How Can the stock market rise when the economy plunges

How Can the stock market rise when the economy plunges
How Can the stock market rise when the economy plunges

Are the markets wrong since the beginning of the crisis?

Why is that most of the time the stock market rise when the economy is down? Let us analyze

Since their great downfall in March, stock markets have been recovering at top speed, seemingly trying to erase the Covid episode. S&P 500 is now only 10% far from its February records and have already recovered two-thirds of their lost in March. The recovery is less marked in Europe, and particularly in France, but it is at odds with the increasingly bleak prospects for growth and employment. The stock markets thus seem to be playing the partition of the return of business as usual, ignoring the fact that on the real economy side the negative signals have continued to accumulate, and that the abyss into which the real economy is being absorbed will leave its mark for many years to come. Should we be concerned about this recurring divorce between the real economy and finance?

The stock market is currently relying on the unconditional support of central banks

This bet exposes those who take it to new risks. In the short term, of course, this price swerve allows management funds and investment banks to recover. Some individuals have joined the movement. The historic crash in March attracted many new investors who wanted to take advantage of the significant discounts on the best stocks. All of this mitigates the wealth effects. But there is a risk that this speculative rally could be the prelude to a fall that will only get worse.

Because the stock market is playing today is the unconditional support of central banks, particularly in the United States, where the Fed has started on an asset buyback program on an unprecedented scale. Management funds, overwhelmed by liquidity, are looking for returns and are investing in any asset that can yield a return, even if the rise is ephemeral. Only equities can play this role in the short term. But they do so knowing that they will have to pull out in time. And under these conditions, we should expect an upward over adjustment followed by strong corrective instability in the coming weeks. The question is whether this correction will be catastrophic.

Firms capable of shaping their sector to their advantage

We could think that firms’ resilience and capability to face the crisis is what is pushing the markets upwards, however, there are two arguments to moderate this sentence.

  1. Not all stocks recover at the same speed and to the same extent. Some sectors are still seriously affected (energy, banks and industry in particular). These are not the sectors in which the funds are playing today. Healthcare, information technology, the communications sector, the consumer staples sector, of which Amazon alone accounts for the bulk of the listing, are erasing the March shock. However, these sectors remain marginally affected by the crisis or even benefit from it. And these star sectors account for the largest share of the US stock market today. The information technology, communication and healthcare sectors alone account for more than 52% of market capitalization. The same is true in Europe. Healthcare, technology and telecoms are leading the way, while industry, energy and finance are struggling to recover. The composition of the stock market overweighs the sectors most spared by the crisis, offering only a distorted image of the real economy.
  2. The second argument in favor of stock market resilience is that the major actors of the global economy will not experience the same crisis as the vast majority of companies. It is true that these companies are facing a historical contraction in demand and advertising revenues. But they can reposition themselves by selling off assets, by concentrating and consolidating their sector to their benefit, which can transform the crisis into an opportunity. Prices reflect this micro-economic reality. Even if the new economic equilibrium will be below pre-crisis levels, large listed companies will not necessarily be the losers of this new equilibrium.

In short, the stock market will undoubtedly play yo-yo. But it is not certain that the recent recovery is the prelude to the big tumble.

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