In the first quarter of 2020, the Gross Domestic Product, the chief tool used to measure the economy shrinks by 5% in the US. The analysts suggest that the worst could be yet to come. On top of that, as of May 28th, more than 40 million American workers have filed for unemployment benefits. The effects of COVID-19 on our economy is abundantly clear. Yet the Stock Market which plummeted from Feb 19th through March 23rd may be on the rebound. The S&P 500 is up 36% as of June 1st. How can that be? How can unemployment be soaring, GDP shrinking, and stocks marching on as if nothing is wrong. For starters, stock market is not the economy. The stock market is forward looking, meaning Stock prices are based on expectations of companies’ future earnings, not just present earnings and in that sense it is possible for the markets to be less impacted by the current circumstances if investors feel that there is a bright future ahead. Now that we have decoupled the Stock market from the overall economy, let us talk about how the Stock market is coming on so strongly despite the factors working against it.

The fact that people are buying tells us that there is some confidence in a good recovery from the losses brought on by the corona virus. The question then is where is the confidence coming from. It likely starts with aggressive and unprecedented maneuvers from the Fed. To calm the markets the Fed slashed the interest rates to zero and bought mortgage backed securities and high yield ETFs. It is safe to assume the Fed is not done yet. When asked his opinion on the current market, Torsten Slok, chief economist at Deutsche Bank Securities, said, “ This rally in equities is clearly not driven by fundamentals – it’s driven by the liquidity support from the Federal Reserve, companies are getting cash to keep the lights on through the significant support to credit markets.” Then there are the stimulus bills from congress like the CARES Act which increased unemployment benefits and provided direct payments to individuals. In short, investors confidence could be coming from the fact that the government is placing a large pillow under the market to soften the fall. Another factor that may be driving the stocks up is a flood of new investors entering the market. 

The government stimulus funding combined with the fear of missing out on the dip in equity pricing and zero commissions is driving lot of interest in buying stocks. With more free time and fewer entertainment options like sports some people are turning to stock trading to pass the time. Also with lowered interest rates, stocks are one of the only ways to find some yield. Looking at what stocks people are buying can shed more light on the stock market’s expectations about the post Covid-19 economy. Overall, as of June 1st, S&P 500 is back up above its 200 day moving average after rising 36% from its low on March 23rd. Looking at the 11 sectors of the S&P 500 over the last three months, energy, financials and utilities sectors have not bounced back  as well as the communication services, information technology and consumer discretionary sectors. FAANG stocks, Facebook, Apple, Amazon, Netflix and Google’s parent company Alphabet which drove the longest bull market in history leading up to the crash are also leading the charge in this rally. Because of the way the stock indices measure the market the out performance of these few huge companies can help bully the overall indices, potentially covering up areas of weakness. Overall this disparity may suggest that investors envision future economy even more dominated by digital companies. So, while the stock market is not the economy it is a leading indicator where the investors think the economy will go. Taking a closer look at who is buying and what they are buying may give us clues as to what the recovery may look like. 

Courtesy: TD Ameritrade