FINANCE TODAY | ISSUE NO.00
March 9, 2020, marked the beginning of a historic stock market crash that rocked the global economy. What some people are calling Black Monday 2020 was the start of a series of sharp decreases, causing the Dow Jones Industrial Average (DJIA) to lose 19.3% from its previous February 12, 2020, high (Amadeo, 2020). Investor fears about the impact of the coronavirus pandemic and mounting tensions between China and the U.S led to the 2020 crash. As businesses closed, over 2.7 million jobs were lost in Canada and real GDP declined by 11% in April, according to Statistics Canada (Government of Canada, 2020). The overall economic health of Canada and the U.S has recently begun to improve as restrictions are lifted and businesses slowly reopen. However, despite a bleak economic picture, markets have since risen to session highs and almost made a full recovery. This disconnect between market performance and the economy has left many people puzzled and wondering- why?
TWO DIFFERENT NARRATIVES
As of May, the C.D Howe Institute’s Business Cycle Council has announced that Canada is officially in a recession (Evans, 2020), with the U.S in a similar position as well. This has left many investors questioning why the stock market is breaking records while the economy is still suffering. Here are some recent market achievements that highlight the disconnect (Leonhardt, 2020):
- The S&P 500 Composite Index was up 11.2% from a year ago at the beginning of June
- Both the S&P 500 and the Dow Indexes are up 30% from their March 2020 bear market lows
- On June 8, 2020, the S&P 500 Index recovered its 2020 losses
- On June 10, 2020, the Nasdaq Index reached a never before seen high and closed above 10,000
Meanwhile, GDP levels are plunging and unemployment levels still hover around 13% in Canada and the U.S (Leonhardt, 2020). While it would seem logical that the stock market directly mirrors economic performance, that is not the case.
The graph on the left depicts the S&P 500 Index’s steady recovery since early April. Meanwhile, the graph on the right shows the unemployment rate, which has been rising up until May.
THE STOCK MARKET IS NOT THE ECONOMY
There are three main reasons why the stock market rallied while the economy shrank.
The Market is a Leading Indicator
The stock market is a forward-looking mechanism, which means that the market anticipates coming economic change. This is because stock prices are based on what companies are expected to earn if estimates are correct. As a result, the stock market begins to recover when the economy is still in bad shape, in anticipation of an economic uptick.
Swift action by the government helped reduce the impact of the pandemic and buoyed the market with the help of a $2 trillion USD stimulus package in the U.S (Warmbrodt, 2020). The package offered tax breaks, stimulus payments to citizens, and large injections of cash into the economy. Canada also followed suit with an economic relief plan. The goal of early government intervention is to dampen the blow and to ensure a faster recovery. Governments intervened very early in the pandemic to avoid long-lasting effects like those felt during the 2008 recession.
Investor Behaviour Bias
Investors have been decidedly bullish and confident throughout the pandemic. When hefty economic relief packages were announced, many investors saw this as evidence that affirmed their bias that the market was going to be strengthened and invested further into the market. This is an example of a fallacy called confirmation bias, where investors only seek out and act on information that affirms their beliefs (Braun, 2020). Another factor is that there is little incentive for fixed income investments, as bond yields are at record lows. As a result, investors are now turning to the stock market as a way of earning more money.
Restrictions are gradually being lifted in Canada and the U.S, with high hopes for Canada as coronavirus case numbers continue to fall. Many investors believe that the worst is over for the market and are hopeful for a brighter future. Based on past recessions, there are two different scenarios that could play out. If the recovery continues, we could be on track to see a situation similar to the mortgage crisis of 2009-2010, where stock prices continued to rise despite skepticism about the economy (Achuthan, 2020). Alternatively, the market could recover initially and then bottom out, as it did during the 2002-2003 dot-com bubble (Achuthan, 2020). So far, things are looking positive. However, the unusual and unprecedented nature of the coronavirus pandemic means that things could change quickly, and the only aspect that is certain is the looming uncertainty.
Achuthan, L. (2020, June 24). Opinion: Yes, we’re in a recession. But the stock market’s rally still makes perfect sense. Retrieved June 24, 2020, from https://www.cnn.com/2020/06/24/perspectives/recession-stock-market/index.html
Amadeo, K. (2020, May 27). Is the 2020 Stock Market Crash One of the Worst? Retrieved June 25, 2020, from https://www.thebalance.com/fundamentals-of-the-2020-market-crash-4799950
Braun, P. (2020, May 13). Why Is The Stock Market Up When The Economy Is Down. Retrieved June 25, 2020, from https://www.forbes.com/sites/phillipbraun/2020/04/28/why-is-the-stock-market-up-when-the-economy-is-down/
Evans, P. (2020, May 01). It’s official – Canada’s economy is in a recession, C.D. Howe says | CBC News. Retrieved June 23, 2020, from https://www.cbc.ca/news/business/canada-recession-economy-1.5552135
Government of Canada, S. (2020, June 24). Recent developments in the Canadian economy, COVID-19, second edition. Retrieved June 25, 2020, from https://www150.statcan.gc.ca/n1/daily-quotidien/200624/dq200624d-eng.htm
Leonhardt, M. (2020, June 11). Why are we in a recession if the stock market is recovering? Retrieved June 23, 2020, from https://www.cnbc.com/2020/06/11/why-are-we-in-a-recession-if-the-stock-market-is-recovering.html
Warmbrodt, Z. (2020, May 3). Here’s what’s in the $2 trillion stimulus package – and what’s next. Retrieved June 24, 2020, from https://www.politico.com/news/2020/03/25/whats-in-stimulus-package-coronavirus-149282