MARKET COMMENTARY

Untangling the Current Market/Economy Relationship

As economies and markets head in opposite directions, investors are challenged to reconcile the very visible disconnect. Here’s a closer look at how things are “working.”

08.03.2020 - Kevin McLachlan, Vice President, Portfolio Manager

On the one hand: Canada’s second quarter real GDP is expected to drop by an estimated 40% at an annualized rate.[1] In the United States, the Federal Reserve Bank of Atlanta estimates real annualized second quarter GDP growth will be -45.5% (as of June 17).[2] These are staggering, but not surprising numbers given the dramatic shutdowns that accompanied the pandemic wave.

On the other hand: Very strong equity markets behaviour since late March. Between February 19, 2020 and March 23, 2020, the S&P 500 Index fell by 33.9% as the market digested COVID-19 implications.[3] Since then, it has risen by 36.1% to the end of May, and is now down only 10.1% from the February peak.[4] The Canadian market has followed a similar pattern and is down 15.2% from the peak.[5]

Investors have not been complaining about the reversal in stock markets, but some may have been challenged to reconcile the market/economy disconnect. While it may not make total sense, there are reasons behind the equity market recovery. Here are highlights of what we are seeing.

Extraordinary Support

Responding quickly to the crisis, central banks worldwide have worked to avoid a liquidity crisis by:

  • Slashing short-term interest rates to near zero to stimulate economic growth.
  • Introducing or expanding quantitative easing (QE)— i.e, printing money to purchase bonds—to lower longer-term interest rates. Bond purchases have increased bond prices and lowered bond yields. Larger in scope than the post-2009 financial crisis program, these QE initiatives are purchasing both government and corporate bonds.
  • Introducing lending initiatives to support companies.

Governments have introduced multi-trilliondollar programs aimed at:

  • Offsetting the tidal wave of unemployment through short-term income and rent supplements for citizens.
  • Shoring up small businesses through rent, tax and employee-focused initiatives.
  • Providing strategic support for large companies and industries.

In the United States, for instance, the combined efforts of the US Federal Reserve and the federal government appear to have soothed equity investors’ nerves.

Vaccine Expectations

Though timing, availability and efficacy remain uncertain, ongoing “progress” news helps influence market sentiment.

Differences Between the Stock Market and the Economy

At a grassroots level, local news understandably features the dire, daily challenges our small- to medium-sized businesses are facing. Keep in mind, few such companies are listed on the stock market. Alternatively, some companies are doing well, particularly large public firms, such as Microsoft, Apple and Amazon.

Looking Through the Crisis

Stock markets have been looking past recent economic and earnings declines and have begun to price in a more normalized environment. We also know that markets, shaped by investor sentiment, can be overly pessimistic and overly optimistic.

Seeing Through Uncertainty

Clearly, much uncertainty remains on various fronts—ranging from the pace of corporate earnings recovery to how consumer behaviour unfolds, to the potential shape and timing of a second COVID-19 wave.

From experience, we know dramatic swings work both ways. It is nearly impossible to predict short-term market movements, and volatility will be part of the market story going forward. In our view, the world and the economy will recover, but the path to recovery will be filled with twists and turns.

 

 

Footnotes:

1. “The Upturn Has Begun but Recovery Will Be Gradual,” Economic & Financial Outlook, June 18, 2020, Desjardins, https://www.desjardins.com/resources/pdf/peft2006-e.pdf?resVer=1592484987000.
2. “GDP Now,” Federal Reserve Bank of Atlanta, June 17, 2020, https://www.frbatlanta.org/cqer/research/gdpnow?panel=3.
3. Source: FactSet, as at May 31, 2020.
4. Source: FactSet, as at May 31, 2020.
5. Source: FactSet, as at May 31, 2020.

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