high.

If the S&P 500 reaches a new high, it would be the fastest recovery from a bear market ever. The previous record was 310 trading days from a bear-market low on Feb. 9, 1966 to May 4, 1967. If you started hibernation on February 19 and woke up on August 14, you wouldn't think anything had happened to the financial markets.

There are questions arising regarding the "bear market" this year. By definition, a bear market requires a 20 percent drop, and the S&P 500's 34 percent drop between February 19 and March 23 more than met that requirement. However, there are other factors that play into typical bear markets. According to Dow Jones Market Data, a peak-to-peak recovery takes 1,542 trading days on average.

Michael Shaoul, CEO of Marketfield Asset Management, compared the 2020 sell-off to two other big declines, one bear market and one not.

  • The first decline occurred in 1987 when the S&P 500 fell 34 percent from its all-time high- including Black Monday when the index fell 20 percent in one day.
  • The second decline occurred in 1998 when the market debt crisis and the downfall of hedge fund Long-Term Capital Management sent the S&P 500 tumbling 19.3 percent.

In both cases, the markets rebounded with support from the Fed and ended up leading to market bubbles. Shaoul believes another bubble is forming now. “Under current circumstances, the odds of central banks being ‘third time lucky’ appear to be remote, and we increasingly believe that we are heading for some form of ‘bubble trouble’ along the road,” Shaoul said.

Jason Brady, CEO of Thornburg believes the market is being driven by companies that have benefited from the coronavirus crisis. Investors believe these companies can grow while having access to capital at interest rates below inflation. “That’s where things are getting a little bit silly,” Brady says.

If the market is in a bubble, a few things could lead to a massive pop. BTIG strategist Julian Emanuel has identified a few.

  • A vaccine may lead to investors flooding cyclical stocks and selling-off stocks that benefit work-from-home policies.
  • Increases in interest rates could cause financial stocks to rise.
  • Further disintegration of the relationship between the US and China could pose issues for tech stocks.

“Or will there be no catalyst, as bubbles tend to be identified in hindsight, as it was in Y2K,” Emanuel said.

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Economics, Finance and Investing