The economy is doing so poorly, so why are financial markets going up?
Over the course of 2020, the global economy has been forced to move through the throes of the COVID-19 pandemic. Combined with fears of a contested U.S. presidential election, social justice unrest worldwide and a new work-from-home environment, investor behaviour and the economy at large has been impacted in more ways than one.
Right now, there’s a bit of a disconnect in the current environment. Unemployment rates are depressionary, small businesses are closing and the underlying economy is performing poorly, yet the stock market continues to rise. In order to properly navigate this environment, it’s essential to understand what is actually taking place.
So, why do markets continue to rise? There’s a handful of reasons for this:
1. The transfer of wealth from small businesses to big corporations
Throughout the pandemic, there has been a real transfer of wealth from small business owners and sole proprietors to big corporations. Lockdown restrictions were felt most by the mom and pop shops, pizzerias and cafes, while the big guys like Wal-Mart, Loblaws and Amazon were able to stay open and continue selling goods and services – making them the net beneficiaries of this pandemic. As such, big corporations in many sectors of the economy have gained more than they’ve lost during this time.
2. Interest rates have been suppressed, forcing people into the stock market.
Interest rates have hit historic lows, making it nearly impossible to get a rational rate of return in the bond market. If you’re a bond investor, you’re likely losing money in this environment because real rates are negative (real rates = the nominal interest rate minus inflation and taxes). Therefore, bond investors have been forced to enter the stock market to seek a rate of return.
3. Increased government monetary and fiscal stimulus.
In an effort to protect the economy against a depression, governments globally have poured trillions of dollars into the financial system through various monetary and fiscal stimulus programs and relief packages. For example, in Canada, the government is providing basic income to keep people afloat through Canada Emergency Response Benefit (CERB).
As well, central banks in North America are purchasing bonds and mortgage liabilities from institutions so they can inject liquidity into the system. This has resulted in significant interest rate drops throughout the year, while driving asset prices up.
4. Retail investor stock mania.
Lockdown restrictions have forced many people to remain at home, unable to travel and with extra money in their pocket. With market noise and headlines going awry, people are chasing the U.S. equity bull market driven by excess liquidity and momentum in the technology sector. The digital direct investing options of today have made it extremely easy for new investors to enter the stock market with fractional share ownership – a new phenomenon that allows retail investors to purchase small pieces of big companies online.
Taken as a whole, the liquidity and momentum in the stock market has made retail investors want to jump without realizing what they’re actually buying and the price they’re paying for their assets. The price you pay for assets is relevant, it’s just not relevant right now due to a lack of education among investors.
The technology and renewables sector are hot and extremely expensive in the current environment. The stock price movement we are currently seeing is based on short-term market noise and impatience among investors, rather than fundamental changes within a company’s earnings results. At the end of the day, although markets continue to rise, double-digit returns will always draw back to the mean over time.