The Stock Market And The Economy Are Not The Same: How Has Covid-19 Affected Them?
This week we would like to address a question clients continue to ask, “How have the markets recovered so quickly given some of the worst economic numbers we have seen since the Great Depression?” From the S&P500’s February 19th high of 3,393 to its March 23rd low of 2,191, the S&P500 dropped over 35%. From the March 23rd bottom, the S&P500 jumped to 2,945 points on May 12th . The increase from March 23rd to May 12th represented a 22% recoup of the full 35% drop [1]. If you find the recovery confusing considering the current state of the economy, you are not alone. John Maynard Keynes once empathized stating, “Markets can remain irrational longer than you can remain solvent.”
These are confusing times but we remain confident that the markets are working properly. The winners are just simply being separated from the losers. Fortunately, the Federal Reserve and Treasury have helped soften COVID-19’s blow upon both the winners and losers through implementing a number of actions. The unprecedented fiscal and monetary policy is serving as a backstop for stocks. The Federal Reserve Bank in collaboration with the U.S. Treasury have directed trillions of dollars to funnel to individuals, small businesses, large corporations, and municipalities. The funds and stimulus measures used are equal to nearly 20% of U.S. gross domestic product. This is a massive number -- almost three times the size of the injection from the 2007-2009 Financial Crisis [2]. Below, we review what we believe to be the largest drivers in the markets’ recent partial recovery:
1) The Federal Reserve (FED)
On April 9th the FED made it crystal clear they were going to keep credit markets flowing no matter what. The message was well received and in April corporate bond issuance hit a monthly record of $335 Billion [3]. This action appeared to take the worst-case-scenario off of the table and should help provide corporations with assistance in weathering the COVID-19 storm. History has shown us that when the FED increases its balance sheet, much of the money printed ends up going into the stock market. An analysis done by Wealth Advisor predicts that the FED balance sheet will be between $6 and $8 Trillion when all is said and done. This is an unprecedented amount [4].
2) Government Stimulus
We are already seeing the U.S. government spend more money as some workers will get additional unemployment benefits. In some cases, unemployed individuals are collecting more than they were making while at work. Some retirees who suffered no apparent employment losses are getting stimulus checks, and even a number of small businesses still functioning are collecting Paycheck Protection Program loan proceeds. While we are not taking a position as to whether these policies were appropriate, a portion of this money will ultimately flow into the stock market.
3) Low interest Rates
With U.S. Treasury bond interest rates near record lows, many retirees will be forced into the stock market to generate income for living expenses.
4) Cash & Money Markets
An analyst at J.P. Morgan recently stated, “Cumulative government money markets have seen $1 Trillion of inflows over the past 7 weeks. If we include U.S. bank deposits this amount rises to $2 Trillion.” A representative at Morgan Stanley mentioned, “$4.7 Trillion is the total stashed away in money market funds, and bank deposits have also surged.” [5] An article from Federated Hermes says, “The U.S. supply of readily available money (cash and money market savings but not bank CD’s and other deposits) has jumped 19% year-over-year to almost $19 Trillion.” [6] The potential for new cash to flow into equity markets, along with the tendency of retail investors to invest at higher price levels may indicate stocks have room to move higher.
5) Tech Stocks
Because of how the S&P500 is structured, the stock market is now largely driven by the biggest companies. Many of these large companies happen to be tech stocks and benefit from consumers working from home, not necessarily a broad economic reopening. The five largest stocks in the S&P500 are Microsoft, Amazon, Apple, Google, and Facebook. Collectively, these five stocks represent a piece of the S&P500 pie that is larger than any other five stocks since the late 1970s. Microsoft alone represents 5.5% of the S&P500 index. To illustrate just how significant this piece of pie is, the aforementioned five stocks have as big of a weighting as the bottom 350 stocks in the index. [7]
In closing it is important to understand that the stock market is not the economy. Many economic data measures are backward-looking and the stock market is forward-looking. The market tends to lead the economy according to NED Davis Research. “An average of four months before the end of recessions is when the S&P500 bottoms. So, if you look out a few months and think things will be getting a little bit better, stocks should anticipate that.” [8] The market will likely continue to confound investors of all shapes and sizes, so we feel it best to keep an open mind and stick to your long-term game plan. We may not know what the markets hold tomorrow but remind you that long-term investors have continuously been rewarded historically. We hope you and your loved ones stay safe and healthy and remind you that we are always here for you.
Sincerely,
Dustin Padgett and Your Team at Big Sioux Wealth Management
