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4 Lessons We Can Learn From The Stock Markets’ Bull Charge Reaction To The COVID-19 Pandemic

Trying to predict stock market movement is like trying to get to guess when the COVID-19 pandemic will end. Everyone has an opinion, but no one really knows for sure.


2020 is a year of unprecedented volatility with a global pandemic and global recession. From 19 Feb 2020 to 23 Mar 2020, the S&P 500 has dropped 33.9% in just 33 days, and recovered in 11 weeks. This is the swiftest market crash and recovery in history. In comparison, the Global Financial Crisis took almost three years to recover. What can we learn from the stock markets’ reaction to the pandemic?

Read Also: Opportunities Beyond COVID-19: Is This The Right Time To Start Investing?

#1 Stock Markets’ Recovery Are Not Equal

In general, most people use the term ‘stock market’ to refer to the stock markets as a whole. However, it would be a misconception to think that stock markets are homogeneous. Each stock market has its own stock exchange which comprises of different listed companies.

The truth is that the recovery is not the same for all stock markets. Our local stock market, the Straits Times Index (STI), has not staged a recovery as robust as the S&P 500. As of 16 June, the STI is still negative 17.9% from the start of the year, while the S&P 500 is only down 5.9% and the NASDAQ is actually positive 10.8%.

Similarly, the Asian stock markets show unequal performance, with China and Hong Kong leading the recovery. While the Nikkei and STI have recovered from their lows, their recovery is not as strong as compared to the Hang Seng Index (HSI) and the FTSE China A50.

If you have been investing in the overseas stock indices, you would have seen a better recovery from your investments than the STI.

Lesson learnt: There is value in diversifying your investment beyond the Singapore Exchange.

#2 The Stock Market Is Not Necessarily A Reflection Of The Current Economy

To some, it seems unimaginable that the stock markets are continuing their blistering rally as dire economic data continues to be released. The conflicting headlines, such as “Nasdaq hits record high as U.S. recession becomes official”, does not seem to make sense to most non-investors and even some investors.

However, keep in mind that the stock market is not the economy. Instead, very often, the stock market is a reflection of the expectation of future earnings. Stock prices rise and fall, depending on the expectation of whether the company’s earnings would be positive or negative. This means the stock market may price in the expectation of a v-shaped recovery where economic activities will resume, and companies will be able to meet their earnings forecasts.

The other point to remember is that economic data are lagging indicators. Macroeconomic data, such as unemployment data, are collated and released later, with at least a month’s delay. Instead, economists are beginning to turn to alternative real-time indicators such as Google Map data, booking reservations and e-payment volumes to have a better sensing of consumer and business sentiment.

The stock market is also blind to individual economic hardship and socio-political issues that have no impact on earnings. While George Floyd protests are taking place in the USA, the stock market has continued its rally without pause. Likewise, for the millions who have lost their jobs, the stock market rally is of little comfort.

Lesson learnt: Stock markets are forward-looking and can be agnostic to current events.

#3 Stock Market Performance Is Driven By A Few Stocks

The stock market’s performance begins to make sense when you look at the individual stocks that make up the index. The top 10 constituents of the S&P 500 (forming 26% of the index) on 15 June 2020 are Microsoft, Apple, Amazon, Facebook, Alphabet (Google), Johnson & Johnson, Berkshire Hathaway (owned by Warren Buffett), Visa and JPMorgan. These are mostly technology companies and some finance related companies who are not as badly affected by the pandemic and in some cases, may even be seeing some growth.

As people are confined at home, technology companies like Microsoft, Apple, Facebook and Alphabet are thriving as people turn to digital solutions and communications. Amazon is still able to generate revenue from home deliveries. Visa is riding the rise of e-payments. When you realise that the overall stock index is driven by the massive movement of a few major stocks, the recent stock market rally begins to make more sense.

Lesson learnt: Stock market performance can be driven by the outperformance of a few major stocks.

#4 The Stock Markets Are Flush With Credit Stimulus From Central Banks

The Federal Reserve (Fed)’s stimulus is the major trigger for the market rally after the markets crashed due to coronavirus-induced fears. In fact, the announcement of the Fed stimulus measures on 23 March 2020 marks the turning point of the market movement.

In line with the Fed, other central banks have also implemented huge stimulus packages and lowered interest rates. Singapore has also implemented the Resilience, Solidarity and Fortitude Budgets to the tune of $92 billion to support the country economically through the crisis.

Central banks typically implement stimulus measures through lowered interest rates, asset buying and other programmes that aim to increase credit liquidity in the monetary system. This makes it easier for companies to take loans to tide them through rough periods.

The Fed has an outsized effect on global stock markets compared to other central banks. This is because of the US dollar’s role as the global reserve currency and because the US stock market is the largest stock market in the world. US stocks make up more than half (54.5%) of global stocks, followed by Japan at 7.7%, UK at 5.1% and China at 4% (as of Jan 2020).

While the Fed does not participate directly in the stock market, the Fed has enlarged its bond-buying powers by expanding the amount of bonds ($3 trillion in loans and asset purchases) and the type of bonds the Fed buys (from bond ETFs to individual investment grade corporate bonds). This has led to a drastic drop in bond yields.

Traditionally, bonds and stocks are inversely related: when stock prices go up, bond prices go down and vice versa. The economic logic behind this is that investors have to choose between the safety, but relatively low return, of bonds, or the risky nature, but relatively high return, of stocks.

However, because of Fed intervention, we are seeing a case where both bond and stock prices are high. Due to the Fed buying bonds, bond yields have dropped to historic lows, while bond prices have risen. In search of better yields, investors have piled into stocks, further pushing up stock prices, leading to the stock market rally.

This is happening globally as central banks have injected monetary stimulus to soften the economic impact of the pandemic. The impact of stimulus on stock performance is so significant that the market observers have coined the term “Powell Put” to refer to the point below which Fed Chairman Jerome Powell would not let the market fall before stepping in with stimulus.

Lesson learnt: Do not underestimate the impact of monetary policies on stock market performance.

With these lessons learnt, investors will need to keep vigilant and balance both risk and opportunity. As we enter Phase 2 of Singapore’s reopening, we need to keep in mind that we have not seen the last of COVID-19, both in Singapore and around the world. Thus, it is still unknown how the stock market will play out through the rest of the pandemic.

Read Also: Singapore Mobile Brokerages: 5 Important Factors For Investors To Consider Before Opening An Account

 

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