The times we currently live in are unprecedented. The world never had to collectively battle a pandemic at the same time and there is no “guide” as to how governments should act and what measures to implement. It is somewhat of a trial and error period for everyone until we get it right. The only thing we can be sure of, is that we do not know what is coming, and not knowing is probably the safest and most correct answer at the moment.
Yes, we have had recessions, we have had bear markets, we even had depressions, but not like this. This time is different. There was never a time in history where pretty much the whole world had to come to a halt. Economies are at a standstill, people are at home, and only now, in the beginning of May are we seeing countries reopening their economies with a lot of restrictions and a fear that a second wave of COVID-19 might be coming. It took the U.S economy 5 weeks to lose all the jobs it created since the 2008 financial crisis. That is correct, 26.5 million jobs were lost as a result of the Coronavirus in just 5 weeks. This number is equivalent to 16% of the entire U.S. labor force.
For the stock market, these are times in which no investor is sure on how to better position himself, or even how to hedge against this great deal of uncertainty. The volatility index (VIX) has reached its second highest point of all time, and it is still considerably high if we compare it to the past few years. In the middle of April, after more than 16M lost their jobs in only 3 weeks’ time, the Dow experienced its best week since 1938. For most people, such statistic sounds bizarre as there is not much sense for a stock market rally during an oncoming recession. Bears are upset that the market is not reflecting the economic context and the bulls are confused on how this is even possible. The investing game is hard, it always has been, but now, more than ever, it is exceptionally confusing.
“IT TOOK THE U.S ECONOMY 5 WEEKS TO LOSE ALL THE JOBS IT CREATED SINCE THE 2008 FINANCIAL CRISIS.”
The stock market is not a benchmark. It is not the S&P 500 nor the Russell 1000. It is a market where buyers and sellers come together to exchange equity. What most people seem to forget is that it does not always have to make sense. Not every factor and piece of information is priced in and most of the times, the markets will be inefficient, and its agents will act more irrationally rather than rationally. The top 5 companies in the S&P 500 have as much weight as the bottom 350 in the index. This, however, does not mean that these companies generate the same revenue as those 350 or employ as many people. Therefore, the stock market should not be used as an accurate economic indicator. The stocks and the economy are not, and never have been perfectly correlated.
But if this does not sound convincing enough, let us look at how markets have historically behaved in times of exceptional uncertainty. During WW1 and WW2, despite the fact that economies were in shambles, the stock market actually showed strong gains through both wars. From the 1914 to 1918, the Dow was up by 43%, and from 1939 to 1945, the U.S. stock market was up by 115%. This can come at a surprise for many people, but it just goes to show how it does not always have to make sense, and there is no perfect correlation between stocks and the state of the economy.
The table below shows 13 periods where economic growth did not match the stock market performance. It is quite simple to understand why these disparities happened in the past. Economic data is backward looking, and the stock market tends to be forward looking. What is different this time is that we know for a fact that the economic data regarding 2020 will be awful. We just do not know the extent of it. What we also know is that this crisis will only be over when there is a vaccine in circulation to fully stop the spread of the virus, but we also do now know when that is going to happen.
Despite all this, stocks are down just 17% from their highs and 1% year-over-year. The S&P 500 experienced a historic bounce from its 23rd of March lows. A lot of historical things are happening this year and it will certainly be one for the books. For now, what we know is that the FED’s action was able to stop this from getting worse and it came to add a lot of much needed liquidity to the markets. It was clear this time that they did not want to replicate the 2008 crisis with such a delayed response. We are living in a time where saying that stocks will reach all time high by the end of the year has probably the same likelihood of happening as reaching historical lows. The stock market will surely continue to perplex investors that try to reason with it. COVID-19 came to remind investors that nothing is for granted and the stock market is never going to be predictable.
Article published in our April Newsletter
Rodrigo Marques, MSc in Finance