Explaining the Disconnect Between Stocks and the Economy
In recent conversations with clients, we are getting fewer questions about our economic outlook. Many of our clients are themselves business owners and have already felt the pandemic’s economic pinch firsthand. They don’t need investors to explain the fear gripping Main Street. What puzzles them is how the stock market could be so at odds with the economic gloom.
While entire industries are on the sideline during the pandemic and the unemployment rate continues to climb, stocks have recovered much (though not all) of March’s losses. So, what’s behind the rally that seems so out of sync? In short, we think the market is confident about the safety net the Fed and the government has provided. Given the size and scope of that safety net, markets are already looking ahead to when the quarantine ends.
The Fed Deserves Some Credit
We credit the Federal Reserve and the federal government for learning from previous crises, and realizing they needed to act in creative ways to avoid a Great Depression-like scenario. To call recent Fed actions unconventional is an understatement. Among other measures, the central bank is lending to small businesses, buying high yield ETFs to keep credit spreads and lending rates reasonable, and lending directly to state and local governments through a Municipal Liquidity Facility.
We were also impressed by the federal government’s ability to set aside partisan animosity and pass a $2 trillion economic relief plan, which included stimulus payments and expanded unemployment coverage.
The bottom line is that the Federal Reserve and federal government have put a sizeable safety net under the economy. Markets are forward looking and tend to rebound before the economy. With both the central bank and government appearing willing to do whatever it takes to avoid a longer-term catastrophe; markets are now looking toward economic improvement as social restrictions ease.
Markets Could Stay Volatile
While Wall Street’s rally seems reasonable given the scope of monetary and fiscal support, that doesn’t mean there won’t be more volatility. Consumers and businesses could need more stimulus, and if the second wave of coronavirus spreads quicker than expected, a return to more restrictive measures could certainly weigh on markets.
At Dana, we are not calling the bottom or a further rebound. As part of our investment process, we stay fully invested throughout the cycle because we don’t believe any investor can consistently time markets. But the seeming disconnect between markets and the economy deserves context, and we felt it was worth sharing.
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