Wall Street's party is over. Coronavirus fears are back

New York(CNN Business) The runaway train on Wall Street has been derailed by a force nearly as powerful as easy money: a healthy dose of reality.

The Dow plunged 1,862 points, or 6.9%, on Thursday in the biggest selloff since March 16. Even the previously red-hot Nasdaq tumbled 5.3% back below the 10,000 level.

The sharp selling was driven in large part by fears of a resurgence of the coronavirus pandemic that wrecked the economy. Several US states that reopened weeks ago are now reporting rising infections and hospitalizations.

Wall Street is unprepared for a potential second wave of the pandemic. It would completely undermine the extreme optimism about the economy that had catapulted US stocks towards record highs.

"The rally in the stock market from the March 23 lows was simply overdone," said David Kelly, chief global market strategist at JPMorgan Funds. "We are still in a very deep recession. We still have a tremendous amount of uncertainty about the virus but also about stimulus and politics."

But you wouldn't know that from looking at the markets, which have surged even in the face of mostly-dreadful news about the economy. Boosted by unprecedented stimulus from the Federal Reserve, the S&P 500 surged as much as 44% from the lows. The Nasdaq was up 46% and had already set new highs.

"The market is pricing in a V-shaped recovery. But what you really have is a huge slump, a bump and then a crawl until we get a vaccine," said Kelly.

'Mass unemployment' isn't going away anytime soon

The surprisingly strong May jobs report, which showed an unexpected surge in hiring, raised hopes for a sharp economic recovery.

But the Labor Department reported Thursday that another 1.5 million Americans filed for first-time unemployment benefits last week. The good news is that initial claims have dropped for 10 weeks in a row. The bad news is that claims are still extremely elevated.

Prior to this crisis, the biggest weekly jobless claims figure was 665,000 during the Great Recession. In other words, claims are still rising at more than twice the prior record pace.

"Mass unemployment is going to be the primary condition that defines the economic narrative going forward," Joe Brusuelas, chief economist at RSM International, wrote in a report Thursday.

Hospitalizations are up in 12 states

Meanwhile, the coronavirus numbers have deteriorated in recent days, raising fears of a return of the health restrictions that caused mass layoffs in the first place. A second wave would slow the economy, hurt corporate profits and dent consumer and business confidence.

Although trends in hard-hit states like New York and New Jersey continue to improve, there has been an acceleration of cases in some states that have already reopened. Coronavirus hospitalizations have gone up in 12 states since Memorial Day weekend: Alaska, Arkansas, Arizona, California, Kentucky, Mississippi, Montana, North Carolina, Oregon, South Carolina, Texas and Utah.

Morgan Stanley biotech analyst Matthew Harrison called the trends "manageable" but noted they're a "concerning signal for the fall" when hospital space will be more limited and people are stuck indoors.

Harrison rejected the argument that the recent uptick in cases is being driven mainly by increased testing.

"We conclude active community spread is likely still ongoing," Harrison wrote in a Thursday report to clients.

An influential model cited by the White House is now predicting daily deaths will decrease through June and July before climbing sharply in September.

"The market is not prepared for a material second wave that would result in additional lockdowns," said Jeff Kleintop, chief global investment strategist at Charles Schwab.

Despite the worsening coronavirus trends, Treasury Secretary Steven Mnuchin said the federal government won't put the entire nation back into lockdown to fight the pandemic.

"We can't shut down the economy again," Mnuchin told CNBC on Thursday. "We've learned that if you shut down the economy, you're going to create more damage, not just economic damage. Medical problems and everything else that gets put on hold."

Still, parts of the country could need to bring back some health restrictions if outbreaks emerge.

Airlines, cruise lines get crushed

Optimism about pandemic trends led investors to bet in recent weeks on the parts of the stock market most exposed, including airlines, cruises and hotels. That trend is now reversing.

American Airlines (AAL) plunged more than 10% on Thursday, giving back a chunk of its stunning one-month spike of 68%. Spirit Airlines (SAVE) lost 15%, erasing some of its eye-popping surge of 84% in the month before that date.

Likewise, Royal Caribbean (RCL) and Carnival (CCL) fell double-digits on Thursday. Both had been up more than 49% over the prior month.

The energy market also got clobbered, with investors selling oil companies with heavy debt such as Occidental Petroleum (OXY), which tumbled 13%.

US oil prices, which had spiked from -$40 a barrel on April 20 to $40 this week, tumbled. Crude dropped 8% to $36 a barrel.

"The idea the hotel, travel industry or energy demand will come back fast -- those are pipe dreams," JPMorgan's Kelly said.

Vaccine hopes

Amid the market turmoil, President Donald Trump expressed confidence about the economic and health outlook.

"We will have a very good third quarter, a great fourth quarter and one of our best ever years in 2021," Trump tweeted on Thursday. "We will also soon have a vaccine & therapeutics/cure. That's my opinion. WATCH!"

Dr. Anthony Fauci, the nation's top infectious disease expert, has said he's confident a vaccine candidate will be proven safe and effective by the first quarter of 2021. But some doctors say that is a highly optimistic timeframe.

Kelly cautioned that there is no guarantee a vaccine will be effective, nor that most of the population agrees to take it.

"We could be haunted by this thing for some time to come," he said.

The heavy selling on Wall Street Thursday will bring back bad memories of the turmoil in February and March that rocked markets.

But Schwab's Kleintop doesn't think US stocks will necessarily retest their March 23 lows.

"We may only need to unwind a few weeks of the rally," Kleintop said.

Still, given the rapid rise in the stock market over that that span, it could be a painful unwind.