Are we in a COVID-19 stock bubble? Here’s why you should prepare for the worst and look long term

Lots of virtual ink has been spilled wondering what the heck is going on with this stock market. How can we be facing a nasty recession and yet stocks go wild, admittedly after a brutal drop in March? 

As I’ve written elsewhere, the market is being driven, at least in the short term, by lots of liquidity. The Federal Reserve has committed to holding interest rates at near zero through 2022, and the government unleashed a flood of deficit spending. Not only have rates been slashed but the Fed is out there in the market buying securities and putting a floor on prices.

The net result of those actions has been a de facto “put” on the stock market. That is, investors are truly betting that the government will ride in to save the markets – and it (so far) hasn’t been a bad bet! The market is up a stunning 49 percent since its recent low, and the strength does not show any signs of flagging. 

Still, that hasn’t stopped big named investors such as Mark Cuban from warning people that today’s market feels like the dotcom bubble. I can’t say I disagree with him, either. While the Fed’s liquidity can juice the market in the short term, the fundamental performance of the companies themselves drives long-term returns. And we’re just not that deep into the crisis that we’ve been able to see how things will affect the numbers at corporate America. 

Sure, things are tough and profits are down for many companies now, but the question is not on today’s numbers but rather tomorrow’s. Will the economy be stronger in six months and trending up? Or will the spring-back in unemployment fizzle and we’ll just be muddling along or worse? 

We’re already seeing signs that the real economic rebound is slowing, with the rapid swingback in jobs slowing. Yes, it’s still increasing but at a lower rate. But some jobs won’t be coming back. For example, The Wall Street Journal just reported that 15,000 restaurants across the U.S. have permanently closed. This is just the first-order effect of the crisis. If the economy doesn’t get back on track soon, plenty more businesses will become second-order effects of the crisis – out of business not because of the crisis itself but because of its follow-on effects. 

It all sounds scary – and it is. And guess what? NO ONE knows what’s going to happen from here. We’re at a point where things could go either way. If the government unleashed some massive spending plan and could rush it into action, I might be more optimistic on the economy. But even if that doesn’t happen, we may still recover soon – or not.

Of course, the economy should eventually recover, but we may well go through a lot more pain along the way. Without a silver bullet for the coronavirus such as an effective vaccine, an economic recovery is likely to be stop-and-go, at best. 

What should investors do?

So how should investors respond to all this uncertainty? Probably the way that makes the most sense – keep a long-term mentality, keep investing, and prepare for the worst.

1. Keep a long-term mentality

In 1987, stocks suffered their worst one-day performance in history – down about 23 percent in a single day. A single day! However, if you look back on a 40-year stock chart, you’ll see barely a bump (see the chart above, about 1/4 of the way across). It didn’t matter one iota on your long-term returns – if you didn’t sell and go away. The S&P 500 still managed to keep to its long-term average of 10 percent annual returns. If you had some extra cash lying around, you could have bought on the dip and had even higher returns. 

2. Keep investing

The stock market is a proven wealth generator, allowing you to rack up gains by owning a piece of some of the world’s best businesses. It’s vital to your own long-term wealth that you own some of them. That doesn’t mean you have to be 100 percent allocated to stocks, of course, but you need some assets in a well-diversified portfolio of stocks. If you want to dial back your exposure to stocks some, fine. But for those with a long time horizon, stocks are the best game in town. 

3. Prepare for the worst

If you’re relying on your stock’s performance today or tomorrow (as opposed to five or 10 years from now or more) to fund your lifestyle, then don’t. If you can live off your dividends and never have to sell, then bully for you. You’re going to rack up some monster gains by not having to sell. 

However, if you need to sell your stocks, you may have to do so when they’re down – not an ideal situation. Money that you definitely need to live off of should be in cash or cash-like accounts (high-yield savings accounts, for example), so it’s there when you need it.  

Where do you think we’re heading now? What are you doing to prepare?