Another volatile week in the U.S. equity market highlighted an inconvenient reality that investors have not yet fully grasped: Stocks now lack not just upward drivers but also anchors to maintain what has been an astonishing disconnect between elevated prices and challenged economic and corporate realities.

The market has seemingly exhausted three potent drivers of returns — policy support, fundamentals and retail inflows — and investors are left searching for a new fuel for a market that is now missing not just momentum but also a stabilizer. Their hope is that the Federal Reserve will come to the rescue again with a new round of policy support. This “Fed put” has proved to be highly effective in the past in repressing volatility, enticing more risk-taking and attracting additional investment funds. The risk is that the central bank feels more compelled to wait for further signs of market stress before extending an already stretched, if not overstretched, policy response.

A down week for the S&P 500 Index, which dropped 3%, has now taken returns for June into negative territory and exposed investors to considerable daily volatility. Dispersion among the top indexes remains evident, especially with the exhaustion of the rotation trade that for a short time favored many “reopening” stocks, especially those that had lagged badly. Consequently, the Nasdaq composite index is still up 3% for the month while the Dow Jones Industrial Average is down 1%. That divergence has produced a 9% gain for the Nasdaq so far this year but an 11% loss for the Dow and a 6% drop for the S&P 500.

Behind these numbers are drivers — mostly sequential but also overlapping at times — that impressively pulled the main indexes from their lows on March 23 but started to run out of steam after June 8, when the Nasdaq hit a record and the S&P 500 briefly turned positive for 2020. Since then, the S&P 500 has lost 7%, the Dow 9% and the Nasdaq 2%.

The first surge after March 23 was essentially led by extraordinary fiscal and monetary policy interventions, including previously unthinkable cash handouts and a remarkable expansion in the scale and scope of the Fed’s direct involvement in market pricing and functioning. While the vast majority of stocks benefited, the outperformance was concentrated among the “stay-at-home” companies, including Big Tech, which obviously favored Nasdaq.

The second phase was led by corporate and economic fundamentals. High-frequency indicators of economic activity and associated corporate revenue generation shot up, turbocharging heavily downtrodden stocks such as airlines and, yes, even Hertz, the car-rental company in the midst of bankruptcy proceedings. 

The third and final phase was more technical. It was dominated by the greater involvement of retail investors, accentuated by the fear-of-missing-out (FOMO) influence that has been present awhile among institutional investors who had recently become more cautious.

All three drivers now seem less effective and are, in the process, also robbing the stock market of anchors.

A shockingly good jobs report for May diminished the urgency for more fiscal policy actions. Not only did it lead to a more divided Congress on what to do next, but it also risks the elimination of important household and corporate relief payments in the next few weeks. The Fed remains more worried about the outlook, but the astounding scale and scope of its previous interventions have come under growing criticism. In particular, there are concerns that by venturing into buying junk bonds, the segment of the credit market with high default risk, it has encouraged huge corporate debt issuance and even more excessive risk-taking by creditors and investors.

Regarding fundamentals, the process of healthy reopenings has run into problems in a growing number of states, including Arizona, California, Florida, South Carolina and Texas. With both a record surge in cases and hospitalizations increasing, some local and state governments have opted in the last few days to halt and reverse reopenings. And even before that, the highest-frequency partial indicators of economic activity suggested that certain households were already pulling back from physical economic interactions. On the corporate side, Apple announced it was reclosing certain stores.

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