In markets vs economy, Covid-19 remains the big unknown

2 mins read

By Hussein Sayed, Chief Market Strategist at FXTM

The 31% rally in the S&P 500 since hitting a bottom of 2,191 on March 23 has been truly incredible. Economic factors should be the key determining factor for equity markets, but there seems to be an enormous disconnect between the performance of stocks and the economy.

The dire data is breaking all records and seemingly only going to get worse – US jobless claims have topped 20 million since the start of the lockdowns, nearly erasing all jobs created since the last decade. Retail sales plunged 8.7% last month, the deepest drop in history, while new housebuilding projects fell 22% as confidence in the sector plunged by a record 42 points.

Last week, the International Monetary Fund described the current crisis like no other and projected global growth in 2020 falling to 3%, making ‘The Great Lockdown’ far worse than the 2009 Global Financial Crisis where the global GDP fell by only 0.1%.

The simple explanation for the bull run since March 23 is that central banks, led by the Federal Reserve, have followed the ’whatever it takes’ playbook. The US Fed has thrown all its tools at the crisis, ranging from slashing interest rates to zero, restarting its asset purchase programme, providing credit lines for small businesses, to even relaxing regulations on banks to help provide liquidity. The $2 trillion economic aid package has also played an important role in alleviating investors’ sentiment.

The huge monetary and fiscal action so far has been successful in putting a floor under equity prices and refuelling a new bull run. Investors will likely ignore the terrible numbers we are about to see in upcoming economic data and earnings results, as most of this has already been priced in for the first quarter and possibly for most of the second.

The key determinant to equity performance beyond this period is the trajectory of the Covid-19 virus and how fast economies open up. The faster the global economy restarts, the more gains we are likely to see in risk assets in the short term. However, the mid-term outlook continues to be murky as many variables remain unknown.

Several European governments, including Germany, are now in the process of taking cautious steps towards lifting their lockdowns. We will learn a great deal from these governments and countries of how life will look like in the near future.

But what if the virus infection rate begins to accelerate again and another lockdown is imposed? That is going to be a disastrous outcome, and instead of confronting a steep recession, we might end up with a long-lasting depression. Without a vaccine and proper treatment, life will not return to normal and spending behaviour will continue to adjust to this new reality.

Equity performance cannot diverge for a prolonged period of time from fundamentals, so if we do not see a true economic recovery in the coming months, expect another leg lower in stock markets.

The success of the lockdown easing measures in countries like Germany, Spain, Italy and Switzerland among others will determine whether this bull market still has further potential to go higher.


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