Nearly 17 million Americans have filed for unemployment benefits across the last three weeks. More than half a million have contracted the Coronavirus, including over 20,000 who have succumbed to the deadly virus. Businesses have closed around the country and economic growth is expected to plunge, with a steep recession all but a certainty.
It makes for a depressing picture, yet the US stock market has somehow managed to bounce of its low despite everything that should be weighing against investor sentiment. In fact, the S&P 500 index is down just 14% from its all-time high, having shed nearly a third of its value at one point.
So just why are stocks showing some signs of resilience?
Enter the Federal Government
It’s not by coincidence that stocks have found some support since the Federal Reserve turned to the printing press in an effort to support the economy. At this point, the immediate and even near-term health and economic effects of the Coronavirus seem to be playing second fiddle in terms of shaping the direction of the market.
In what can only be described as a scenario where bad news might be considered good news, the startling deterioration in the US economy is ironically the very thing that has market makers hitting the buy button. It’s not because investors think the current crisis can be averted. We are likely already in a recession. However, there is a belief that the worse things get, the more the government will do to shore up the long-term outlook of the economy.
We’ve already seen the early effects of this. An initial US$2.2 trillion in stimulus spending was given the green light by Congress and enacted into law. Now, in the wake of another US$2.3 trillion in stimulus support, the market cemented positive gains last week despite an increasingly shocking tally of Americans out of a job. In fact, last week amounted to the best weekly performance by the US stock market since 1974.
Big companies are propping up the market
The biggest beneficiaries of the government’s concerted efforts to prop up the economy are also the largest companies. Aside from generally having a better footing as far as the state of their balance sheets, their scale equips them with robustness to make necessary changes that will help see them through to the other side of this crisis.
What’s more, large companies tend to have greater access to capital, either through institutional investors or programs being rolled out by the government. What it all means is that the companies that make up the largest portion of the stock market, and which ultimately dictate the market’s momentum, are those which could increase their market share as smaller businesses struggle to stay afloat.
If large companies are able to increase their market share, despite the unfortunate circumstances that come with it, that will almost certainly translate into better earnings prospects over the long-term. With current uncertainty hanging over the economy, future earnings are atop every investor’s wishlist.
This factor is also flowing through to the market’s forward estimates. S&P 500 companies are expected to chalk up just a 0.1% decline in revenue across the calendar year, despite a forecast drop in earnings of 8.5%. With what can only be described as a modest impact priced in, the market is clearly remaining optimistic that the large companies which underpinned the multi-year bull run can help the market find its feet amid the toughest of circumstances.
Some of the biggest rallies occur during bear markets
Another important thing worth reflecting on is history. While past performance is no indicator of future performance, sometimes history does have a habit of repeating itself. And on this point, some of the strongest market rallies of all time have occurred during bear markets.
What needs to be considered in this context are the reasons behind this. When you consider the overwhelming volume of stock that is sold ‘short’ during a downturn, momentum can play a significant role. As soon as that momentum begins to shift, it can swing rapidly in the other direction.
Consider the amount of travel-related stocks that have been targets of short selling over the last month. It is also these stocks that have suddenly turned on a dime and posted significant gains as short-sellers were squeezed and closed out their positions.
Similarly, oil companies have felt the brunt of the bear market as prices for the commodity have plunged. When news broke that President Trump had apparently brokered a deal between Russia and Saudi Arabia for OPEC+ to slash oil production, energy stocks soared higher. Again, momentum here was driven by short-sellers closing their position and fanning the flames for a rally.
The market is forward-looking
There is no doubt that the current economic crisis is set to eclipse just about anything we have seen in modern history. Already, the extent of the downturn is looking to exceed that of the Global Financial Crisis. During past recessions, the market has typically found a bottom before economic expansion began or unemployment reached its peak.
This downturn is unprecedented in so many ways that we cannot be sure as to whether history will repeat itself. Capital markets have been disconnected from the underlying economy for years now, but if momentum is any indicator, the market is not just hoping for normality to return soon, it is betting on it.