A sign board in Toronto shows the closing number for the TSX on Thursday, October 29, 2020. THE CANADIAN PRESS/Frank Gunn

A sign board in Toronto shows the closing number for the TSX on Thursday, October 29, 2020. THE CANADIAN PRESS/Frank Gunn

Overheated stock market at risk of bubble in a disconnect from economy, experts say

TORONTO — “We’re all in this together” has been a common refrain since the arrival of the COVID-19 pandemic last March, but the yawning chasm between dismal economic data and soaring stock market valuations suggests some Canadians are doing much better than others.

A large segment of the population is untouched financially by the crisis or in better shape. The housing market is strong and those able to work remotely have saved mountains of cash they are using to pump up stock markets.

Meanwhile, lockdowns have caused major disruptions for workers in the service sector and other parts of the economy that have been forced to rely on government support.

“All the jobs that were lost in the country since the beginning of the crisis — not some, all — were in low-paying sectors, low-paying occupations,” says Benjamin Tal, deputy chief economist for CIBC.

North American stock markets have been on a tear since March, setting record highs almost daily even while COVID-19 has battered the economy and produced lacklustre employment data.

Some individual stocks have soared amid the froth. Tesla shares are up about 1,160 per cent over the past year while Ottawa’s Shopify Inc. has risen 425 per cent to become Canada’s most valuable company by market capitalization.

The S&P/TSX composite is up 65 per cent from March 2020 lows and 6.5 per cent in February alone. The rebound has been even stronger in the U.S., with the Dow up 73 per cent, S&P 500 79.5 per cent and the tech-heavy Nasdaq composite up about 113 per cent.

Meanwhile, Canada’s unemployment rate climbed to 9.6 per cent in January as 212,800 jobs were erased that month.

The disconnect between so-called Main Street and Bay or Wall streets is not new, but has been accentuated during the most “asymmetrical recession” in Canadian history, said Tal.

Retail investors with healthy cash balances have increased market volumes and contributed to frenzied buying that propelled stocks like GameStop and BlackBerry Inc.

The TMX Group, which runs the Toronto Stock Exchange, has noted that amid an increase in volumes, the proportion of retail trading peaked at 45 per cent of total volume traded in January, compared with an average of 35 per cent a year earlier.

“The things that are underlying the strength in retail trading are drivers that are going to continue for some time,” TMX chief executive John McKenzie recently told analysts on an earnings call.

He pointed to the low interest rate environment that supports market valuations, a large work-from-home culture right now and continuing growth in retail trading applications.

Famed investor Jeremy Grantham, who has predicted some past bubbles, now says that the bull market that began in 2009 has “matured into a full-fledged epic bubble” featuring “extreme overvaluation, explosive price increases, frenzied issuance and hysterically speculative investor behaviour.”

“I believe this event will be recorded as one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000,” he wrote in a commentary posted on his company website.

“These great bubbles are where fortunes are made and lost — and where investors truly prove their mettle.”

While some stocks are overheated and could burst, Tal doesn’t see that happening for the whole market.

“I think that clearly we have to distinguish between the speculative pockets everybody’s talking about and the general market,” he said.

“Of course there’s always risks that it will be dragged into it but at this point it doesn’t seem to be a reasonable scenario.”

Massive fiscal and monetary stimulus is propping up markets, observers say, unless earnings collapse and central banks tighten their policies.

Yet Federal Reserve chairman Jerome Powell said last week that the U.S. central bank will remain dovish until employment fully recovers.

Erik Bregar, head of currency strategy at the Exchange Bank of Canada, thought that the GameStop Reddit frenzy might have taken some speculative excess out of the market.

“But as soon as those stocks crashed, everybody breathed a sigh of relief and bid the market up again,” he said in an interview.

“It’s hard to kill this thing … you can make lots of fundamental arguments that it shouldn’t be this high, but it hasn’t paid to bet against it just yet.”

He said there’s just too much positive news and widespread expectation that the global economy will be strong in the second half of the year as COVID-19 vaccinations progress.

“I continue to believe that stocks are going to represent good value as we move forward here throughout 2021,” said Mike Archibald, vice-president and portfolio manager with AGF Investments Inc.

He said unlimited liquidity and people putting their saved money into the stock market are key drivers for its growth.

In fact, the savings rate and cash deposits have increased by more than 10 per cent the last two quarters, the highest level on record, says Brian Belski, chief investment strategist at BMO Capital Markets.

“Yes, valuations appear stretched at first glance, but they also need to be considered within the context of historically low interest rates and little inflation, ingredients that are likely to persist throughout 2021 and beyond, in our view,” he wrote in a report.

“When viewed through this lens, we believe it is not unreasonable for market valuation to sustain (or even expand slightly) from its current level.”

Some areas of the market, including cannabis stocks, cryptocurrency and parts of technology are “frothy,” but other investments remain attractive, said Archibald.

“By and large if you look at what I would call solid, stalwart companies … those stocks still appear to be reasonably priced to me and I still think there’s good upside potential for a number of those businesses.”

It’s natural and healthy for markets to pause after strong runs. Stock markets are forward-looking and anticipate where things are going in the future, not where they stand now.

“If you can look beyond the next few months, the outlook is looking extremely bright,” said Candice Bangsund, portfolio manager for Fiera Capital.

A near-term correction of five to 10 per cent is possible and should be viewed as a buying opportunity, but massive spending is putting a floor under any big movements downward, she said.

Besides, we won’t know if we are in a sustained rally or a speculative bubble “until it is in the rear-view mirror,” Kristina Hooper, chief global market strategist at Invesco, wrote in a note.

“And it really doesn’t matter for longer-term investors. The reality is that market rallies and corrections occur, but the trend line for stocks over the long run is upward.”

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