What on earth is the stock market doing?
Death and despair are all around. The number of people filing for unemployment benefits each of the last two weeks was about 10 times the previous record — and is probably being artificially held back by overloaded government systems. Vast swaths of American business are shuttered indefinitely. The economic quarter now underway will most likely feature Great Depression-caliber shrinkage in economic activity.
Yet at Thursday’s close, the S&P 500 was up 25% from its recent low March 23. It is down only about 14% this year — and is up from its levels of just 11 months ago. There are answers as to why. But that doesn’t take away the extremity of the juxtaposition between an economy in free fall and a stock market that is, in the scheme of things, doing just fine.
Two powerful forces are pushing in opposite directions. Commerce is being disrupted to a degree that seemed impossible just weeks ago. But simultaneously, stock investors are betting that powerful interventions out of Washington — including an additional $2.3 trillion in lending programs from the Federal Reserve announced Thursday — will be enough to enable major companies to emerge with little damage to their long-term profitability.
It is a battle between collapsing economic activity and, to use a silly meme from finance Twitter, the federal government’s money printer going “brrr.” In the stock market, at least, the revving of the money printer is winning.
Paradoxically, said Gene Goldman, chief investment officer of Cetera Investment Management, the shockingly high numbers of jobless claims can even be viewed as helpful to the market, as they increase political pressure on Congress to scale up rescue measures beyond the $2 trillion legislation already enacted.
“Imagine you’re a Democrat or a Republican talking about 16 million people unemployed,” he said. “It really creates more bipartisan pressure to support the next stimulus package.”
The large companies that make up major stock indexes tend to have reliable access to capital, particularly after the Fed’s latest actions to prop up corporate lending. They may be more likely than small, independent-owned businesses to weather the economic storm and come out on the other side with greater market share and profits.
The analysts who project corporate earnings are, in the aggregate, forecasting a relatively mild hit. They expect the companies that make up the S&P 500 to experience only an 8.5% decline in earnings in 2020, with revenue falling a mere 0.1%, according to FactSet.
Then there are technical factors.
Some of the strongest performers in this market rally have been the companies most severely affected by the coronavirus crisis, like cruise lines, hotel chains and airlines. That suggests “short squeeze” dynamics, in which a small upturn forced investors betting against those companies to close out their positions, turning the small rally into a large one.
And Saudi Arabia and Russia apparently reached a truce to reduce oil output, causing a rally in oil prices, which is good news for oil companies that have been hammered by plunging prices of crude.
Finally, the gush of money into safe investments, both from private savers and the Fed, is pushing down longer-term interest rates. That makes even weak or uncertain future earnings for shareholders more appealing than they would have been when interest rates were higher.
But just because there are reasons for the stock market rally does not mean those reasons are good ones.
Stock prices are always based on what the world will look like in the future, not the present. In the global financial crisis, stock prices bottomed out in March 2009. The economy did not begin expanding again until July, and the unemployment rate would not peak until October.
But current market pricing suggests that investors are counting on a speedy rebound.
“If this doesn’t go on much longer than expected, if it really is a three- to six-month event from the time we turned the switch on the economy off to when we turn it on, then markets have already accounted for that and are looking ahead,” said Jim Paulsen, chief investment strategist for the Leuthold Group. “It could be that the virus stays hot, and this situation stays in place for three or four quarters, and we’re not priced for that.”
In effect, financial markets are betting that there is some reasonable approximation of normal on some foreseeable horizon.
The current pricing assumes that a cascading series of failures will not happen. That widespread job losses and drops in income will not cause the mass closure of businesses. That people will have a job to go back to and will be willing to spend when the public health crisis ebbs.
Everything about this crisis has been incredibly fast, with the economy going from full health to devastating recession within weeks. In that sense, the financial markets are preemptively adjusting to a possible world in which trillions of dollars from the Treasury and the Fed do the trick and prevent the virus from doing lasting damage.
“The stock market during periods of stress can be quite manic,” said Jason Pride, chief investment officer of private wealth at Glenmede. “What is happening here is a flip-flopping of perception from the ‘sky is falling’ for the majority of March, to being able to glimpse a light at the end of the tunnel today.”
It is, in other words, an unusual time in which we can only hope that stock investors know something that millions of people facing a catastrophic economic situation do not.