Why Are Stocks Rising While The Economy Is Tanking? đ€
The US economy shrank at a 32.9% annual rate between April and June as the country grappled with lockdowns and spending cutbacks during the pandemic.
It was the deepest decline since the Government began keeping records in 1947 and three times more severe than the prior record of 10% set in 1958. The U.S. is just one of the many examples of the economic catastrophe that the pandemic has inflicted across the globe.Â
Throughout February and March this year, the value of stock markets across the world plummeted due to the fear and uncertainty generated by the Coronavirus. In the weeks and months that followed, COVID-19 went on to kill thousands of people all over the world.
But as the global economies stuttered as the impact of COVID-19 hit hard, the stock markets in the U.S. and Australia bounced off their March low and climbed and climbed to rise back up toward pre-virus levels. At the time of this newsletter, The Nasdaq-100 and S&P500 are all in positive territory for the year to date, while the ASX 200 is slightly off its record highs set in February.Â
With such a dramatic fall in economic activity, you might be wondering why the stock market isn't moving in parallel. Well, there are a few good reasons for this.Â
Firstly, unlike the economic data we're seeing, which is looking into the past, the stock market is very forward-looking. Instead of looking backward, stock market analysts are looking ahead into a post COVID-19 world and forecasting the future performance of companies based on normal economic conditions. After the initial shock in February and March, the market has realised that the economic impacts of the pandemic will be relatively shortlived, and has therefore begun re-valuing stocks based on forecast revenues and earnings in 2021 & 2022, which part of the reason why we're seeing prices rise.Â
Secondly, Governments have stepped in with enormous economic aid packages to help prevent economic disaster. On March 23rd, the Federal Reserve, America's central bank announced that it would create new money to buy corporate bonds and lend to companies, allowing businesses to borrow cash at an unprecedented scale. The Australian Government has acted similarly by legislating support packages like Jobkeeper, early access to super, and cash grants to businesses. These stimulus packages have instilled investors with the confidence to get back into the marketplace, causing markets to recoup their initial losses and keep rising.Â
Thirdly, interest rates in the U.S, Australia, Japan, and most European Countries are at record lows,  making the return on alternative asset classes like bonds and cash much less attractive. This has left investors with limited opportunities for decent returns in safer asset classes, which has persuaded them to take on more risk by investing in stocks because the alternative options offer little returns. Interest rates were already low before coronavirus hit, but the impact of the virus has caused the U.S. and the Australian government to lower interest rates even further in order to kickstart their economies. By lowering interest rates again in the face of the pandemic, the attractiveness of stocks has become even more tempting for investors searching for yield and has helped to rally the markets.Â
So there you have it, the combination of optimism in a quick economic recovery,  low-interest rates, and unprecedented federal stimulus have pushed stocks to historically high valuations in what looks to be the early stage of a deep economic recession.Â
What happens to the stock market from here is anyone's guess...