The sharp rebound of the stock market has been as surprising as the sharp selloff in March. Unemployment has reached levels unseen since the Great Depression of 1929; production has dropped 40% and M2 money creation is up 25%, all in the space of only a few months. There seems to be no limit to the size of the deficit we are willing to accept in the face of this crisis, and nobody seems capable of assessing the risk of these record deficits.
The huge drop in production coupled with the record monetary growth would seem an inevitable prelude to inflation, yet it is not yet visible. The common stimulative tools are unable to overcome the fear that is blocking consumer behavior.
Why is the stock market so resilient?
It is misleading to speak of the market as a single organic entity that moves in unity. The Covid market has diverged into the tech sector which is hitting new highs and the rest of the old economy which is struggling. It is common to see the tech laden NASDAQ go up on the same days that the Dow goes down. Tech is disproportionately represented in the S&P 500.
There are some special situations in the Covid economy that benefitted certain companies. Teledoc hits new highs as the regulatory roadblocks to telemedicine tumble. Dollar General hits new highs as its small markets attract consumers from larger more crowded venues. Chewy, the pet supply mail order, serves a growing market for shut-ins that want the company of pets. Animal shelters are emptying their pens. Papa John’s Pizza, already designed for home delivery, hit record sales. Clorox hit new highs in the midst of the selloff.
Energy, banks, travel, hospitality, insurance, and restaurants were all heavily hit, and remain below pre Covid levels.
Can you imagine how much more difficult this isolation would be without Amazon, social medial, and conferencing apps like ZOOM? We are ever more dependent on our digital connections and the stock prices in that market responded accordingly?
We are forced to recognize efficiencies that will remain when the virus passes. Media personalities broadcast from home, telecommuting is more acceptable, and online classes have moved to the default position.
When the vast amount of money from the Fed is dropped on the economy it does not matter where it is directed, much of it will find its way to the service providers and producers where the money will be spent. When trillions of dollars are pulled from thin air and dropped on the economy it is inevitable that much of it will find its way into the stock market.
In the short run the market is a voting machine, but in the long run it is a weighing machine. The prices for shares are ultimately dependent on the value the underlying companies can produce, but it is also dependent on the alternatives available. This tallest midget scenario has driven this market for the last ten years. Interest rates on short term and long-term securities are at record lows, real estate will be very regional dependent, and other alternatives have limited liquidity and lack the critical mass of the stock market. In such uncertain times the liquidity premium makes stocks more attractive; with a click shares can be turned into cash commonly without any commission or fee.
This does not reduce the risk in equities. There is little understanding from the most credentialled, and even less agreement on how the dramatic actions from the Fed and the Congress will unwind. Investors can tolerate known unknowns much more than unknown unknowns. Fear drives the equities market just as it is affecting the underlying economy. For a lot of investors low returns on cash is still preferable to the potential losses in a market that few understand.