The Stock Market is Social Distancing From the Economy

//The Stock Market is Social Distancing From the Economy

The Stock Market is Social Distancing From the Economy

The stock market topped out on February 19 and experienced the third bear market in 20 years, falling 34% by March 23. In just over two months since then, stocks have risen nearly 40% to reclaim most of the losses. Both the decline and the rebound were the fastest on record. All the while, economic news has been weak, consistent with the effects of shutting down much of an economy that is only now opening. Why the gap?

Stock prices are forward looking. They do not care as much about the here and now but are more interested in a company’s earnings potential in 6-18 months. This happened coming out of the last recession that started in 2008. The 17-month bear market bottomed in March 2009, but GDP contracted four straight quarters through September 2009, half a year later. Following the then-massive liquidity injection by the Federal Reserve, investors saw economic growth and earnings potential and put their funds back to work.

The same thing is happening now. Economic data has been weak with a massive jump in unemployment and negative GDP for the first and second quarters. Meanwhile, monetary and fiscal policy have distributed trillions of dollars to individuals and business to replace (hopefully) temporary revenue declines. Investors incorporated the weak data into stock prices long ago, but believe the fiscal and monetary stimulus will bridge the economic gap to where the economy can grow again.

Even so, there are missing contributors to this stock market recovery. Cyclical stocks are those most affected by changes in the overall economy and include examples such as airlines, hotels or car makers. Defensive stocks, or non-cyclical, are generally profitable regardless of economic trends and include examples such as utilities and healthcare companies. When investors see growth ahead, most often cyclical stocks materially lead the defensive stocks that performed best as the economy slowed or contracted. In the current rebound, cyclical stocks have led defensive stocks, but only slightly.

We are also missing the leadership of small cap stocks. Because they have less ability to diversify internationally and enjoy less access to capital, small-cap stocks typically fall further than larger company stocks in a bear market that accompanies a recession. Conversely, exiting that recession, small-cap stocks usually lead the way as economic prospects brighten at home and consumers begin spending more. To date, small cap stocks are doing only about as well as their larger competitors.

It may simply just take more time for these trends to show greater clarity. Most of the country is now reopened for business, but consumers are reengaging in economic activity on their own timetable. Many consumer activity data points are off their lows yet are nowhere near highs seen earlier this year. Markets are reflecting optimism that the remarkably broad actions taken by the Federal Reserve and Congress, and the progress of various vaccine developers are going to translate into renewed economic growth. Perhaps not tomorrow, but sooner than our worst outlooks will allow.

Disclosure: https://mitchcap.com/disclosure/

2020-07-24T11:03:09-05:00 June 5th, 2020|Investment Management|0 Comments