The United States stock market showed extreme resilience to the most prominent economic shock in our recent history – the coronavirus pandemic. After an initial drop of over 30%, the fastest drop in the stock market history, the subsequent rally has left many confused.
After all, the economy is on life support as the United States added over 30 million unemployed workers in the few months, production levels are at all-time lows, and the services industry barely survives. So why are US stock indices so high?
For instance, Nasdaq currently sits at a couple of percentage points below where it started the year. With the potential for breaking it’s all time highs ,very realistic.
Does the Stock Market Reflect Economic Reality?
Yes and no. No, because all economic indicators point to bearish sentiment, with little or no sign of a turning point in the near future. Yes, because of at least a few reasons.
First, the stock market is a leading indicator. It encapsulates investors’ belief that somehow the economic shock will go away, this pandemic will end, and the economy will pick up sooner rather than later.
Second, the FANG companies are doing great during a time of remote work, and Internet activity levels have increased dramatically. Facebook, Amazon, Netflix, Google, together with Apple and Microsoft, have all recorded better than expected Q1 sales and revenue figures, due to the global lockdown. With these companies being huge contributors to the value of indices, their performance has translated into greater growth for the likes of the S&P500.
Third, the quick correction that came proved to be the one expected by many long-term investors. Hedge funds hurried to buy the 30% drop to improve averages, and many retail traders did the same.
Finally, and perhaps the most important factor – the Fed. The Federal reserve quickly spotted the troubles, both locally and internationally. So it flooded the market with funding, started to buy assets, and lowered the federal funds rate to almost zero in an emergency meeting. When the Fed does not wait until its regular FOMC Statement to announce important monetary policy decisions, you know that things are serious, and you prepare for the worse. Which markets initially did at the time.
After the initial shock, the money kept pouring in. Many investors are familiar only with the delivered rate cut, but the Fed went into areas it never went before – and it is open to expanding its capabilities, offering unlimited funding until the economy goes back to normality.