3 Reasons Why Stocks Are Up


3 REASONS WHY STOCKS ARE UP

Despite a fragile yet recovering economy, stocks have continued to climb in May. We are undoubtedly experiencing the deepest recession since the Great Depression. Yet, the S&P 500 has rallied 43% from the March 23rd lows, and the NASDAQ 100 is less than 1% from reaching its all-time high.

How can this be in an era of extreme uncertainty? We are in the middle of a global pandemic and civil unrest, yet stocks are rallying? The following three reasons can explain the divergence between the markets and the economy.

1. The Recession is Over

The stock market is betting that we have already seen the end of the recession. It sounds crazy, but it might be true (technically).

recession, as defined by the National Bureau of Economic Research (NBER), is “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” 

Without a doubt, we have seen a significant slowdown due to the COVID-19 shutdowns. The catalyst that caused this recession is artificial. It was not caused by an excessive amount of consumer or corporate debt (the 2008 GFC). It was not caused by a massive misallocation of capital (the 2000-02 Tech Bubble). It was a gigantic black-swan event that forced consumers to disrupt the natural demand and supply behaviors of a normally functioning economy. 

You can measure the severity of a recession in three ways: it’s depth, diffusion, and duration. This recession is very diffuse and deep, but it will likely not last long. 

Three Ds Recession

To be clear, while we technically might be experiencing the beginnings of a recovery, it won’t feel like it. The Congressional Budget Office projected that the coronavirus pandemic could cost the United States economy $16 trillion over the next ten years. (CNBC) The recovery will be slow, and the tens of millions of jobs that have been lost will take some time to recover. 

CBO GDP and Labor
Sources: Congressional Budget Office; Bureau of Economic Analysis; Bureau of Labor Statistics

However, the official unemployment rate for May 2020 is 13.3% after a surprise fall as companies hired workers this past month, suggesting that a recovery is underway. Could this be a result of the Paycheck Protection Plan (PPP) taking hold?

April 2020 unemployment rate

2. TINA

The stock market is doing well because interest rates are so low. The 10-yr Treasury Bond is currently yielding 0.82%, near historic lows. 

10 yr interest ratesAs an investor, you invest your money in asset classes that you believe will provide you with a reasonable return. If bonds, cash, and other fixed-income products will only provide you with a meager return, you will look elsewhere for a more profitable investment. In today’s marketplace, stocks are the alternative. With unprecedented monetary actions, the Fed has left us with very few options. As such, investors are forced to purchase stocks as There Is No Alternative (TINA).

3. COVID-19 End In Sight

There is a growing sentiment that believes we will have a readily-available vaccine within 6-9 months. Dr. Anthony Fauci hopes to have a ‘couple hundred million‘ vaccines by the beginning of 2021. Even though the first vaccine candidate, made by biotech company Moderna, has yet to begin Phase 3 trials, preparations to manufacture these vaccines are already underway. The idea is to produce these vaccines before it is clear whether or not the vaccine works. If it does work, then it can be deployed quickly. 

Alternatively, a more morbid scenario that can play out is that as the number of infected individuals continues to climb, the closer we get to herd immunity. While we don’t know the true number of exposed people, it is safe to assume that herd immunity is a feasible option. However, if a vaccine really will be available within 6-9 months, it is well worth it to wait. Either way, the worst is likely behind us. 

Caveat

In my humble opinion, the stock market has gotten ahead of itself. Life will not return to normal anytime soon. Social distancing policies will continue to be a drag on the economy until it is safe to live our ‘normal’ lives. Anything short of this will hamper recovery efforts. 

As the knock-off effects begin to impact the economy (E.g. commercial real estate losses mount, corporate losses don’t rebound quickly to profits, bankruptcies rise, etc.), as fiscal stimulus measures wane, and if or when the second wave of COVID cases arrives, we will be reminded that the market and the economy are positively correlated.

However, this is only my opinion. There are many, many variables that influence the global economy, and almost all of them individually are near impossible to predict (a different story, however, concerning leading indicators). Even if we were able to project the vast majority of these variables, all it takes is one miscalculation to throw it all by the wayside. Because we cannot accurately forecast the stock market in the short-term, we must have faith that humans are able to progress forward. An optimistic outlook has always favored long-term investors. 

Stick to your investment plan and take advantage of any market selloff, if you can. Stocks have shown remarkable resilience throughout history. Companies have been able to adapt to policy changes, currency fluctuations, geopolitical conflicts, and even pandemics. There is no other asset class that compares. But it will always be a bumpy ride.

We are only five months into 2020, and we have seven months left to go. So, buckle up and stay the course.

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