These Factors Help Explain The Market’s Strength During Economic Collapse

The markets have risen very strongly off the late March lows, this despite the economic data unambiguously deteriorating. While this may seem surprising there are a few factors fueling the market’s rally.

Major Stimulus

Stimulus has helped the markets a great deal. Americans losing their jobs are getting additional funds, that’s not unusual. What is unusual is that American’s who haven’t lost their jobs are getting cash too. This is so-called helicopter money. In fact, some of it is going right back into the markets. Plus the HEROES Act, or some variant of it, could offer more stimulus checks. Yes, unemployment numbers are dreadful, quite comparable with some of the worst economic crises America has seen, but the stimulus is may be a lot larger than we’ve seen historically too. That means the economy may hold up a little better than the scale of the unemployment numbers indicate, at least while the stimulus measures are in place. Therefore, you can’t consider the rise in unemployment without also taking account of the rise in stimulus which offers a potential offset, for now.

Declining Bond Yields

However, in addition to the actions of Congress, the Fed has stepped in too. Short-term bond yields are now essentially at zero for the foreseeable future. In fact, the Fed is considering guaranteeing zero rates for some time. That has potentially pushed up equity valuations.

Bonds and stocks are substitutes for many investors. If bonds are giving you next to nothing in interest, then stocks look a little more attractive by comparison. For example a stock yielding 2% looks a lot more interesting as bond yields decline. So the relatively dramatic drop in bond yields may help push up stock valuations further when you consider that even a 30-year Treasury bond offers under 2% a year in interest payments today, or about half the interest rate you could have received a little over 12 months ago.

Market Structure

In addition to the actions of policy-markets, remember that the S&P 500 was never intended to be an accurate barometer of the overall U.S. economy. You have Microsoft MSFT and Apple AAPL representing a greater weight in the S&P 500 than the entire consumer discretionary sector. That’s just two stocks holding a greater weight than a critical sector of the U.S. economy.

Also, it’s smaller businesses that are feeling the real pain, whereas S&P 500 companies generally have far better access to funding to sustain them. So the S&P 500 has a greater weight to the tech names that are generally better positioned in the crisis and very little direct weight to the smaller businesses that may not exist coming out of the crisis. Therefore it’s quite possible for indices such as the S&P 500 to hold up better than the U.S. economy given what’s included and how stocks are weighted in major indices.

Predictive Markets

Bear in mind too, that the markets are predictive. What’s happening now is known, the markets are pricing in the future path of the economy several years out and taking an apparently optimistic view. That forecast may not come to pass. In fact, there’s no way to know if the market’s view is accurate or not at the moment. Indeed, the relatively elevated level of VIX signals elevated uncertainty. However, it’s not that the markets are ignoring the current situation, they appear to be positioning for a relatively quick rebound supported by further stimulus. If that scenario doesn’t happen then recent market upward moves could quickly reverse, especially at currently elevated valuations compared to history.

So the rapid rally in the markets may feel disconcerting at a time of major economic and social upheaval. However, there are reasons behind it. These reasons may not last. If stimulus falls back or the costs of stimulus in terms of higher taxes or inflationary risks printing money become more evident. Still, it is important to acknowledge the scale of the stimulus in response to the current crisis. For now those measures are giving the markets some degree of comfort.

Source: Forbes – Money