Why is the stock market so strong compared to the real economy?
Before the Covid-19 crisis, the world economy was exceedingly strong. Indeed, we were almost at full employment and the stock markets were reaching all-time highs. Everything seemed to be going well, until the economy almost completely shut down. Indeed, between January 1st and February 20, the TSX index was up 5% while the unemployment rate was down 0.1%. Then comes the Covid-19 crisis where public markets lose around 35% and the unemployment rate is increasing at a record speed.
So here we are seven months later, still having record numbers of new cases every day, with stock markets almost as strong as before the pandemic hit us. So, I asked myself the question: “How is it possible that the stock markets are so strong in such an unstable situation?”
Current economic situation
So, I started by trying to understand the real economic situation. There are several aspects to consider in order to understand what is going on in the economy. The first aspect to understand to be able to do my analysis is the variation in employment. It allows you to seek a better understanding of the economic situation of a country. Here are the results since the economy closed due to covid-19:
It is very interesting to see the variation in employment in 2020 compared to the last economic crises. It is easy to see a sharp rise in the unemployment rate followed by an almost equally rapid increase. Many economists predicted this economic crisis due to the pandemic was going to have a “V” shape, which is well represented for Canada in this graph. On the other hand, if we look at the variation in employment in the United States, the recovery seems to be slowing down drastically over the past month. Still without a vaccine or medication to beat the disease, and with the number of new cases in the United States increasing exponentially, it’s hard to see how the number of jobs will grow as quickly as it was a couple of months ago. If the slowdown in the decline in the unemployment rate continues over the next few months, things could be very difficult for the United States for the medium term.
A second economic aspect that I saw fit to look at is the percentage of overdue mortgages. This indicator has allowed analysts and economists to predict the economic crisis of 2008. It shows, in a way, the difficulties that households experience since the mortgage is very often one of the first bills people will pay. Here’s what the history of mortgage arrears has looked like over the past 30 years:
In this chart, we see an unmatched growth rate in the United States in the number of 90-day overdue mortgages as a percentage of residential loans. The situation in 2020 is worse than in 2008 during the economic crisis. The United States therefore finds itself in a very precarious situation. It will therefore be very interesting to see the actions of the US government in the coming months to avoid a recession.
Why are the stock markets so strong?
Looking at these two economic indicators, we can conclude that it is not as strong as it was before the pandemic and even a little worrying. In contrast, the stock market situation does not seem as difficult as the real economy. Some explanations allow to understand the why.
First, to avoid recession, governments of different countries are doing everything in their power to provide maximum economic stimulus. Since March, both the government of Justin Trudeau and the Fed in the United States have been offering a lot of help to companies and injecting enormous amounts of liquidity into the markets in order to help companies get through this pandemic by decreasing interest rates.
Second, since the start of the pandemic, some sectors, such as the tech sector (in brown in the graph below) have grown in value enormously. The change in the way of working has allowed some companies such as Zoom to take a lot of value. On the other hand, “classic” stocks (value with dividends) are struggling. It is therefore possible to conclude that the emergence of these new companies is driving up stock market indexes such as the TSX and the NYSE Composite.
Finally, a majority of investors in the stock markets believe that we are approaching the end of the pandemic. On the other hand, there is a lot of speculation about the release date of this vaccine. Several economists believe there will be an explosion in the markets once there is a vaccine to defeat covid-19. Therefore, investors are trying to buy before it is too late.
Knowing that the North American economy is primarily influenced by the consumption of goods, the sharp increase in mortgage arrears coupled with the historically high unemployment situation suggests that the profits of public companies will be under pressure. Therefore, one might expect a market correction if the pandemic situation continues without further aid measures by governments. It will be very interesting to watch the development of the stock markets over the next few months as we enter “the second wave” of covid-19. Moreover, without the emergence of the vaccine, it will be very interesting to see if there will be an adjustment of the stock markets with the real economy.
Thomas, D. (2020, 8 octobre). Why Is The Market So Strong And Economy So Weak? Forbes. https://www.forbes.com/sites/greatspeculations/2020/10/08/why-is-the-market-so-strong-while-the-economy-is-so-weak/#66751b171721
4 reasons the stock market is at record highs despite the sharpest economic decline since the Great Depression | Markets Insider. (2020, 11 août). markets.businessinsider.com. https://markets.businessinsider.com/news/stocks/stocks-market-outlook-record-highs-disconnect-sharp-economic-decline-why-2020-8-1029492559#
Radio-Canada. (2020, 5 juin). Le taux de chômage au Canada bondit à 13,7 % en mai. Radio-Canada.ca. https://ici.radio-canada.ca/nouvelle/1709450/coronavirus-emplois-canada-taux-chomage
Linderman, M. M. A. J. (2020, 9 octobre). U.S. official expects coronavirus vaccine to arrive in January, contradicting Trump. Global News. https://globalnews.ca/news/7390349/coronavirus-vaccine-us-january/