Opportunities and Risks of the Dramatic Rise in US Stocks

After the spread of COVID-19 to the United States in early March, U.S. stocks fell continuously, experiencing several meltdowns. However, since March 23, U.S. stocks have shown a V-shaped rebound, and the Nasdaq Index recovered its lost ground by early June, even setting new highs in early July. The S&P 500 and the Dow Jones Industrial Average have also surpassed their pre-pandemic highs. Why is there such a dramatic rise in U.S. stocks when the COVID-19 pandemic has not eased and the fundamentals of the economy continue to fluctuate? Given that Taiwanese and American stocks are strongly correlated (with a correlation coefficient of 0.95 from March 23 until July 9), the change in the trend of U.S. stocks deserves the attention of Taiwanese investors.

From observing the seven major factors that triggered the decline of U.S. stocks after the outbreak of the pandemic, it can be seen that four factors — fundamental economic decline, the proliferation of social media, a global supply chain crisis, and international political and economic disorder — still pose major risks to restraining the market. They have turned into the driving force for the V-shaped rebound of U.S. stocks, influencing the risk of decline in the credit and bond markets, the prevalence of systematic trading and the large technology companies that dominate the financial market.

Specifically, at the beginning of the pandemic, each country implemented quarantine and lockdown measures, hindering daily economic activities and resulting in the shrinking of corporate revenue and soaring unemployment rates. The first batch of countries where the pandemic broke out included major manufacturing countries, such as China and South Korea, which affected the global supply chain and economy. At the same time, contemporary social media has facilitated the spread of information and fake news, causing market confidence to plummet. Investors have sold risky assets, triggering a collapse in prices.

Coupled with its frequent reprimands of the World Health Organization being pro-China, and of China for hiding the pandemic, the United States is not shouldering leadership responsibility in pandemic prevention and the alleviation of disasters, as it has in the past. This global pandemic has resulted in a loss of central leadership, and geopolitical conflicts in Northeast Asia and Europe remain unabated. The instability of political and economic systems has also added to the chaos of efforts to prevent the pandemic, leading to the instability of financial markets. As a result, the overall financial environment is ripe with risk aversion. At the same time, due to the rapid freezing of economic activities, the risk of credit rating agency downgrades on the corporate bond market has increased, and investors are increasingly worried that a large number of fallen angels (high-yield bonds whose credit ratings have been downgraded from investment grade to non-investment grade) may emerge.

However, on March 23 the Federal Reserve issued an unlimited amount of quantitative easing, a monetary policy used to increase the domestic money supply, bringing a dramatic turn in the U.S. stock market. For example, it first announced an unlimited purchase of government bonds, investment-grade corporate bonds and other assets, and then expanded the scope of acquisitions to include eligible fallen angel bonds — greatly alleviating the concerns of previous investors about corporate bonds and stimulating the return of funds. At this time, the pandemic also showed signs of slowing down, which caused the financial market to become more optimistic and to move to a risk-chasing pattern.

In addition, the technology industry, driven by lifestyle changes during the pandemic, has also rebounded sharply. System trading has further expanded market vitality and brought opportunities to the financial market. The high equity-to-earnings ratio of U.S. technology prior to the pandemic caused concern among investors that the bubble would burst when the pandemic spread. Unexpectedly, the pandemic and the quarantine policies of various countries have promoted the booming home economy of online games, shopping and streaming platforms. The demand for remote work, big data and communication networks has greatly increased, and e-commerce and information technology stocks have rebounded against the trend. Technology giants, closely connected to the service industry, have become the main force in promoting the overall market. It has become quite common in recent years for technology giants to intervene in the online service industry, and the algorithms used in promoting e-commerce and information technology are primarily based on popular trading strategy systems.

In other words, the current rebound in U.S. stocks is due to the unlimited federal QE support to the market and investors who make bold purchases because they are afraid of missing out on money-making opportunities. The support from investors stems not only from a positive future outlook for technology stocks worldwide but also from hopes of triggering a boost in the capital market. Given the market optimism, four of the aforementioned seven factors can still be classified as risks that drag down American stocks.

For example, the global pandemic has yet to subside, which may force many countries to block off severely affected areas again and lead to a downturn in production and consumption activities. The interruption to the global supply chain has not been lifted, and its recovery will be even more difficult. The current financial asset prices and the decoupling of the economy imply a significant increase in market fragility, which can easily fluctuate with investor sentiment. Combined with the disorder of the international political and economic situation and the fueling effect of social media, even the slightest bit of turmoil will bring the possibility of a market reversal. Investors must be cautious.

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