Why Are Stocks Soaring in the Middle of a Pandemic?

BY DIANE SWONK, DAVID ROSENBERG, MOHAMED A. EL-ERIAN, ADAM POSEN, EDUARDO PORTER, TREVOR JACKSON
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The contrast seems grotesque. A deadly pandemic has shut down the global economy and left millions of workers furloughed, fired, or stranded without gigs. The future for most businesses looks uncertain to dismal. Yet U.S. stock indices are near all-time highs, at giddy valuations comparable to the 2000 dot-com bubble and 1929.

Foreign Policy researched but could not find a moment in financial history that remotely resembles today—so we asked a panel of leading experts to help us make sense of the markets, and what their state tells us about the economy and society going forward.

Investors See the World Through Pre-Pandemic Lenses

by Diane Swonk, the chief economist at Grant Thornton.

It is hard to reconcile the rich pricing and resilience of the stock market with the devastation brought on by the pandemic. One reason for the dissonance is that the value of the major stock indices is determined by fewer firms—and is less reflective of overall economic conditions—than ever before. The indices are heavily weighted by technology firms, many of which are better positioned to weather and even benefit from the pandemic than companies in other industries.Both the economy and corporate profits will be much smaller than before the pandemic—and will remain that way for a long time.

The U.S. Federal Reserve’s aggressive actions to stop a credit market meltdown in March are indirectly providing support for stock prices. There are other reasons for U.S. equity market strength: Investors fleeing emerging markets see the S&P 500 Index as a safe haven, just as investors fled to the perceived safety of U.S. Treasury bonds during the 2008-2009 global financial crisis. This appears to reflect investors’ hopes that U.S. stocks won’t correct downward much, which could be a misplaced bet.

Perhaps most worrisome, many investors still see the world through pre-pandemic-tinted lenses. They take previous recessions as a benchmark and expect profits to rebound as in the past—and don’t see the much larger and longer-term challenges created by COVID-19, including our need to maintain social distancing in the future. They would be better served to view the world with clear eyes: Both the economy and corporate profits will be much smaller than before the pandemic and will remain that way for a long time.

Corporate bankruptcies and consolidation will likely accelerate, which could further derail the rosy scenarios. A little more humility and a little less hubris from Wall Street would be welcome given the magnitude of the devastation we are enduring now and are likely to grapple with for some time to come.

Nothing in Financial History Compares

by David Rosenberg, the president and chief economist of Rosenberg Research.

This is the mother of all liquidity-induced equity market rallies. Nothing in financial history compares. This is not about vaccine hopes, not about the economy reopening, and certainly not about the deep economic contraction coming to an end.

This is not about vaccine hopes, not about the economy reopening, and certainly not about the deep economic contraction coming to an end.

It is all about massive amounts of liquidity provided by the U.S. Federal Reserve. Look at the timing and numbers, and it becomes obvious: Since the end of March, the Fed’s balance sheet has expanded by $3 trillion—twice the expansion that took place at the depths of the 2008-2009 Great Recession. It just so happens that over the same period, the S&P 500 market capitalization has jumped nearly in lockstep—by $2.8 trillion, hand in hand with the Fed’s balance sheet. In fact, statistically speaking, the correlation between the equity market and the Fed balance sheet has now crossed above 90 percent, even higher than the already close relationship between equity prices and the Fed’s quantitative easing programs between 2009 and 2013.

Conversely, the correlation between the S&P 500 and the performance of the real economy over this interval is close to zero. So current stock prices have nothing to do with the economy—but everything to do with Fed liquidity.

Wall Street Is Flourishing While Main Street Is Suffering

by Mohamed A. El-Erian, chief economic advisor at Allianz and the designated president of the University of Cambridge’s Queens’ College.

Main Street and Wall Street seem to be on different planets. More than 40 million Americans, or about a quarter of the labor force, have lost their jobs, and the economy is set to contract by as much as 30 or 40 percent during the second quarter—despite some $6 trillion of emergency fiscal and monetary intervention. Yet, after an initial fall, major stock market indices have staged a remarkable recovery.The more the markets rely on the Fed, the less the economy will be able to sustain high growth and robust job creation.

What is driving markets is a bet investors believe they can’t lose: They win if—based on the notion that stock markets can see past the short term—the economy quickly returns to normal; they also win if it doesn’t, given that the U.S. Federal Reserve has repeatedly demonstrated that it is both willing and able to backstop markets. After all, what is more reassuring than a buyer with a seemingly endless appetite and a money-printing press to boot?

