For many, it is difficult to compare an economy in tatters and a thriving stock market. Why is there such a discrepancy between the two?
It is a common fallacy to look at the stock market as a representation of the U.S. economy. While a strong correlation between the two entities usually exists, they can sometimes find themselves diverging, leaving many people scratching their heads. Now is one of those times.
For the most part, the stock market and the economy go hand in hand. While the stock market may move much more erratically than the economy, they usually share the same destination. However, there are thousands of other factors in play and it is folly to look at it in terms of black and white. Take 2018 as a recent example: unemployment was below 4%, jobs were being created at an astonishing rate and the outlook for the U.S. economy was peachy; the stock market fell 5% that year.
In case you missed it:
We’ve established that divergences between Wall Street and Main Street can occur, and it’s pretty clear that right now is one of those times, so what is causing this discrepancy? Let’s take a look at some of the reasons.
Everything’s already priced in
The repetition of this phrase ad nauseam by market bulls has worn me down over the past weeks as I’ve questioned the V-shaped recovery the market has been on, but there is a lot of weight behind the argument. In little over a month, the S&P 500 (NYSEARCA:VOO) fell 34%, the fastest bear market in history. In the six weeks since the lows of March 23rd, we’ve seen the index rise 31% off the back of the recovery of stocks like AMD (NASDAQ:AMD), Netflix (NASDAQ:NFLX), Nvidia (NASDAQ:NVDA), and Paypal (NASDAQ:PYPL) amongst many others.
The bull case for the market’s recovery is that this 34% drop encapsulates all the economic fallout that has already occurred and is yet to arise from the global pandemic. Businesses being forced to close, stay-at-home orders across the country, and record-breaking jobless reports have all been accounted for in the freefall from February 20th to March 23rd. The stock market has digested this information and is now looking past it with eyes on a recovery.
While many remain skeptical over this explanation, myself included, we can never overestimate the market’s forward-looking ability, and a 34% drop is nothing to be scoffed at. However, this is far from the only factor in the recovery.
The Fed Stimulus Package
Jerome Powell and the Federal Reserve are at the helm of a stimulus package that is injecting trillions of dollars into the economy. The relief package has dwarfed that of the Great Recession and is a massive factor in the speed of recovery in the markets. By providing grants to distressed industries and purchasing corporate bonds, the Fed is essentially removing the risk of bankruptcy for many businesses that find themselves severely affected by the global pandemic. Companies have issued $560 billion in bonds in the past six weeks, twice that of normal levels. Even Norwegian Cruise Lines (NYSE:NCLH), which had all of its operations at a standstill and had ‘substantial doubt’ over whether it would remain afloat (couldn’t resist) only last Tuesday, managed to raise over $2 billion in a combination of debt and equity last week.
This commitment to propping up businesses and taking bankruptcy off the table for certain industries has given rise to a wave of contrarian investors pouring into companies like Carnival (NYSE:CCL), Delta (NYSE:DAL), and Southwest (NYSE:LUV) to name a few.
There’s Nowhere Else to Go
Perhaps the most significant reason why stocks have seen such a swift recovery is the simplest: there’s nowhere else to go. Interest rates are at 0 and the current yields from government bonds are not attractive for investors. By essentially removing these options from the equation, where else are institutional investors supposed to put their money?
The answer so far has been big tech, with less risk-averse investors seeing Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Facebook (NASDAQ:FB), Google (NASDAQ:GOOG), and Microsoft (NASDAQ:MSFT) as a safe haven in these turbulent times. This quintet now makes up a fifth of the S&P 500 and this share of the index is growing. The growth of the market as a whole has never been dictated by so few and while FAAMG continues to prosper, so will the wider index.
What happens next?
For the bulls amongst us, you may have seen enough to confirm that we’re through the worst and out the other side, with an eye already on the reopening economy and a full recovery. For the bears, I hope the three explanations above work towards at least explaining somewhat how we’ve seen such a bounce while the economy is looking down the barrel of a global recession. If I knew what happens next I don’t think I’d be here writing a blog post on Monday morning, but one thing is for certain, it won’t be a smooth journey. The recovery has nearly been as fast as the fall and there’s still a lot of this story to be told.
MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in companies mentioned above. Read our full disclosure policy here.