In the first quarter of 2020, gross domestic product, the chief tool used to measure the
economy, shrank by 5% in the United States, and analysts suggest the worst could be yet
to come.
On top of that, as of May 28, more than 40 million American workers have filed for unemployment
benefits.
The effects of Covid-19 on our economy are abundantly clear.
Yet, the stock market, which plummeted February 19 through March 23, may be on the rebound.
The S&P 500 is up 36% as of June 1.
How can that be?
How can unemployment be soaring, GDP shrinking, and stocks marching along as if nothing's
wrong?
Well, for starters, the stock market is not the economy.
The stock market is forward-looking, meaning stock prices are based on expectations of
companies' future earnings, not just present earnings.
In that sense, it's possible for the market to be less impacted by current circumstances,
if investors feel there's a bright future ahead.
Now that we've decoupled the stock market from the overall economy, let's talk about
how the stock market is coming on so strongly despite the factors working against it.
The fact that people are buying tells us there's some confidence in a good recovery from the
losses brought on by the coronavirus.
The question then is, where is the confidence coming from?
It likely starts with the aggressive and unprecedented maneuvers from the Fed.
To calm the markets, the Fed slashed interest rates to zero and bought mortgage-backed securities
and high-yield ETFs.
It's safe to assume the Fed isn't done yet.
When asked his opinion on the current market, Torsten Slok, Chief Economist at Deutsche
Bank Securities said: This rally in equities is clearly not driven by fundamentals it's
driven by the liquidity support from the Federal Reserve.
Companies are getting cash to keep the lights on through the significant support to credit
markets.
Then there's the stimulus bills from congress like the CARES Act, which increased unemployment
benefits and provided direct payments to individuals.
In short, investors' confidence could be coming from the fact that the government is
placing a large pillow under the market to soften the fall.
Another factor that may be driving stocks up is a flood of new investors entering the
market.
The government stimulus funding, combined with a fear of missing out on the dip in equity
pricing and zero commissions, is driving a lot of interest in buying stocks.
With more free time and fewer entertainment options, like sports, some people are turning
to stock trading to pass the time.
Also, with the lowered interest rates, stocks are one of the only ways to find some yield.
Looking at what stocks people are buying can shed more light on the stock market's expectations
about a post-COVID-19 economy.
Overall, as of June 1, the S&P 500 is back above its 200-day moving average after rising
36% from its low on March 23.
Looking at the 11 sectors of the S&P 500 over the last three months, the Energy tied to
the crash of oil Financials, and Utility sectors haven't bounced back as well as
the communication services, Information technology, and Consumer Discretionary sectors.
Faang stocks Facebook, Apple, Amazon, Netflix, and google's parent company, Alphabet, which
drove the longest bull market in history leading up to the crash are also leading the charge
in this rally.
Because of the way stock indices measure the market, the outperformance of these few huge
companies can help buoy overall indices, potentially covering up areas of weakness.
Overall, this disparity may suggest that investors envision a future economy even more dominated
by digital companies.
So, while the stock market is not the economy, it is a leading indicator of where investors
think the economy will go.
Taking a closer look at who's buying and what they're buying may give us clues as
to what a recovery may look like.
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