Thursday, May 21, 2020

Some Stocks Just Hit Record Highs – Is It Cause to Celebrate?

NBHM Research Team

Many stocks have seen record surges in the recent past. Is it a sign of economic recovery? Is the stock market in sync with the real-world economy?

 

Some Stocks Just Hit Record Highs – Is It Cause to Celebrate?

Time and again, the global stock markets record surges, despite dismal and practically scary economic data in the background. On May 18, 2020, the Dow Jones gained 912 points, it’s best daily performance since April 6, 2020, while the Nasdaq hit its highest levels since February 25, 2020.  The S&P 500 also gained 90 points, the best since March 6, 2020.

Some stocks like Apple, Dollar General, PayPal and Nvidia hit all-time highs. These rallies were attributed to investors flocking to riskier assets, following positive news of a likely COVID-19 vaccine from biotech company Moderna.

The Asian stock indices, like the Nikkei, Hang Seng and Shanghai Composite, as well as the Australian SPX ASX 200, all rose on the same optimism.

Something similar happened on May 13, 2020 as well. The DJIA climbed 1.6% and the S&P 500 rose 1.15%, even as unemployment data released in the US was dismal. On April 16, 2020, giants like Amazon and Netflix soared to record highs, even as the overall market declined 14% in the year so far.

Is It a Sign of Potential Recovery?

These intermittent surges cannot be taken as a signal of economic recovery, given that the economic data says otherwise. From March to April 2020, over 20.5 million people in the United States alone lost their jobs. Over 36 million US citizens are now out of work, as of May 2020. The service PMI for US declined to 26.7 in April 2020, from 36.7 in March 2020, while the US economy contracted at an annualized 4.8% in Q1 2020, the sharpest decline since 2008 crisis.

The overall service PMI for the Eurozone was also down to 12 in April 2020, from 26.4 in March 2020. The overall EU GDP fell at an annualized 13.3% in Q1 2020. Japan’s economy recorded a straight second quarter of decline, with 3.4% shrinkage at an annualized rate, pushing the country into recession.

Stock market volatility was at record high levels in Q1 2020, with major equity market indices moving from all-time highs in late February to bearish territory at a rate not seen since 1987. This highlights a more pressing concern: how disengaged is the stock market from the real economy?

The Stock Market Does Not Reflect the Real Economy

There are various factors that influence stock movements, which results in the stock market not really reflecting the actual condition of the economy.

1. Injection of Huge Liquidity by Central Banks

In the 2020 Tsinghua PBCSF Finance Forum held online in Beijing, economists explained that the stock market currently doesn’t reflect the real economy. Right now, it is solely supported by the vast amount of liquidity injected by the central banks to help economic recovery.

In both the 1929 Great Depression and the 2008 financial crisis, the stock market saw short-term rebounds due to government bailout packages, while the real economy showed no signs of recovery.

According to experts, this disconnection between the actual economy and Wall Street will not last long. Even analysts at Bank of America believe that all the liquidity injected cannot compensate for the collapse of real-world economic activities, and the surges are temporary.

2. Investors are Optimistic about a Recovery

The next plausible explanation would be that investors are more hopeful, and frankly have no other sources of viable income. Right now, they don’t have a lot of avenues to gain returns from, with even government bonds offering low returns at present. The US Fed’s actions have, to some extent, restored faith in corporate bond buyers and equity traders that they have the backing of the central bank.

There is plenty of FOMO going around among investor circles, as they don’t want to be locked out of an eventual economic recovery. Historically, economies have rebounded after pandemics, and investors might believe that if they keep waiting, they might miss out on the upside, when it does occur.

3. Corporate Buybacks and Improved EPS

Business professor from Tulane University, Peter Ricchiuti, says that the stock market surges are all about corporate profits, while the rest of it is noise. Over 70% of the equity markets are based on consumer spending, and a very small portion depends on the real value of stocks. Low interest rates can inflate prices of asset, like stocks, so some stocks are high on valuation.

Many companies have bought back shares, as a result of which their EPS (Earnings per Share) report has been bolstered. This has nothing to do with the real economy.

4. Overperformance of Some Sectors in the COVID-19 Crisis

A thing to note here is that even if the markets are not acting according to real-time economic fundamentals, they are moving on reasonable judgments of the fundamentals. Industries that have benefited from this crisis are edging up, compared to those that have been hit the hardest.

Mega tech companies like Netflix, Apple, Facebook and Google have done well, particularly Amazon, whose stock has surged 30% since mid-March. Costco, Clorox and Walmart are doing well too. On the other hand, retail stores have seen decline of 50% and only marginally improved since March 2020. Oil company stocks are declining due to the oil market volatility, low demand and high debt loads.

5. Structure of Major Equity Indices

The composition of the stock market has some part to play in the rallies too. The S&P 500 is dominated by large global companies that are highly profitable, have large sums of cash and have regular access to the public bond markets. Approximately 40% of the revenues of S&P companies come from overseas. These companies, like Microsoft, Apple and Facebook, have done exceedingly well in this crisis. Their share prices have underplayed the impact of the economic collapse in the US.

Stock ownership among the middle class is also low. Recent data from the US Federal Reserve shows that the top wealthiest 10% American households account for 84% of the value of all household stock ownership. High net worth individuals are less likely to be impacted severely by economic downturns.

If experts are to be believed, the world economy is heading towards a long, slow and uneven recovery, which is not priced into the stock markets. Analyst forecasts regarding earnings growth of companies might be too optimistic. More downward revisions might be in the pipeline. Traders need to be prepared for choppy market conditions in the near future.

 

Reference Links

https://www.vox.com/covid-19-coronavirus-economy-recession-stock-market/2020/5/6/21248069/stock-market-economy-federal-reserve-jerome-powell

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