Editor's note: A century ago, the markets bounced back swiftly from a flu pandemic...

And over the past six weeks, we've seen hints of a similar recovery in stocks amid the coronavirus pandemic. But our good friend and Empire Financial Research editor Enrique Abeyta believes it's still smart to proceed with caution, just in case we see more pain ahead.

In today's Masters Series essay – adapted from the April 29 edition of Empire Elite Trader – Enrique tackles the one question he's hearing the most right now. And as you'll see, history provides an example of what we can expect as the coronavirus recovery continues...

The Burning Question for Investors Right Now

By Enrique Abeyta, editor, Empire Elite Growth

Given my 25-plus years of working on Wall Street, I'm constantly receiving questions about investing from family, friends, and acquaintances.

And as I moved into the business of newsletter writing, the number of inquiries has grown exponentially.

These questions are useful. They tell me a lot about the market environment.

The overwhelming sentiment right now from people that I speak to – both professionals and individuals – is confusion. Of course, nobody can be completely sure about what the markets and economy are going to do next... but right now, the level of confusion is as high as I've ever seen it.

The question I hear the most is, "How can the market continue to go higher despite the terrible fundamentals?"

First, it's common that markets move higher (and often much higher) as fundamentals are terrible. As I told my readers recently, the stock market is a "discounting" mechanism...

This view states that the markets at all times are pricing in a stream of future outcomes (earnings). When the markets go down, it's because those expectations on profits have gone down (and vice versa)...

The fact that earnings might be going down may trigger a negative response. But if everyone knows they're going down and expects them to go down, then that response may be muted. Furthermore, if the overwhelming expectation is for negative news and we get even some positive news, then the positive chemical reaction in our brains can be extreme.

And for the next few months, the sequential economic data will get better. Let me explain...

Take restaurants, for example. Think of how many of them were open (and their economic activity) in late March (right as we entered into the full lockdown), and then consider how many will be open next month.

This number is going to be higher – probably a lot higher.

Now, this doesn't mean that restaurants are going back to where they were in January or February. It also doesn't mean we won't have a "start-stop" situation depending on the coronavirus mitigation efforts. But ultimately, the activity will be higher.

Some would argue that the market has already gone to levels where the "valuation" has priced this in and that stocks are due for a correction.

But I don't ascribe to this view...

It's not "valuation" that matters most for stock prices, it's "stimulus." If the incremental news is good, expensive stocks get more expensive. If incremental news is bad, cheap stocks get cheaper.

By definition, the incremental news for the economy is getting better and, for right now, probably a lot better!

And think about "stimulus"... particularly the monetary stimulus that's being pumped into the global economy. "Monetary stimulus" means that global central banks are printing more currency.

Using an incredibly simple model – absent the ability to spend those dollars at a restaurant or a ballgame – they may very well flow into assets... like stocks.

Given the unheard-of magnitude of the amount of monetary liquidity injected into global economies, it's possible we might see a continued rally well beyond anyone's expectations.

The S&P 500 Index is "only" down about 10% year-to-date, and we could see it at new highs by the end of the summer. I'm not saying that this is probable... but it's possible.

And in late April, an article in Bloomberg showed how some of this can happen...

It outlines how private-equity-backed Surgery Partners – which runs a network of outpatient clinics and was struggling financially prior to the coronavirus pandemic – was able to get financing for its bonds done at better rates than it was able to last year.

In 2019, Surgery Partners went to the market to refinance some maturing bonds and was quoted an interest rate of 10%. Those higher-risk bonds were recently trading for $0.55 on the dollar.

But after the U.S. Federal Reserve stepped in last month and said it was willing to buy even risky debt as part of the emergency financing for the economy, not only did Surgery Partners' bonds trade back to par... but the company raised an additional $120 million from investors at a 9% interest rate – a better rate than in 2019.

Of course, I'm not mentioning this to say that Surgery Partners is (or isn't) deserving this loan or interest rate... Investors are obviously making up their own minds on the subject and risking real money on the company.

But considering this with my point about the injection of monetary liquidity, a lot more dollars are floating around to make these kinds of loans. This is the exact kind of environment that can set the market up for new highs.

I've also seen something like this before in my career... back in the late 1990s when I first became a full-time portfolio manager.

In late 1997, Thailand's government was forced to let its currency "unpeg" from the U.S. dollar. This un-pegging caused the Thai baht to collapse. It started a wave of bankruptcies among Thai businesses that borrowed in U.S. dollars, thus injecting a ton of financial volatility into the Asian financial markets.

The situation continued to build through the following year, and the escalating market volatility eventually culminated the collapse of a famous and successful hedge fund called Long-Term Capital Management ("LTCM").

What happened with the fund was complex. Here's a simple explanation...

LTCM had $25 borrowed for every $1 it had in the bank. Eventually, the people lending the fund the money became concerned that it might not be able to pay everything back and all asked for their money back at once.

This led to forced selling on the behalf of LTCM, and began to drive prices of financial assets lower. The lower the prices went, the more concerned LTCM's lenders became... and they asked for even more of their money back.

This spiraled into a self-fulfilling prophecy and began to affect the holdings of other financial institutions like the large banks and brokerage houses.

The government eventually intervened, and the Fed saw a substantial risk to the whole financial system. If this stress were allowed to spread, then it could eventually bring down the entire global financial system.

Correctly identifying this risk, the Fed stepped in and set up a consortium of financial institutions that took over the assets and liabilities of LTCM. In doing so, it stopped the force selling and asset prices stabilized quickly... but not before causing a huge amount of short-term volatility in the financial markets.

Going into that period, the S&P 500 was performing well. Year-to-date, it was up 22% as of July 20, 1998 and at an all-time high. By early October, it was down as much as 23%.

After the Fed actions, though, the market quickly recovered... and returned to its old highs within four months from July.

In fact, it ended 1998 at another all-time high, or up 29% on the year. And the next year, we had the biggest "melt up" in stocks with the dot-com bubble... The S&P 500 was "only" up 21%, but the Nasdaq was up an incredible 86%.

Of course, there are huge differences to today... but in some ways, the coronavirus is a modern (albeit much bigger) version of the LTCM situation as the fund was collapsing. And looking back at history, big gains could be very possible ahead as we recover from the coronavirus pandemic.

Regards,

Enrique Abeyta

Editor's note: Enrique recently turned down a seven-figure job offer to join our corporate affiliate Empire Financial Research. Now, he's showing everyday folks how to make 500% or 1,000% (or more) using the same unique approach he used to grow his first hedge fund by more than 130,000%. He lays everything out in a brand-new video – and even shares the name of one of his favorite stocks today. Get the details here.