There has never been a bigger disconnect between the stock market’s movements and what is happening in the real economy.
In spite of a global economic slowdown, historic levels of unemployment and mass equality protests worldwide, stocks have rallied since their lows at the end of March. But the strong bounce has not been seen by all sectors. Whilst the airlines, travel industry and hospitality businesses have participated in muted rallies the technology stocks and online businesses have been the winners. Investors do need to keep a close eye on their investments to actively manage their exposure.
Stock market resilience
More than 20 million US citizens lost their jobs in April, resulting in the highest levels of unemployment since at least 1947. Yet the Dow Jones industrial average is now down about 8% year-to-date having climbed 40% from its low. What explains this remarkable bounce-back from the fastest bear market plunge in history?
CNBC “Mad Money” host Jim Cramer attributes the rally to large public companies driving the Dow upwards as they emerge from the coronavirus pandemic.
In his words, “the market doesn't represent the economy, it represents the future of big business … This is the first recession where big business … is coming through virtually unscathed, if not going for the gold."
Ultimately, the stock market’s rebound reflects investor confidence that Washington’s interventions – which include the additional USD 2.3 trillion in lending programs from the Federal Reserve – will see major companies through the pandemic and undercut weak corporate earnings.
Large companies making up major stock indexes are more likely to have reliable access to capital, especially in light of the Fed’s increased corporate lending, rendering them better positioned to survive the crisis than small, independently-owned businesses.
The juxtaposition between dire economic data and the financial markets has been fuelled by announcements from the likes of the Fed, European Central Bank and the Bank of England to begin purchasing individual corporate bonds as part of a stimulus plan. Such quantitative easing measures is clearly providing excess liquidity and huge support for the financial markets.
Second wave risks
As internet-based business models thrive and countries around the world begin to reopen for business, hopes are high for a V-shaped economic recovery. Investors should, however, be cautious of overly-optimistic forecasts according to some commentators.
Ajay Rajadhyaksha, head of macro research for Barclays, warned that we are not fully in the clear of the bear market and commented that “stocks have gone up way too much, way too quickly.”
Beijing’s partial lockdown in recent days serves as a stark reminder that swift economic recovery and a return to normal is threatened by a second wave of infections. One of the greatest risks is that consumer spending will be far more deeply affected if there is indeed a second wave.
Historic wealth transfer
Whilst big business is poised to emerge from the pandemic relatively unscathed, small and medium-sized businesses – the most visible parts of local economies – are not publicly traded and are much more vulnerable to bankruptcy with the loss of their cash flow, despite government initiatives to support them.
Cramer has described the fallout as “one of the greatest wealth transfers in history”, pointing to the fact that the 48% surge in bankruptcies year-on-year in May included very few public companies.
He argued that US stimulus packages will likely be insufficient in carrying small businesses through the pandemic due to the problem of social distancing. Local restaurants, bars and cafes will often lack the space to make social distancing economically viable, whilst big chains can afford to partner with delivery services.
Katie Nicholls, chief executive of UK Hospitality, has assessed that without government support, 50% of hospitality businesses in the UK would go bust and 2 million jobs would be lost if businesses try to reopen with social distancing measures in place.
Given all the uncertainty due to the pandemic, what's apparent is that the old normal will not return until a vaccine or reliable treatment for Covid-19 is distributed to the mass people. Time will tell whether the real economy is able to narrow the gap to stock market valuations by performing better than the miserable forecasts.
By Sasha Skovron