As compelling as this bet appears to many investors, it should be worrisome for those of us who care about longer-term inclusive prosperity, sustainability, genuine financial stability, and the broad buy-in by society that’s needed to support all this.

The more the markets ignore economic and business fundamentals and rely on the Fed, the more they will struggle to efficiently allocate resources throughout the economy. The crucial role played by equity prices in signaling which companies have the best prospects is eroded. This undermines productivity growth and makes the economy less able to sustain high growth and robust job creation.

Only a few months into this tragic COVID-19 shock, there are already concerns that Wall Street is once again flourishing while Main Street is suffering, heightening worries about a further rise in an already large inequality of income, wealth, and opportunity. If current asset prices fail to be validated by a decisive economic recovery, the longer-term well-being not just of the economy and markets but of institutions and society as well will be at risk.

Ignore the Stock Markets

by Adam Posen, the president of the Peterson Institute for International Economics.

Average investors are right to ignore stock market swings and should tell their elected officials to do the same. Movements in overall equity prices have little direct impact on economic growth and rarely forecast future developments. If broad stock market moves have any meaning, it is as a barometer of the share of GDP going to the profits of a small set of publicly listed companies.Today’s market exuberance may seem grotesque, but rising share prices reflect a grim underlying reality.

Those profits may have nothing to do with the welfare of citizens or the overall economy and everything to do with the way political decisions and technology drive redistribution. Deregulation and lax enforcement can increase profits without creating growth and weaken the market power of workers and consumers. Network effects, especially those associated with the internet economy, may entrench the profitability of a few large firms against smaller competitors and newcomers.

The pandemic makes these forces even stronger. Workers are scared if not unemployed; networked companies are becoming more critical to daily life; large internet-based retailers and service providers are stepping in while small local companies close. Today’s market exuberance may seem grotesque, but the rising share prices of listed companies reflect the grim underlying reality. Taxes and regulation are the only way to change that.

Equities Will Defy the Downturn

by Eduardo Porter, an economics reporter at the New York Times and the author of American Poison: How Racial Hostility Destroyed Our Promise.

Wall Street types like to believe that the price of the stocks they peddle somehow represents the value of a business or the state of the economy. Nonsense. These days, the price of stocks has mostly been a function of policy at the U.S. Federal Reserve: When the Fed unleashes waves of money on the economy, that money seeks assets to buy.The biggest risk to equity markets is that Fed Chair Jerome Powell may take the punch bowl away.

Takeaway 1: It would be a mistake to conclude that markets believe this recession will be V-shaped, with the economy ready to bounce back sharply in a few months. Markets have no clue. And it likely won’t be so rosy. Takeaway 2: Barring another calamity—an even more devastating second wave of COVID-19, for example—the biggest risk to equity markets is that Fed Chair Jerome Powell may take the punch bowl away. As long as the Fed keeps buying bonds hand over fist, depressing bond yields and flooding markets in liquidity, equities will defy the economic downturn.

Indeed, who knows what will follow? In the past, investors stretching for yield have piled into all sorts of alternative assets, from emerging market debt and equities to mortgage-backed bonds. Today, bets such as these seem outlandish, given the enormous risks. But give the markets time.

Not Even Remotely All in This Together

by Trevor Jackson, an assistant professor of economic history at George Washington University.

In 1977, the radical economist Robert Rowthorn argued that inflation could be thought of as the price governments paid for social peace. That decade, oil shocks, political unrest, and the end of the Bretton Woods monetary system imposed a high price for social peace, in the form of persistent inflation. The subsequent “Great Moderation” from the late 1980s to 2007 was an era of low inflation, with broken labor unions, abundant credit, and the end of any credible communist threat. Social peace was cheap.A world with guaranteed income for capital and unprecedented unemployment for labor tells us about the relative power of each.

Since 2008, central bank policies have produced inflation again—but only in asset prices—while workers have endured a lost decade of unemployment and stagnant wages. Never before this spring have so many people lost their jobs so quickly, and never before have central banks stepped in to provide so much liquidity to financial markets with no obvious limit. A world with guaranteed income for capital and unprecedented unemployment for labor tells us about the relative power of each: It has become very expensive to buy social peace from capital, while labor can be offered next to nothing. That contradiction has lasted for a decade and intensified this year. That is what the surge in asset prices is telling us. But it cannot last forever.