Do you find it confusing when a bleak economic report emerges from the press, only to be accompanied by a positive surge in the global share market? You're not alone. The last few months have produced many examples of a stark contrast between global market performance and economic indicators.
On 8 June 2020, the National Bureau of Economic Research committee announced the US economy officially entered a recession in February 2020.
But the S&P 500, a leading US share market index, climbed back to the positive territory where it began the year – i.e., before the pandemic brought the US economy to a halt, before more than 110,000 Americans died from the virus, before the police killing of George Floyd in Minneapolis set off nationwide protests.
Now let's look at New Zealand market, the NZX 50 index has been climbing up every day since hitting bottom on 23 March, and it is back in positive territory and is now higher than it started this year. All of it is despite the latest Jobseeker Support recipients number reaching 189,500, and leading economic overview reports affirming that the consequences will be severe with the GDP set to decline by 17% through the first half of the year.
So, one can understand from the above that the stock markets are doing fine, even though everything else is definitely not. So why the apparent disconnect between stock market performance and economic indicators?
It is impossible to pinpoint what exactly is driving the market's movement. But there are a handful of explanations that could describe what is happening now.
Explanation no 1: Investors are feeling good
Since late March, major central banks around the world have announced a series of stimulus measures to help stabilise the broken global economy, including plans to buy back government and high-yield corporate bonds. This move has injected an enormous amount of liquidity in the markets, restored faith of equity investors and created an appetite in the bond market to invest in debt.
An example of that impact is aerospace company Boeing raising $25 billion in a bond offering to private investors. Other companies, including Nike, Procter & Gamble and Visa, have done the same thing. Closer to home numerous listed companies have successfully raised capital to shore up their balance sheets and prepare for opportunities ahead.
Explanation no 2: Tech companies are doing well
Many companies are doing well, particularly in technology – Amazon, Apple, Facebook, Google, Microsoft, and Zoom all reported strong earnings and they make up about one-fifth of the S&P 500's market value.
Clearly, the stock market doesn't reflect the total economy. Sole proprietors, small businesses and companies that aren't publicly traded are being hit hard right now and that doesn't show up in share market performance. In New Zealand, small medium-sized enterprises represent 97% of all businesses, employ 29% of the workforce and produce 28% of our GDP.
Explanation no 3: Markets and investors are forward-looking
The stock market is sometimes considered to be a leading indicator of what is going to happen in the economy. And at the beginning of the pandemic, the market blared alarm bells before the economic data did – which resulted in shaving off 30% of its value over the course of a month.
If the current positive swing in the share market is considered as the same type of leading indicator, then that will mean investors think things will be potentially better in three to six months from now.
Explanation no 4: Not a lot of options right now
Retail investors don't have a lot of options right now in terms of investing their money – term deposits are offering record low rates; government bonds are offering low yields, and real estate is not seen as a safe haven any more. And then there is definitely the fear of missing out among the investors.
Overall, it appears the investors may be feeling a bit more optimistic about the future than the economic indicators would suggest.
What does all this mean for portfolios?
Markets are forward-looking, meaning current asset prices reflect market participants' aggregate expectations. Those expectations include whatever future economic developments are anticipated, and their potential impact on cash flows, which are key to a stock's value.
For example, if the market expects the economic environment to weaken company cash flows, stock markets may react well in advance of when we observe that impact, as expectations are embedded in prices.
The future direction of the stock market will depend on how the economic outcome compares to expectations. If things aren't as bad as expected, poor economic news can be greeted with a positive stock reaction.
Each person is unique, with different tastes, preferences and risk appetites. Relying on generic market data can put investors at a disadvantage as they don't account for specific needs, goals and life stages.
That is why it is important to have a personalised investment strategy that is closely monitored by a financial adviser as market forces change. A good adviser comes alongside you, guides you with integrity, and every investment decision will be made within the bigger context of your life goals.
Nick Stewart is an Authorised Financial Advisers and CEO at Stewart Group, A Hawke's Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.
This article is produced in association with Dimensional Fund Advisors. The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
